Enforceability of Attorney Fee Provisions in the Bond or Bonded Contract
October 18, 2022
In this Surety Today Blog post we will continue exploring the important issue of exposure to attorney’s fees. In prior posts we have focused on the “American Rule” and its exceptions relating to attorney fees and the question of reasonableness of attorney’s fees. In this post, we will discuss various aspects of whether the surety will have liability for attorney’s fees.
In complex performance bond litigation, a big point of contention often develops over whether the surety will be liable for the obligee’s attorneys’ fees and expenses if the obligee prevails at trial. Where litigation can span over years and fees can run well into the six- or even seven-figures, this disagreement can present a major roadblock to settlement efforts and contribute significantly to uncertainty surrounding the surety’s ultimate exposure, particularly where the claimed loss is less than the penal sum. Whether the surety will have liability for the obligee’s attorneys’ fees, costs and expenses is typically dependent on the language of the bond and sometimes the bonded subcontract.
ATTORNEY FEE PROVISIONS IN THE BOND
Some bond forms have an attorneys’ fee or hold harmless provision baked into them. Most jurisdictions follow the American Rule, which provides that unless a statute or contractual provision states otherwise, the prevailing party will be responsible for its own attorneys’ fees. Therefore, where the bond form appears to entitle the claimant to attorneys’ fees, courts will hold the surety to the precise language of the bond, because it is a contract like any other. If the bond says explicitly that the surety will be responsible to pay any attorneys’ fees incurred by the obligee as a result of the principal’s default, you can expect that provision to be enforced.
But, what if the bond doesn’t expressly mention attorneys’ fees, and instead includes broad hold harmless language that arguably may include attorney fees in the class of recoverable damages? Consider the following language pulled from a performance bond required by a locality in Virginia:
If Principal shall perform or cause to be performed the Contract, and any amendment, or extension of or addition thereto, perform all tasks in a good and workmanlike manner, complete the same within the period required, and comply with the conditions therein and fully indemnify and save harmless Owner from all costs and damages which it may suffer by reason of failure to do so and fully reimburse and repay Owner all expenses which Owner may incur in making good any such default, then these obligations shall be null and void.
Are attorneys’ fees part of the “costs and damages” that the surety will be responsible to pay? And, if attorneys’ fees are part of a valid recovery, how far does it go? Will the surety be responsible to pay the fees incurred by the owner just in negotiating with the surety on a tender and completion agreement, or also for litigation? If it is a subcontract bond, does it include fees incurred in litigating claims with other subcontractors who seek to recover for delay and other damages supposedly caused by the principal’s default?
In 1985, the Fourth Circuit evaluated similar language in Tomlinson v. Sentry Engineering & Constr., Inc., 777 F.2d 918 (4th Cir. 1985), where an owner brought a performance bond suit against the principal and surety after the principal defaulted on an apartment project. Just like the sample language above, the bond there did not expressly mention attorneys’ fees. The owner won at trial and filed a motion to recover its attorneys’ fees. The Court applied South Carolina law, which is typical and provides that if the bond does not include a provision for recovery of attorneys’ fees, they cannot be allowed as an element of damage. The Court essentially recognized a “magic words” rule and said that if the bond doesn’t expressly say “attorneys’ fees,” the obligee cannot recover them. There is a long “partial concurrence” (basically a dissent) in Tomlinson that argues that “all cost and damage” and “all expense” essentially constitute a full hold harmless clause that would cover attorneys’ fees.
In USF&G v. Braspetro, 369 F.3d 34 (2d Cir. 2004), the AIA A312 performance bond entitled the obligees to “legal costs” resulting from the default and resulting from the surety’s failure to act. The Court had to determine whether legal costs included attorneys’ fees. It found that the protection of the American Rule should control unless the intention to waive it was “unmistakably clear.” It inferred from the bond language that the right to legal costs extended only to administrative costs arising when an obligee has to retain counsel to draft contracts to complete the project. It went on to look at dictionary definitions, which didn’t provide a conclusive answer as to whether attorneys’ fees were included in the definition of “legal costs.” Therefore, there were two equally valid interpretations, so it was not unmistakably clear that the obligees were entitled to recover attorneys’ fees incurred in litigation against the surety. The surety was liable for attorneys’ fees incurred by the obligee to complete the project, but not for those incurred in litigation.
