There are circumstances where a performance bond surety will pursue a claim against an owner – such as a government owner—and assert an equitable subrogation claim. A performance bond surety may assert an equitable subrogation claim to recover contract funds that are still in the government’s control after the contract is completed or to recover from the government when the government improperly disburses progress payments to the defaulted contractor (principal of the performance bond). Capitol Indemnity Corp. v. U.S., 2020 WL 877687, n.7 (Fed.Cl. 2020). As to the improper disbursement of progress payments, a performance bond surety is asserting a claim against the owner in this fashion when it has had to pay under the bond and believes certain rights of it were prejudiced based on improper payments by the owner — it would have had to pay less based on the contractors’ default had the owner not impermissibly paid the defaulted contractor.
[A]n equitable subrogation claim is based on the theory “that the triggering of a surety’s bond obligation gives rise to an implied assignment of rights by operation of law whereby the surety ‘is subrogated to the [principal obligor’s] property rights in the contract balance.’ ” “[A] legally enforceableduty can arise between the government and a surety if the surety notifies the government that its principal is in default of the bond agreement.” Thecourt in a case affirmed by the Federal Circuit has also recognized that notice to the government that the contractor “is in danger of defaulting under the bond” from other sources besides the surety may be adequate to trigger the assignment of rights to the surety. Finally, a surety’s equitable subrogation rights can be triggered where the government “had knowledge of the default … and so informed the surety.”
Capitol Indemnity Corp., supra, at *7 (internal citations omitted).
An example of a performance bond surety asserting an equitable subrogation claim against the government can be found in Capitol Indemnity Corp. Here, a contractor was hired to renovate a building and complete the renovation by September 30, 2015. After numerous letters to the contractor including cure notices relating to non-conforming work, on December 30, 2015, the government notified the contractor’s performance bond surety that the contractor’s work was not complete and the surety should be receiving payment bond claims from unpaid subcontractors. A few days later, the government suspended the contract and copied the surety. The surety claims that after this date, the government impermissibly made payment to the contractor even though the surety requested any such payment to the contractor be in the form of joint checks to the contractor and corresponding subcontractor. A couple of months later, in March 2016, the government declared the contractor in default. The surety entered into a takeover agreement with the government to complete the defaulted contractor’s work, which reserved certain rights of the surety to pursue claims against the government.
Around the time the takeover work was complete, the surety sued the government. One of the arguments the surety raised was equitable subrogation as to impermissible payments the government made to the contractor. Stated differently, the surety claimed that the government abused its discretion (and prejudiced the surety) in making payment to the contractor when it knew the contractor was in default. The government moved to dismiss the surety’s equitable subrogation claim.
Initially, as to a jurisdictional argument, the US Court of Federal Claims held that the surety can sue the government in equitable subrogation without having to first raise this issue to the contracting officer through submitting a claim under the Contract Disputes Act.
Next, the US Court of Federal Claims found that the alleged facts raised by the surety as to payment to the contractor shortly before the contractor was defaulted was enough to trigger a surety’s equitable subrogation claim against the government. The surety raised facts to support that its equitable subrogation rights were triggered on December 30, 2015 when (i) the government notified the surety that the contractor’s work was not complete and the surety should expect to receive payment bond claims, (ii) the government then suspended the contractor’s performance a few days later, (iii) the surety requested that the government issue joint checks to the contractor and unpaid subcontractors, and (iv) the government refused to issue joint checks and paid the contractor directly only to default the contractor a couple of months later. The direct payment to the contractor was an impermissible payment, and through equitable subrogation, the government may owe the surety the amount of that payment irrespective of the fact that the government already paid that amount to the defaulted contractor.
Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.