Surety Case Law Note: Non-Compliance with the A312 and Obligee Attempted Claim Against the Payment Bond
April 18, 2023
In this Surety Today Blog post we consider a Case Law Note addressing the issues of an obligee failing to comply with the requirements of the A312 performance bond, and, as a bonus, we have another example of an obligee trying to recover under the payment bond. The case is:
MCM MGMT. CORP. V. HUDSON INS. CO., No. 21 C 4255, 2022 WL 17583756, at *1–4 (N.D. Ill. Dec. 12, 2022).
Plaintiff, MCM Management Corp. (“MCM”) entered into a subcontract with Jenkins Environmental, Inc. (“JEI”), in connection with a demolition project on the south side of Chicago. JEI, in turn, entered into a sub-subcontract with Marine Technology Solutions, LLC (“Marine Tech”). Hudson issued A312 performance and payment bonds for the sub-subcontract with Marine Tech as its principal and JEI as the obligee. MCM was included in the Bonds as an additional obligee on a Rider. The A312 Performance Bond contained the usual Paragraph 3 notice and meeting requirements, declaration of default and termination requirement and agreement to pay the balance of the contract requirement. If the obligee complied with the requirements of paragraph 3, and was not in default, then under paragraph 4 the surety had several performance options to choose from. The A312 Payment Bond provided that a claimant was defined as “An individual or entity supplying labor, materials or equipment in the prosecution of the work provided for in the subcontract.”
It was undisputed in the case that both JEI (the obligee) and Marine Tech defaulted. It was also undisputed that the first notice Hudson received from anyone about problems at the project was on July 31, 2020, well after the defaults, when MCM sent a letter demanding payment. The MCM letter stated that JEI and Marine Tech had defaulted, that Marine Tech had been removed from the Project prior to the completion of its scope of work. The letter continued by noting that after the removal of Marine Tech from the Project, MCM was forced to perform the remaining scope of work at an additional cost of over $4.6 million. These costs exceeded the penal sum of the Performance Bond, which was only $299,622.00. So, right off the bat we see a very flawed picture – before any notice to the surety was given the principal was removed from the project and the remaining scope of work was completed and costs incurred. Hudson properly denied the plaintiff’s bond claim and plaintiff filed suit. Hudson moved for summary judgment.
The court began its analysis by reviewing basic surety law in Illinois and noting that a surety bond is a contract and must be interpreted as a contract and that a surety is not bound beyond the express terms of the bond. Further, when interpreting a performance bond, the court must look solely to the unambiguous language of the bond as evidence of the intentions of the parties. The court also noted that the legal duties of a surety on its bond should not be expanded beyond the terms of the surety’s promise.
Hudson argued that MCM failed to comply with the notice requirements under the Performance Bond, thereby robbing the surety of its contractual options for performance. The court noted the importance of compliance with the notice requirements under the Performance Bond and quoted from L&A Contracting and Dragon Constr. The court, relying on several authorities from around the country, stated that “[t]he plain language of the Performance Bond convinces the Court that, as [the surety] argues, plaintiff was required to comply with the conditions of Paragraph 3 before [the surety’s] duties under Paragraph 4 were triggered.”
MCM argued that its situation was different because it was an “additional obligee.” It believed that its status as additional obligee exempted it from complying with the conditions precedent. The court disagreed and stated that as an additional obligee, MCM was, in effect, a third-party beneficiary. A third-party beneficiary is not entitled to expand or enlarge a promisor’s obligation under a contract. Rather, the “terms of the contract are controlling with respect to the rights of the third party beneficiary.” The court observed “Plaintiff, as additional obligee, cannot have it two ways; it cannot expect to take the benefits of the agreement without taking the obligations.” Accordingly, the court agreed with courts from around the country that have concluded that additional obligees are subject to the terms – including the conditions precedent – of performance bonds.
In addition, Hudson also argued that it was entitled to summary judgment, because its obligation under the Performance Bond was never triggered in light of the fact that it was admitted and undisputed that the co-obligee, JEI, had defaulted. Paragraph 3 of the Performance Bond opens with the wording, “If there is no [obligee] Default, the Surety’s obligation under this Bond shall arise after: …” Under this plain language, Hudson’s obligations did not arise if the obligee defaulted. So, as a matter of law, Hudson’s obligation under the Performance Bond did not arise. Accordingly, the court held that even had plaintiff complied with the conditions precedent regarding notice, the default of JEI as co-obligee prevented Hudson’s obligations under the Performance Bond from ever being triggered.
Finally, the court made quick work of MCM’s claim under the Payment Bond. It began by noting that “[a] payment bond guarantees the obligor’s obligation to pay for labor and materials, so laborers and suppliers have a right to enforce such a bond as third-party beneficiaries.” The Payment Bond defined a “Claimant” as an individual or entity supplying labor, materials or equipment in the prosecution of the work provided for in the subcontract. MCM put forth no evidence that it supplied labor or supplies to Marine Tech. The court stated “The Payment Bond, . . . , is not a performance bond. Payment bonds benefit laborers and suppliers, . . . not obligees.” Accordingly, the court entered summary judgment in favor of Hudson on all claims.
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (410-659-1321 or mstover@wcslaw.com) or any member of the Surety and Fidelity Practice Group.