Other courts have gone in a different direction. In N. Am. Specialty Ins. Co. v. Chichester School Dist., 158 F. Supp. 2d 468 (E.D. Pa. 2001), the court considered the same A312 performance bond language as in Braspetro. The owner terminated the principal and the surety elected a takeover. The owner refused to sign the takeover agreement but the completion contractor was allowed to complete the project. The owner refused to release remaining contract funds, the surety sued, and the owner counterclaimed for delay, noncompliant work, and attorneys’ fees. Each side obtained a judgment on its respective claim, and the owner moved for attorneys’ fees. The Court found that the owner was entitled to recover attorneys’ fees resulting either from the principal’s default, or the surety’s acts or failures to act. This included fees incurred in litigating the counterclaim filed by the owner, but not the surety’s complaint. It also included expert fees to the extent the expert assisted the owner’s recovery.
Chichester is concerning, but the Braspetro decision seems to have become the majority rule, at least with respect to the A312 bond. Courts generally will enforce the American rule and will not impose liability for attorneys’ fees based solely on the bond language unless the bond expressly allows an award for them. But, that doesn’t mean a surety is necessarily off the hook for paying the obligee’s fees. Incorporation of the bonded contract’s attorneys’ fee provision is another way that the obligee may seek to recover its fees against the surety
ATTORNEY FEE PROVISIONS IN THE BONDED CONTRACT
The performance bond guarantees the performance of the bonded contract and usually incorporates by reference the contract between the principal and the obligee. In the event of a default and termination, the surety is bound to perform the contract. Many construction contracts require the contractor to indemnify the owner for any attorneys’ fees incurred as the result of default. Generally, under the incorporation by reference doctrine, when a contract incorporates another contract, the contract being incorporated becomes a part of the second contract and the rights and duties are carried over verbatim. The incorporation by reference clause usually states something like, “the contract between principal and obligee is hereby referred to and made part hereof by reference.” Can the surety be hooked by the incorporation clause in the bond because its principal agreed to pay the obligee’s fees?
The answer to this is very jurisdiction-dependent. In another Pennsylvania federal case, Wise Investments, Inc. v. Bracy Contracting, Inc., 232 F. Supp. 2d 390 (E.D. Pa. 2002), the bond required the surety only to perform the underlying contract and did not mention attorneys’ fees, but the bonded contract required the principal to pay them. The obligee argued that the surety is required to pay everything for which the principal would be liable under the bonded contract, and that included attorneys’ fees. The surety said that the bond only required it to pay costs of project completion, and that not all damages the obligee can claim against the principal can be charged to the surety. The court followed Pennsylvania law and found that a bond given pursuant to a contract incorporated in a bond will be construed in light of the terms of the contract, but the obligation cannot be extended beyond the plain import of the words used. Coverage was limited by the terms of the bond. The surety was only liable to pay the costs of performance as required by the bond.
This is not the law everywhere. In Hicks & Warren LLC v. Liberty Mut. Ins. Co., 2011 WL 2436703 (S.D.N.Y. June 16, 2011), the Court interpreted a performance bond and bonded contract with similar language under New York law. The contract granted costs and reasonable attorneys’ fees to the prevailing party in arbitration. The court quoted similar concepts under New York law to those applied in Wise Investments–that the American Rule controls and that liability of the surety is set forth in the bond. But it took a more expansive view of the incorporation by reference provision and the surety’s duty to perform the construction contract. It held that the incorporation by reference provision made the surety’s liability under the bond coextensive with the principal’s liability under the contract, including the liability created by the attorneys’ fee provision. The Court also took a different approach to the provision of the bond imposing liability for “completion of the Construction Contract.” The surety argued that completion only involved costs relating to the actual construction costs. But the court ruled that the principal’s completion of the contract included indemnifying the obligee for attorneys’ fees and costs arising from the arbitration. Because of these findings the court denied the surety’s summary judgment motion on the attorneys’ fee issue.
In conclusion, a surety practitioner will need to be keenly aware of their jurisdiction’s law on this particular issue, if there is any. Even states that seem to apply the same general concepts of incorporation by reference with respect to surety bonds can come up with different answers.
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Thomas J. Moran, Esq. (804-362-9434/tmoran@wcslaw.com) or any member of the Surety and Fidelity Practice Group.