INFORMATION ON SUBCONTRACTOR DEFAULT INSURANCE (“SDI”)

Posted on May 1, 2016May 1, 2016 by Edward Garber

Subcontractor default insurance (also known as “SDI”) serves as an alternative to requiring subcontractors to furnish payment and performance bonds. For more information on subcontractor default insurance, check out this posting. You can also check out a portion of the below presentation given on subcontractor default insurance.

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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.

INTERACTION BETWEEN CGL INSURANCE, OCIP, AND SUBCONTRACTOR DEFAULT INSURANCE

Posted on November 14, 2015November 14, 2015 by Edward Garber

Here is a great opinion and insurance coverage dispute about the interaction between a CGL policy, and particularly one provided under an Owner’s Controlled Insurance Program, and a subcontractor default insurance policy / subguard policy.

In Pavarani Construction Co. v. Ace American Insurance Co., 2015 WL 6555434 (S.D.Fla. 2015), a general contractor constructed a high-rise condominium project. The general contractor and subcontractors were enrolled in the Owner’s Controlled Insurance Program (“OCIP”). This meant the general contractor and the subcontractors had the same CGL insurer. In addition, and outside of OCIP, the general contractor had subcontractor default insurance which is insurance a general contractor maintains to insure the risk of subcontractor default (and, really, catastrophic subcontractor default).

Post-construction, it was discovered that that the structural shell subcontractors the general contractor hired to (a) install the concrete masonry units and (b) the cast-in-place concrete, performed their work defectively. Specifically, reinforcing steel required to be installed within the concrete masonry units or cast-in-place concrete was omitted or improperly installed. These deficiencies resulted in excessive movement of building components. This movement caused stucco to debond, cracking in the walls, cracking of cast-in-place columns, beams, and shearwalls, and cracking in the mechanical penthouse enclosure on the roof that then resulted in water intrusion.

Upon discovering the deficiencies and/or resulting damage, the owner of the Project put the general contractor on notice. The general contractor notified its subcontractors. The general contractor (and subcontractors) sought indemnification under the CGL policy within OCIP. (Remember, with an OCIP policy, it is the same CGL insurer that covers all enrolled entities.) The CGL carrier, however, denied coverage. This resulted, applicable to the case, in the concrete masonry unit subcontractor defaulting on its subcontract because it was unable to perform repairs to its deficient work and cover the resulting damage without the CGL insurance proceeds. As a consequence, the general contractor submitted a claim to its subcontractor default insurance policy to recover money to fund the repairs that were in excess of $25 Million. The general contractor also worked out a deal with its subcontractor default insurance policy that it would pursue the CGL carrier for reimbursement.

The general contractor then sued the CGL insurer for indemnification by asserting a breach of contract claim and a declaratory relief claim against the insurer.

RESULTING DAMAGE

The insurer argued that there was no coverage because there is no coverage under the CGL policy for the general contractor repairing defective work. This is true, BUT “if the defective work causes damage to otherwise nondefective completed product, i.e., if the inadequate subcontractor work caused cracking in the stucco, collapse of the [mechanical] penthouse enclosure, and cracking in the critical concrete structural elements…[the general contractor] is entitled to coverage for the repair of that non-defective work.” Pavarani, supra, at *4. In other words, while repairing the defective work would NOT be covered, repairing damage resulting from the defective work WOULD be covered.

In discussing coverage for resulting damage, the court relied on a recent Eleventh Circuit Court of Appeals case, Carithers v. Mid-Continent Casualty Co., 782 F.3d 1240 (11^th Cir. 2015). This case is actually a very important case because it held “the complete replacement of defective subcontractor work may be covered when necessary to effective repair ongoing damage to otherwise non-defective work.” Pavarani, supra, at *4. (Please review the specifics of this case here). Basically, if replacement of potentially defective work is necessary to repair resulting damage, then such replacement of the defective work would be covered under the policy. For instance, if you had to remove (or rip-and-tear out) defective work in order to fix the resulting damage, then such removal would be covered.

Here, it was clear that the defective work caused resulting damage triggering the CGL policy’s obligation to indemnify the general contractor and applicable subcontractors.

“OTHER INSURANCE” PROVISION

The CGL policy contained an “Other Insurance” provision. This provision means that the policy will operate as excess (not primary) insurance over any other available insurance. This provision is in virtually every CGL policy and in many other types of insurance policies such as a subcontractor default insurance policy. The “Other Insurance” provision applies “when two or more insurance policies are on the same subject matter, risk and interest.” Pavarani, supra, at *5.

