Opinion
Case No. 2:99CV0141
April 25, 2002
ORDER
This matter involves a surety suit against a municipality for allegedly having improperly paid a general contractor — an act which Capitol Indemnity Corporation ("Capitol" or "surety") argues breached an express provision in a construction contract that integrated the provision of the bond agreement that protected the surety's interests. The parties have filed cross motions for summary judgment. For the reasons stated below, the court DENIES Defendant's motion for summary judgment and GRANTS Plaintiff's motion for summary judgment, with changes to its request for damages.
Background
Price Municipal Corporation ("Price") hired Nelson Irrigation and Construction, Inc. ("Nelson") as the primary construction contractor on a water system expansion project. Price and Nelson entered into a contract specifying what work Nelson was to perform and what performance and payment bonds would be required before work began.
On June 4, 1996, Nelson provided Price with a payment bond for $929,563.50 (to guarantee that Nelson would pay all subcontractors) and a performance bond (to guarantee that Nelson would complete the project to specifications on time, at the contract price). Nelson executed the bonds as the principal and Capitol executed them as the surety.
On June 20, 1996, Nelson hired KP Plumbing and Heating ("KP") as a subcontractor on the project. Nelson and KP performed their obligations under the contract to the satisfaction of Price. The contract with Price provided that Nelson's application for final payment under the contract would include the consent of the surety to the final payment, and required the City Engineer to review the application for payment to ensure that it included all required documentation. Section 14.12 provided that: "After CONTRACTOR has competed all such corrections to the satisfaction of ENGINEER. . . The final application for payment shall be accompanied by . . . consent of the surety." However, Price paid Nelson a final payment of $150,945.43 in November 1997 without notifying or obtaining the consent of Capitol.
But Nelson had not paid for KP's work under the subcontract, and on April 9, 1998, KP sued Nelson and Capitol in state court for payment of $122,448.97, plus interest, costs, and attorneys fees. KP was successful in its lawsuit and was awarded $189,542.97, which included the principal, interest, costs, and attorneys fees.
On June 23, 1999, Nelson's debts were discharged by the United States Bankruptcy Court.
Capitol now has brought this lawsuit against Price, claiming that Price breached its contract with Nelson when it failed to obtain Capitol's consent before issuing final payment, and that Capitol can enforce these contract provisions either under surety law or common law of breach of contract. Capitol seeks damages equal to the amount of the state court judgment against it, which was $189,542.97, and its lawyers' fees for the state action which totaled $43,538.49. Capital also seeks prejudgment and post-judgment interest on the total award of $233,081.46. Price seeks lawyers fees on the present action, contending that it is due them under a state statute prohibiting frivolous lawsuits against municipalities.
Analysis
1. Capitol's Entitlement to Summary Judgment
Price breached its contractual obligations and is liable for damages as a result. Plaintiffs right to sue under the contract is apparent because the construction contract integrates Capital's interest as the bond-issuing surety. As discussed below, this result is also supported by Utah common law on suretyship, Federal surety law, and the law of surety as outlined in the Restatement (Third) of Suretyship and Guaranty.
The contract between Nelson and Price City, executed on June 4, 1996, provided that application for final payment for the project would be issued to Nelson pursuant to these procedures:
after CONTRACTOR has completed all such corrections . . . delivered in accordance with the Contract Documents . . . CONTRACTOR may make application for final payment following the procedure for progress payments. The final Application for Payment shall be accompanied (except as previously delivered) by: (i) all documentation called for in the Contract Documents . . . (ii) consent of the surety, if any, to final payment, and (iii) . . . releases or waivers . . . of all Liens . . .
