Payment Bond Payout…The 45 Day Countdown: Litigation Law

by | Mar 31, 2010 | Bonds, Getting Paid, Litigation & Arbitration

The American Institute of Architects produces contract and bond forms regularly utilized by the construction industry. Payment and performance bond form A311 was introduced by the AIA in 1970 and imposes a series of notification requirements upon a payment bond claimant seeking recovery. It was not until the AIA’s introduction of payment and performance bond form A312 in 1984 that sureties were faced with reciprocal notification requirements. But what good are mandatory payment bond provisions without the potential for enforcement? Said another way, why are payment bond provisions strictly construed against bond claimants when provisions imposing duties on the surety are regularly treated with leniency or altogether ignored? After the recent Wadsworth decision rendered by the Court of Special Appeals of Maryland, this may no longer be the case.

The AIA A312 payment bond imposes a series of duties on both claimants and the surety. Specifically, A312 provides in pertinent part:

  • 4. The Surety shall have no obligation to Claimants under this Bond until:
    • 4.1 Claimants who are employed by or have a direct contract with the Contractor have given notice to the Surety and sent a copy, or notice thereof, to the Owner, stating that a claim is being made under this Bond and, with substantial accuracy, the amount of the claim.
  • 6. When the Claimant has satisfied the conditions of Paragraph 4, the Surety shall promptly and at the Surety’s expense take the following actions:
    • 6.1 Send an answer to the Claimant, with a copy to the Owner, within 45 after receipt of the claim, stating the amounts that are undisputed and the basis for challenging any amounts that are disputed.
    • 6.2 Pay or arrange for payment of any undisputed amounts. (emphasis added).

The word “may” denotes a permissive term rather than the mandatory connotation of the word “shall.” Paragraph four of A312 states that, “The Surety shall have no obligation to Claimants under this Bond until…,” indicating that an obligation shall be imposed upon the surety when the conditions of paragraph four have been complied with. (emphasis added). The payment bond goes on to state in paragraph six, “When the Claimant has satisfied the conditions of Paragraph 4, the Surety shall promptly and at the Surety’s expense take the following actions: Send an answer to the Claimant, with a copy to the Owner, within 45 days after receipt of the claim, stating the amounts that are undisputed and the basis for challenging any amounts that are disputed [and] pay or arrange for payment of any undisputed amounts.” (emphasis added). Pursuant to the express language of A312, mandatory notification requirements are imposed upon both the claimant and the surety.

Courts across the country have typically held that the failure of a claimant to timely comply with the applicable notice requirements of a payment bond renders the claimant’s right to recover under the bond a nullity. In the characteristic case of Travelers Indemnity Co. v. National Gypsum Co., National Gypsum sought to recover on a payment bond after not receiving payment for materials it had supplied. The notice provision of the bond provided that no claimant could bring an action for payment on the bond unless that claimant “shall have given written notice to any of the two following: The Principal, the Owner, or the Surety above named, within ninety (90) days after the claimant did or performed the last of the work or labor, or furnished the last of the materials for which said claim is made….” The Florida Third District Court of Appeal held that National Gypsum’s failure to meet the mandatory condition precedent of supplying timely written notice as prescribed by the terms of the bond precluded its recovery thereon. On appeal, the Florida Supreme Court affirmed the decision, declaring that there was “no reason to allow National Gypsum to enjoy the benefits of the bond without bearing its burdens as well.” This principle of reciprocity is generally echoed by courts throughout the country.

Notwithstanding courts’ rather strict construction of payment bond provisions against potential claimants, the same level of scrutiny has not been imposed as to the provisions which apply to the surety. Such inequities stand contrary to established maxims of contract interpretation. Specifically, courts generally view construction bonds as contracts of insurance, and therefore in construing the terms of these contracts, they must be read and interpreted strictly against the bonding company which prepared them. In addition, any ambiguity as to the nature of the bond must be construed against the surety company and in favor of granting the broadest possible coverage to those intended to benefit under the terms of the bond, such as subcontractors and other claimants.[6]

Such patent disparities are magnified in view of the claimants’ exclusion from the surety selection process. Claimants have no input regarding the selection of the surety, nor are they permitted to negotiate the terms of the bond. Given the claimants’ inability to secure alternate means of financial security, the payment bond is tantamount to a contract of adhesion; claimants have no right to object, protest, or modify its terms. These issues become more significant on public works or other projects where a claimant is not legally entitled or otherwise permitted to secure payment through a lien on the improved property. However, the tide may be turning as a result of a very recent decision.