The CGL insurer argued that based on this “Other Insurance” provision, the general contractor’s subcontractor default insurance should operate as the primary insurance with it serving as any excess insurance. The court correctly dismissed this argument since a CGL policy and subcontractor default insurance policy insure completely different business risks. Besides, the subcontractor default insurance policy insures the general contractor for a subcontractor default and does not insure a subcontractor for its default.

Furthermore, the court held:

Courts disregard ‘Other Insurance’ provisions where, as here, there is a contractual right of indemnification between the parties insured by the relevant policy. Here, AWS [concrete masonry subcontractor] contracted to indemnify Plaintiff [general contractor] for damages resulting from its work and Defendant [CGL insurer] insured AWS [per OCIP] for claims of property damage. Therefore, Defendant cannot utilize the ‘Other Insurance’ provision to shift the loss.

Pavarani, supra, at *5 (internal citation omitted).

ATTORNEY’S FEES

Florida Statute s. 627.428 authorizes attorney’s fees against an insurer in an insurance coverage case. Since the general contractor (insured) prevailed, it was entitled to its reasonable attorney’s fees.

ARE YOU FAMILIAR WITH SUBCONTRACTOR DEFAULT INSURANCE (SUBGUARD)?

Posted on August 24, 2014August 24, 2014 by Edward Garber

Are you familiar with subguard? If not, subguard is an insurance product also known as subcontractor default insurance. It is an insurance product obtained by the general contractor and subcontractors are enrolled by the contractor into the subguard program; the general contractor does the prequalification based on the subcontractors and suppliers it wants to utilize. The general contractor can recover its losses (direct and indirect) from defaulting subcontractors (including consequential losses, losses from defective work, losses from a defaulting subcontractor’s non-payment to others, etc.). Subguard is typically more cost effective than requiring subcontractors to obtain performance bonds and allows the general contractor to recover losses (above a deductible) much quicker than if there was a subcontractor performance bond. (Subguard is not the only subcontractor default insurance product on the market, but it is perhaps the most recognized product. For purposes of this article, subguard will refer to all subcontractor default insurance products.)

Large general contractors on large-scale projects prefer subguard versus requiring subcontractors to obtain performance bonds considering general contractors are in a position to prequalify subcontractors and remedy a potential subcontractor default (without having to jump through the required performance bond hoops that could result in further financial loss to the contractor while the claim is being investigated by the surety). Unlike a performance bond where there is the principal, the surety, and the obligee, with subguard, there is only the general contractor–the insured that obtains the subguard–and the insurance company. Subcontractors, while enrolled in the program, are not parties to the policy; the general contractor is the only party that can submit a claim on the subguard policy.

Subguard is a first party insurance policy but it works different than a typical first party insurance policy. The general contractor obtains a subguard policy with a policy limit and (large) per claim deductibles / self-insured retentions. The policy is written for a set period of time (in numerous instances the 10 year statute of repose period). When there is a claim, after the general contractor pays its deductible, there is a co-pay requirement where the general contractor and subguard insurer share in the losses until the general contractor pays a retention aggregate amount which is the capped amount the general contractor will have to pay relating to a claim. Once the cap has been paid, the subguard insurer pays the balance of the claim up to the policy limit. The sentiment is with a large deductible and co-pay requirement until an aggregate amount is paid, the general contractor has more incentive to prequalify subcontractors, manage the work, and eliminate subcontractor default since the contractor has a vested financial interest to prevent the default from occurring. For example, a subguard policy can have a large deductible of $500,000, a retention aggregate of $1,000,000, and require the contractor to pay 20% of the loss after the $500,000 deductible. So, if a subcontractor default costs the contractor $2,500,000, the contractor will pay the first $500,000 and then 20% of the remaining $2,000,000 up to its retention aggregate. In this example, the contractor would have to pay another $400,000 (20% of the $2,000,000), which would be a total of $900,000 and below its retention aggregate of $1,000,000. The subguard insurer would be responsible for the remaining portion of the claim.

Additionally, a contractor that is well equipped at managing subcontractor defaults may procure a subguard policy with a retrospective premium agreement. This is advantageous to the experienced contractor because deposit premium (sometimes referred as the experience portion of the premium) can be returned to the contractor based on no subcontractor defaults or minimal claims on the policy that the deposit portion of the premium would be applied to.