(See Def.'s Mem. Supp. Summ. J. Ex. A at 40, ¶ 14.12) (emphasis added). The contract also provided that the City Engineer would review the application for final payment to ensure that it included all documentation required under the contract. Id. at ¶ 14.13). Importantly for the issue of Capitol's right to sue as a third-party benficiary of the construction contract, the construction contract also has an integration clause, which clearly makes Capitol a party in interest to the construction contract. That provision reads:
1.10 Contract Documents. The Agreement Addenda (which pertain to the Contract Documents). CONTRACTOR's Bid (including . . . documentation submitted prior to the notice of award) when attached as an exhibit to the Agreement, the Notice to Proceed, the Bonds, these General Conditions, the Supplementary Conditions, the Specifications and Drawing as the same are more specifically identified in the Agreement, together with all Written Amendments, Change Orders, Work Change Directives, Field Orders and ENGINEER's written interpretations and clarifications issued pursuant to paragraphs 3.5, 3.6.1 AND 3.6.3 on or after the Effective Date of the Agreement. Shop Drawing submittals approved pursuant to paragraphs 6.26 and 6.27 and the reports and drawings referred to in paragraphs 4.2.1.1 and 4.2.2.2 are not Contract Documents.
(See Defs Mem. in Supp. Summ. J. Ex A at 13, ¶ 1.10, emphasis added). As the detail in this section suggests, the parties to the construction contract carefully laid out which documents would be the integrated contract documents, specifically included the bonds, and therefore by incorporation, explicitly made Capitol a party in interest to the construction contract. The payment bond, incorporated by the express terms of the contract in ¶ 1.10, states: "By the Contractor furnishing and the Owner accepting this Bond, they agree that all funds earned by the Contractor in the performance of the Construction Contract are dedicated to satisfy obligations of the Contractor and the Surety under this Bond, subject to the Owner's priority to use the funds for the completion of the work." (See Def's Mem. Supp. Summ. J. Ex. B at ¶ 8). Therefore, in light of the integration clause noted above, and because Price accepted the bond (which was incorporated by reference into the construction contract), Price was subject to the terms of the bond and Capitol became a party in interest to the contract under the plain terms of the integrated contract.
Price argues, relying on Utah State Building Bd. v. Walsh Plumbing Co., 399 P.2d 141 (Utah 1965), that Capital was required to file a notice of default. However, as with the equitable subrogation argument, this too is without merit, because, as Capitol has framed this case, it is a simple breach of contract case or one which allows a claim on the construction contract under surety principles outlined in the Restatement (Third).
Utah law, as far back as 1928, has held that a surety has an interest in contracts made between a bonded contractor and a project owner. See Paxton v. Spencer, 265 P. 751, 755 (Utah 1928) (stating "conditions . . . requiring the retention of 10 per cent. [sic] of a contract until the completion of the work are, under all of the authorities, binding upon the parties to the contract. Such provisions are clearly made for the benefit of the surety as well as for the contractors . . . ."); see also generally Corporation of the President of the Church of Latter Day Saints v. Hartford Accident Indemnity Co., 95 P.2d 736 (Utah 1939) (finding surety could recover damages when parties to a construction contract made alterations to the contract terms which increased the surety's liability under the bonds). These precedents are still binding under Utah law.
A much more recent case from the Federal Circuit considered almost exactly these facts, with the difference that the contract there provided that 10% of contract payments, rather than the entirety of the final payment, was to be withheld until the surety agreed that the contract had been performed. See National Surety Corp. v. United States, 118 F.3d 1542 (Fed. Cir. 1997). The parties in National Surety claimed that they had amended the contract to eliminate the obligation to retain 10% of payments, and that the bond terms stated that the surety waived its right to be notified of contract alterations. However, the court found that the parties "did not even attempt to properly modify the contract," and that "contract terms that provide security for the bonded performance can not [sic] be ignored, waived, or modified without consideration of the surety's interests." Id. at 1546-47. The court commented that "it is of course almost axiomatic that any change or modification of the construction contract which materially increases a compensated surety's risk discharges the obligation," that "the government's improper release of this security does not avoid liability to the surety for losses thereby sustained." Id. The court concluded that the surety could recover damages for any losses that resulted directly or indirectly from the impairment of its security interest in the 10% retainage. See id. at 1548; see also Transamerica Premier Ins. Co. v. United States, 32 Fed. Cl. 308, 312 (Fed. Claims 1994) (stating under suretyship law, contract funds in the hands of the obligee are viewed as security or `collateral' to which the surety can turn to cover any losses . . . should the principal obligor (the contractor) default on the underlying obligation . . . as holder of the contract funds, suretyship law requires the Government to use `reasonable care in the custody and preservation of collateral in its possession'").
