BY: Rob Duke, Surety Legal Counsel
On June 5, 2019, the New York Metropolitan Transit Authority (“MTA”) issued regulations on an emergency basis that implement a harsh debarment framework that was established by statute, section 1279-h Public Authorities Law. A debarment prohibits the contractor from responding to or entering into any MTA contract for five years. The regulations (21 NYCRR 1004 et seq.) were effective immediately as emergency regulations, but were open to public comment. Under the regulations, the MTA is required to debar a contractor that has: (i) failed to substantially complete all the work within the required time by more than 10% of “total adjusted time frame” or (ii) asserted a claim for additional work and the amount of the claim determined to be invalid was 10 percent or more the total adjusted contract value. The MTA has no discretion to excuse or justify violations. The regulation applies to all new and ongoing contracts as of April 12, 2019.
The contractor is permitted to bid on other contracts while the debarment is being considered. However, if the MTA awards the contractor a new contract while debarment is being considered and the MTA later debars the contractor, such debarment is a cause for termination under the new contract.
The regulations establish a hearing process for considering the debarment. However, the due process protections are scant. The debarment is not considered by a neutral arbiter, but by “at least three managerial employees” of the MTA. Further, the contractor’s defenses appear limited to force majeure.
The implications of debarment extend beyond the inability to bid on MTA contracts for five years. Under the Governor’s Executive Order 192, a finding of debarment by one agency is binding on all other state agencies.
Contractors should be aware of the drastically harsh consequences of overruns or delays on an MTA contract.
Second Circuit Holds that Surety is Bound to Arbitrate
A surety may be compelled to arbitrate a dispute based on the arbitration provisions in the underlying contract. In Federal Insurance Company v. Metropolitan Transportation Authority, 2019 U.S. App. LEXIS 26361 (2d Cir. August 30, 2019), the Court of Appeals affirmed the judgment of the U.S. District Court for the Southern District of New York, which held that the claims the surety was asserting against the project owner were required to be arbitrated. The Court generally based its decision on the incorporation clause in the bond and the broad language of the arbitration provision. In the case, the owner on a public project terminated the contractor for default and demanded that the surety on the performance bond complete the project. The surety advised that it would not be able to perform the contract as written because the contract failed to comply with applicable building code requirements. The surety filed an action against the owner seeking a declaratory judgment that the surety had no obligation to perform an illegal contract. Further the surety sought relief enjoining the owner from compelling the surety to complete the contract. The owner moved to dismiss the complaint. It argued that the contract contained an arbitration clause that required the surety's claim to be brought before the chief engineer or the Contractual Disputes Review Board. The District Court concluded that the arbitration provision in the contract between the contractor and project owner was broad enough to encompass the surety's claim and provided that the arbitrability of the issue was left to the arbitrators. The court granted the motion to dismiss and the surety appealed.
The Court of Appeals noted that the bond form expressly incorporated the terms of the construction contract. It also observed that the arbitration provision included all disputes having anything to do with the contract. Lastly the Court stated that the broad language in the provision including “any and all” disputes indicated intent by the parties to authorize the arbitrator to decide what issues were subject to arbitration. The Court affirmed the dismissal of the surety’s action, holding that such disputes should be resolved in arbitration.
Surety Has a Superior Right to Contract Funds
The (very) old saying that “sureties are favorites of the law” does not always appear true when reviewing cases decisions involving sureties. However, the case of Kappa Development & General Contracting, Inc. v. Hanover Insurance Company, 2019 Bankr. LEXIS 2002 (Bankr. S.D. Miss. July 2, 2019), indicates that the maximum still has some truth to it, estapecially when the surety performs under the bond. In this case, the court held that the surety had a superior claim to contract funds versus a bank. The bank provided a loan to a contractor and took a security interest in the contractor’s receivables, account proceeds, equipment and general intangibles. Subsequently, a surety wrote performance and payment bonds for the contractor for two projects. On the first project (Waveland), the surety paid $67,683 in payment bond claims. In addition, the project owner and the contractor entered into a settlement agreement by which the owner would pay $421,731 into a court registry, of which $130,107 was identified as retainage. (The contractor had filed for bankruptcy while the dispute was unresolved and the settlement agreement was approved by the Bankruptcy Court.) On the second project (Camp Shelby), the surety paid a total of $121,146 in payment bond claims. As a final payment to the contractor, the owner paid $67,516, of which $58,019 was retainage. The Bankruptcy Court ordered that the funds be placed in a restricted-access debtor in possession account.
In this decision, the surety and the bank filed cross-motions for summary judgment claiming a superior right to the retainage. The Bankruptcy Court held that the right of the surety to retainage was superior to the bank’s security interest. The Court concluded that the surety’s right to the funds was based on equitable subrogation and was superior to the bank’s interest, both with respect to funds that were part of the contractor’s estate and funds that were never part of the estate. It stated that it was immaterial whether the bank filed its financing statement before the bonds were issued. With respect to the funds paid to the contractor for the Camp Shelby Project, the Court stated that the funds came into the contractor’s estate subject to the surety’s interest. Because the defaulting contractor was not entitled to the retainage, the bank was not entitled to the retainage either, noting that the bank had only the rights that the contractor had. (Contrast to the surety, which was subrogated to the rights of the subcontractors and suppliers to whom the surety made payment under the payment bond.) The Court added that, with respect to the Waveland project, the paid funds never became property of the contractor’s estate. The funds were in the hands of the project owner at the time bankruptcy was filed and were paid into the court registry. The Court granted the surety’s motion and held that it was entitled to recover attorneys’ fees.