From an owner’s perspective, subguard is not a substitute for requiring the general contractor to obtain a performance and payment bond. A major reason being that the owner is not an insured under the policy. With that said, subguard is a valuable alternate to requiring subcontractors to obtain performance and payment bonds and is a product on large projects by large contractors that an owner should consider since most of the work will be performed by subcontractors (and, as mentioned above, it is typically more cost effective than requiring subcontractors to be bonded). With subguard, the general contractor is bearing the risk (with no excuses) for subcontractor default since it obtained an insurance product to specifically cover this risk (and the direct and indirect losses associated with this risk) and, thus, is incentivized to best manage the trades and eliminate default.

Check out this presentation for more information on subcontractor default insurance as an alternative to subcontractor performance bonds.

PRESERVING PERFORMANCE BOND CLAIMS

Posted on October 29, 2013October 29, 2013 by Edward Garber

Performance bonds can be a valuable source of protection to owners that want their general contractors to provide a performance bond and, likewise, to general contractors that want certain subcontractors to provide a performance bond. The performance bond is designed to benefit the obligee in the event the contractor that issues the bond defaults under its contractual obligations. It is absolutely crucial that parties take the proper steps under the terms of the performance bonds to preserve their rights and arguments under the bond. To do this requires an unequivocal formal default of the contractor that issued the bond and that the party will be looking solely to the surety to complete the defaulted party’s contractual obligations. Otherwise, a court will rule in favor of the surety finding that the obligee of the bond did not comply with conditions precedent to preserve the performance bond claim and/or breached the terms of the bond by not allowing the surety to investigate and complete performance. This is exactly the situation in two federal district court summary judgment opinions relying on Florida law: North American Specialty Insurance Co. v. Ames Corp., 2010 WL 1027866 (S.D.Fla. 2010) and CC-Aventura, Inc. v. Weitz Co., 2008 WL 2699577 (S.D.Fla. 2008). Both of these cases illustrate the importance of formally and unequivocally declaring the party that issued the performance bond in default irrespective of whether the issue arises pre-completion or post-completion. Both cases also pertain to a subcontractor that provided a performance bond identifying the general contractor as the obligee (or beneficiary) of the bond.

I. North American Specialty Ins. Co. v. Ames Corp. (Pre-Completion)

In this case, a general contractor hired a roofer for a federal project. The roofer provided performance bonds identifying the general contractor as the obligee. The bonds provided as follows (which is common language in performance bonds):

“Whenever Principal shall be, and be declared by Obligee to be in default under the subcontract, the Obligee having performed Obligee’s obligations thereunder:

(1) Surety may promptly remedy the default …;

(2) Obligee after reasonable notice to Surety may, or Surety upon demand of Obligee may arrange for the performance of Principal’s obligation under the subcontract …;

(3) … If the Surety arranges completion or remedies the default, that portion of the balance of the subcontract price as may be required to complete the subcontract or remedy the default and to reimburse the Surety for its outlays shall be paid to the Surety at the times and in the manner as said sums would have been payable to Principal had there been no default under the subcontract.”

Ames Corp., 2010 WL at *1.

During construction, the general contractor notified the surety that the roofer was refusing to perform and that the general contractor will look to the surety for costs incurred above the roofer’s subcontract amount. A follow-up notice advised the surety that expenses were being incurred to finish the roofer’s subcontract amount and no one from the surety visited the jobsite. The surety then commenced an investigation while advising the general contractor that the “prior letters were not accompanied by supporting documentation and/or prior notice to the principal of default and/or potential default.” Ames Corp., 2010 WL at *3. A meeting was coordinated with the owner, the general contractor, the roofer, and the roofer’s surety at which time the surety represented it would need up to 5 months to assume responsibility and take action. After this meeting, the general contractor sent another letter to the surety and the roofer explaining that the roofing subcontract was not terminated or declared in default and that the surety needed to appreciate the short time allotted for completing the roofer’s contract. The surety responded that because the general contractor had not declared the roofer in default, the surety had no obligation to act under the performance bonds.

Notwithstanding the general contractor never formally declaring the subcontractor in default, it supplemented the roofer’s scope of work. Both the roofer and the surety objected; the surety even advised that such efforts would be a material breach of the bonds. However, due to leaks with the roofing system (the manufacturer of the roofing system inspected the roof and found that there were installation defects), the general contractor incurred substantial costs to complete the roofer’s scope of work which exceeded the roofer’s subcontract balance. In addition, the general contractor incurred delay damages associated with completing the roofer’s scope of work.