The principles cited above under Utah and Federal common law are also reflected in the Restatement (Third) of Suretyship and Guaranty § 37, which treats the subject of impairment of suretyship status. Paraphrasing the Restatement in the terms of this case, this section states:
(1) If the obligee [Price] acts to increase the secondary obligor's [Capitol's] risk of loss by . . . decreasing its potential ability to cause the principal obligor [Nelson] to bear the cost of performance, the secondary obligor is discharged . . . and the secondary obligor has a claim against the obligee . . . .
(3) If the obligee impairs the secondary obligor's recourse against the principal obligor by
. . . (d) impairing the value of an interest in collateral securing the underlying obligation.
. . [or] (f) any other act . . . that impairs the principal obligor's . . . duty to reimburse . . . the secondary obligor is discharged from its duties . . . .
Restatement (Third) of Suretyship Guaranty § 37(1)-(3).
Perhaps more importantly, the Restatement also provides:
(4) If the obligee [Price] impairs the secondary obligor's [Capitol Indemnity] surety status [in this case arguably through premature payment that dissipates Capitol's collateral]
(b) before the secondary obligor [Capitol] performs a portion of the secondary obligation [in this case payment to KP], if the secondary obligor [Capitol] then performs: . . .
(ii)for the benefit of an intended beneficiary [KP] who can enforce the secondary obligation notwithstanding such impairment [in this case the state court judgment against Capitol]: . . .
the secondary obligor [Capitol] has a claim against the obligee [Price] with respect to such performance to the extent that such impairment would have discharged the secondary obligor [Capitol] with respect to that performance.
Restatement (Third) of Suretyship Guaranty § 37(4) (emphasis added).
In this case, the city's payment to Nelson in violation of the contract terms requiring prior consent from Capitol clearly increased Capitol's risk of loss. As a result of Price's premature payment, Capitol lost its ability to make Nelson pay its subcontractors. Therefore, as outlined in the Restatement, Capitol has a claim against Price for increasing Capitol's risk as the bondholder, in ways Capitol had not agreed to in issuing the bond. Accordingly, Capitol is granted summary judgment on the issue of Price's liability for breach of contract, and Price's motion for summary judgment is denied.
2. Damages and The Lawyers' Fees Claims
As discussed above, the Restatement (Third) of Suretyship Guaranty § 37(4) is the appropriate legal standard to determine damages. The Comment for this section expands on this language:
When the impairment fundamentally alters the risks imposed on the secondary obligor, the resulting situation is no longer that for which the secondary obligor bargained. Accordingly, the secondary obligor is discharged from its obligation.Id.
Similarly, the court in National Surety Corp., relying in part on the Restatement, concluded that because the government was liable to the surety for improper release of retinage security, damages "are fairly measured . . . by the injury, loss, or prejudice to the surety due to the government's failure to implement the required retention." National Surety Corp., 118 F.3d at 1545. Furthermore, "the surety's recovery should be measured by its actual damages attributable to the release of the retainage." Id. at 1548. Finally, the court concluded that the surety's "recovery should not exceed any losses that ensued, directly, or indirectly, from the impairment of the security." Id. at 1548. See also Home Indemnity Co. v. United States, 376 F.2d 890, 895 (Ct. Claims 1967).
Therefore, applying this standard, because Price impaired the contract when it delivered payment without consent from Capital, and thus, "alter[ed] the risks imposed on [Capital,]" Price is liable to Capital for the damages that resulted. In effect, Price is liable to Capital for impairing Capital's suretyship status, which caused Capital to incur a loss. And the damages suffered by Capital was the judgment in the amount of $189,542.97, and attorneys fees and litigation expenses incurred by Capital in defending the Carbon County Action in the amount of $43,538,49.
Conclusion
For the reasons stated above, the court DENIES Defendant's motion for summary judgment and GRANTS Plaintiffs motion for summary judgment. Defendant is liable to Plaintiff for the judgment in the amount of $189,542.97 and attorneys fees and litigation expenses incurred by Capital in defending the Carbon County Action in the amount of $43,538,49.