On September 9, 2004, the first published opinion construing the AIA A312 “45-day” payment bond provision was released by the Court of Special Appeals of Maryland. This case sets the stage for the imposition of surety accountability, in conformity with the mandatory payment bond provisions of A312. In National Union Fire Insurance Company of Pittsburg, et al. v. Wadsworth Golf Construction Co. of the Midwest d/b/a Wadsworth Golf Construction Co.,[8] National Union Fire Insurance Company of Pittsburg, Federal Insurance Company, and Fidelity and Deposit Company of Maryland issued an AIA A312 payment and performance bond for the construction of an 18-hole golf course. The general contractor, Clark Construction Group, Inc., retained the services of Wadsworth Golf Construction Company, as subcontractor, to excavate the site and perform rough grading work. Wadsworth was not paid all amounts due and therefore, on March 23, 2002, timely notified the sureties of its claim against the payment bond.

On April 5, 2002, the lead surety sent Wadsworth a letter requesting that Wadsworth complete a proof of claim and provide additional information supporting its claim. As is customary, the letter furnished by the lead surety stated, “Please be advised that this action is taken at this time without waiver of or prejudice to any of the rights and defenses, past or present, known or unknown which either the above referenced Surety (National Union Fire Insurance Company) or Principal (The Clark Construction Group, Inc.) may have in this matter.” Notwithstanding this reservation of rights, on May 3, 2002, Wadsworth complied and provided the surety an executed proof of claim along with supporting documentation.

Shortly thereafter, the surety notified Wadsworth by letter that it had received the documents, and that it would “immediately take this matter up with the above referenced Principal (The Clark Construction Group, Inc.), in order to ascertain their position on [the] claim as presented.” The letter further stated that the surety would be in contact with Wadsworth “in due course regarding [Clark’s] position on the Proof of Claim….” Wadsworth, despite having sent a second letter on July 23, 2002, requesting an answer to its claim, received no further information from the sureties. On November 6, 2002, Wadsworth filed a single count complaint against the sureties in the Circuit Court for Dorchester County.

At the trial court level, Wadsworth moved for summary judgment based on the 45-day provision of the payment bond. At the hearing on the motion, the court stated:

I’m going to grant the motion for summary judgment on behalf of Wadsworth … I think that under the terms of the bond itself that they [the Sureties] are estopped from now contesting because there was not a response within the time set forth in the payment bond.

On appeal, the sureties asserted three defenses in support of their contention that the trial court erred in granting summary judgment in favor of Wadsworth. First, payment was not yet due to Wadsworth because Clark, as general contractor, had not yet received final payment from the owner (i.e. the pay-when-paid defense). Second, the express language of the bond did not set forth consequences for a surety’s failure to answer a claim within 45 days of receiving it. Finally, the failure to timely respond to Wadsworth’s claim did not manifest an intentional or implied intent to waive any right to defend against said claim.

Just as the trial court was not persuaded by any of the sureties’ arguments, the Court of Special Appeals of Maryland also viewed the sureties’ defenses with skepticism. The Court nullified appellants’ first argument in holding that any defense premised on the premature nature of Wadsworth’s claim could have been asserted by the sureties’ within 45 days of receipt of Wadsworth’s claim upon the surety bond.

The Court discarded the sureties’ second defense, noting Wadsworth’s compliance with the notice requirements of paragraph four of the payment bond. The Court stated that had the sureties wanted a “non-forfeiture of defenses” provision to be included in the bond, they certainly could have included such a provision in their own bond form.