The surety initiated this lawsuit based on the monetary demands from the general contractor. The surety moved for summary judgment based on the argument that a condition precedent to the bonds obligations was never triggered, that being that the general contractor never declared the roofer in default. The surety also argued that the general contractor breached the bonds by not allowing the surety the right to remedy any default and by not making available to the surety the unpaid subcontract balance in connection with the surety remedying the default.

Relying on Florida law, the Southern District found:

[A] surety’s liability on a bond is determined strictly from the terms and conditions of the bond agreement. The purpose of a performance bond is to guarantee completion of the contract upon default by the contractor.

***

A declaration of default sufficient to invoke the surety’s obligations under the bond must be made in clear, direct, and unequivocal language. The declaration must inform the surety that the principal has committed a material breach or series of material breaches of the subcontract, that the obligee regards the subcontract as terminated, and that the surety must immediately commence performing under the terms of the bond.

Ames Corp., 2010 WL at *6 (internal citations and quotations omitted).

Based on this law, the Southern District held that none of the letters the general contractor sent to the surety defaulted the roofer in clear, direct, and unequivocal language. While the letters urged the surety to become involved and threatened default, they did not formally and unequivocally default the roofer. Accordingly, the court granted summary judgment in favor of the surety.

Furthermore, the Southern District agreed with the surety that the general contractor breached the bond by completing / supplementing the subcontract without giving the surety the opportunity to remedy any default under the subcontract. As the court explained: “‘[O]nce Ames/Dawson [general contractor] engaged in the supplementation of work without allowing NAS [surety] to perform, its conduct constituted a material breach that voided the bond.” Ames Corp., 2010 WL at *9.

II. CC-Aventura, Inc. v. Weitz Co. (Post-Completion)

In this case, the general contractor was hired to construct a senior living facility. The general contractor hired a painter with a subcontract that contained an indemnification provision and a provision that required the painter to correct defective work. The painter provided a performance bond identifying the general contractor as the obligee.

After completion of the project, the owner sued the general contractor for water intrusion and damage. The general contractor sued subcontractors including its painting subcontractor. The general contractor also asserted a claim against the painting subcontractor’s performance bond surety for breach of the bond. The surety moved for summary judgment arguing that the bond obligations were never triggered because the general contractor never formally declared the painting subcontractor in default.

The general contractor argued that it did provide default notices when it transmitted the owner’s expert and its expert reports regarding the paint that the painter applied. In the notices, the general contractor demanded that the surety correct the defects and that the painter’s failure to take corrective action will be a default under the subcontract.

The surety took the position that these types of notices were insufficient. The Southern District of Florida agreed and granted summary judgment in favor of the surety finding:

“Both of Weitz’s [general contractor] letters do state that Delta [subcontractor] is in ‘default’ of its Subcontract-and had Weitz maintained that position and indicated that Weitz now looked to American Casualty [surety] alone, both of its letters could reasonably be interpreted as declarations of default sufficient to trigger American Casualty’s liability on the Bond. However, in its December 30, 2005 letter Weitz also advised Delta to ‘please accept this letter as The Weitz Company’s final written demand that Delta Painting or its Surety take appropriate corrective action’….In its April 11, 2006 letter, Weitz reiterated that it had made ‘numerous demands upon both Delta and American to correct [the painting] deficiency.’ Weitz then stated its intention to perform the corrective work itself and announced that ‘Weitz will seek such costs and all other damages from Delta and American.’ If Weitz wanted to trigger American Casualty’s obligations on the Bond, it would have had to clearly and unambiguously notify American Casualty that it now looked to it to complete Subcontract obligations, in accordance with the Bond.”

CC-Aventura, 2008 WL at *4.

As illustrated above, there are certainly procedural hurdles that are required to take place in order to properly default a contractor that provided a performance bond. Not doing so can be fatal to the performance bond claim. Default is always viewed as a last resort because parties do not want to be in material breach for incorrectly defaulting or terminating a party. However, by not defaulting a party, the performance bond’s obligations are not triggered. Due to these hurdles, general contractors are now obtaining subguard (subcontractor default insurance) instead of requiring individual subcontractors to provide performance bonds. This allows the general contractor to be more involved in the process since it is the one obtaining subguard and it eliminates subcontractors from having to obtain the bond (which could be problematic for certain subcontractors).

For more on performance bonds, please visit: https://floridaconstru.wpengine.com/statute-of-limitations-on-performance-bond-claims/