In addressing the sureties’ final defense, the Court acknowledged that appellants did not expressly waive their right to dispute Wadsworth’s claim. Notwithstanding, the Court determined that “the conduct of the Sureties supports the inference of their intention to relinquish their rights under the payment bond, reflecting an implied waiver of their right to defend against non-payment of the claim.”

After specifically addressing each of the sureties’ defenses, the Court summarized its reasoning and holding as follows:

We are persuaded that Paragraph 6 of the payment bond, read alone and in the context of the remainder of the bond, provides the surety 45 days to dispute a subcontractor’s claim for payment and, if the surety does not answer within that time period, the surety waives its right thereafter to dispute the claim. This construction of the payment bond, moreover, comports with the purpose of such instruments, which is to insure that claimants who perform work are paid for their work in the event that the principal does not pay… To interpret the bond as permitting the Sureties to ignore the period within which to respond to Wadsworth’s claim, only then to raise defenses to the claim upon Wadsworth’s filing of its suit, runs contrary to the bond’s purpose of safeguarding the suppliers of goods and labor. Nor can we imagine a reason for inclusion of the 45-day provision in the bond other than that it is there to be relied upon by the claimant and adhered to by the surety. Furthermore, to read the time period within which the surety “shall” respond to the claims in any way other than as imposing a mandatory time limit upon the surety for contesting the claim borders on the nonsensical, as it renders the 45-day time requirement essentially nugatory.

From a practitioner’s perspective, the Wadsworth decision may alter the conduct of claimants and their counsel. A careful reading of the case reveals that the Court may have counted the 45 days not from the claimant’s initial notice against the bond (the notice of nonpayment), but from the surety’s receipt of the proof of claim. Interestingly, claimants and their counsel routinely ignore the surety’s proof of claim form. Perhaps this is because it requires the claimant to make affirmative statements beyond the scope of the claim (as to warranties or the like), or it may be that neither the bond itself nor any applicable state payment bond statutes require such a proof of claim. In any event, under a strict reading of the Wadsworth case, submission of the proof of claim is not only critical, but it may be the trigger which starts the 45 days running.

Aspects of The Court’s Decision

The authors of this work contend that this aspect of the decision is flawed. Applying the same logic used by the Wadsworth Court, one would reasonably believe that all that is necessary to assert the claim is compliance with paragraph 4.1 of the payment bond. The bond contains no reference to a “proof of claim.” All the bond requires is a notice stating that a claim is being made and, with substantial accuracy, the amount of the claim. This type of notice is typically referred to as a “notice of nonpayment” and is simply a brief letter to the surety, owner, and contractor setting forth the name and address of the owner, contractor, and claimant, the name and location of the project, a description of the claimant’s work, and the amount being claimed.

In light of the Wadsworth decision, it may be prudent to alter the method of asserting claims against AIA A312 payment bond sureties. One modification may be to provide the surety with all customary supporting information at the time the claim is made. In addition to providing a notice of nonpayment, claimants and their counsel may wish to contemporaneously provide the surety with an executed and notarized generic proof of claim and all supporting documents including the subcontract, payment applications, and relevant correspondence. The result will be the commencement of the “45 day countdown” without incurring additional delay inherent in the surety’s customary request for additional information.

It is essential that courts in all jurisdictions look to the Wadsworth holding for guidance when construing the AIA A312 payment bond language. Prior to Wadsworth, countless claimants have been deprived of their right to timely and expeditiously recover under a payment bond. This nullification of claimants’ rights, however, is not the source of discrepancy. Rather, it is the failure to apply the same strict-constructionist standards to sureties that reeks of inequity. As a claimant’s right to recover under a bond is dependent upon compliance with the notice requirements thereof, no greater hardship is imposed upon the surety in requiring timely compliance with those requirements imposed upon the surety by the express terms of its own bond. The holding in Wadsworth is worthy of praise and imitation – accurate interpretation and enforcement of payment bond language is the focus; fairness and equity is the result.[/vc_column_text][/vc_column][/vc_row]

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