Surety’s entitlement to recover costs under general indemnity agreements with contractor and contractor’s owners. Arch Insurance Company v. Centerplan Construction Company, LLC. United States District Court, District of Connecticut (2019), by Hugh Anderson

Summary: Arch Insurance issued performance and payment bonds on numerous projects conducted by Centerplan Construction. The primary project at issue in this case is construction of a minor league baseball stadium in Hartford, Connecticut. The stadium project took a turn for the worse, resulting in payment bond claims by unpaid subcontractors, and a termination by the stadium owner/developer followed by a performance bond claim. The grounds for termination were late completion, refusal to pay liquidated damages for late completion, and “numerous construction deficiencies and code violations” on the project.

After an extensive investigation and review of documents, Arch decided to pay most of the payment bond claims (approximately $20 million), and enter into a takeover agreement with the stadium owner, under which Arch committed to complete the construction contract. Arch spent approximately $16 million (in excess of payments from owner) to complete the stadium. After making these payments and incurring the costs of completion, Arch sued Centerplan and its principal owners under the terms of indemnity agreements that the defendants had entered into with Arch.

Indemnity agreements are invariably required by sureties before issuing performance and payment bonds. Such agreements are contractual commitments by the contractor (and commonly by individual owners and principals) to reimburse the surety if it pays out money on a bond. Often the indemnity is tied to collateral or assets of the contractor or its owners.

The indemnity agreements executed by Centerplan and its owners stated that documentation of payments made by Arch under the bonds would be prima facie evidence of “the fact and extent of liability” of the indemnitors. The indemnity agreements gave Arch the exclusive right to determine how to respond to bond claims, including whether a claim should or should not be “paid, compromised, resisted, defended, tried, or appealed.”

The Centerplan defendants’ primary defense against the indemnity/reimbursement lawsuit was that the surety had acted in bad faith in making payments to subcontractors and incurring completion costs. Arch Insurance contended that there was no basis for the bad faith defense, and moved for summary judgment on its claims.

Decision: The District Court granted summary judgment in favor of Arch, requiring the Centerplan defendants to reimburse Arch for the millions of dollars of claims paid under the payment and performance bonds, as well as for costs incurred by Arch in administering the claims and managing the completion of the stadium—in total, a judgment of over $39 million.

As a threshold issue, the court concluded that as a matter of law the indemnity agreements governed Arch’s entitlement, without reference to the related bonds and construction contracts. The indemnity agreements were unambiguous, independent contracts that did not incorporate the bonds or contracts. The primary indemnity agreement stated that Arch would be entitled to reimbursement for payments made by Arch “…under the belief that it [Arch] was liable…or that it was necessary or expedient to make such disbursements, whether or not such liability, necessity or expediency existed.” Applying Connecticut law, the federal court pointed out that the Connecticut Supreme Court had explained that “under an indemnity agreement, it is not essential that a principal [contractor and its owners] be liable for the claims upon which surety seeks to be indemnified.” The court concluded that although the terms of indemnity agreements in the surety field may be strict, they are essential to inducing sureties to issue bonds, and they are uniformly sustained and upheld.

With respect to the payment bond claims, the Centerplan defendants argued that the subcontractors had not been entitled to payment by Arch because of a pay-if-paid clause in the subcontracts. According to the defendants, the owner had not paid Centerplan, hence the subcontractors did not have valid claims. Arch had analyzed the pay-if-paid clause, and had concluded that it did not stand as a barrier to entitlement to payment. Arch also determined that the best way to complete the stadium was to keep the subcontractors on the job, which made it necessary (or at least expedient) to pay the subs, perhaps at a marginally greater cost than could have been accomplished otherwise. However, the issue was not whether Arch’s legal analysis of the pay-if-paid clause was correct, or whether keeping the subs on the project was the best strategy, but rather whether Arch had acted in bad faith.

The bad faith question also controlled the issue of the completion costs that Arch incurred in completing the stadium project. The Centerplan defendants contended that the owner was not entitled to performance because the owner had failed to pay change orders, claims, and routine payment requisitions. Arch had conducted a detailed review of the project accounting and the nature and status of various claims and demands, and concluded that the owner was entitled to completion of the work.

The only “evidence” of bad faith by the surety were assertions made by one of the Centerplan owners that Arch’s decisions were unjustified and ill-considered. However, the court pointed out that bad faith requires more than mere negligence or poorly reasoned decisions: it requires actions taken with improper motive or dishonest purpose—fraud, deceit, a “sinister motive.” Nothing in the record before the court suggested anything consistent with bad faith as so defined.

Another factor of interest was a clause in one of the indemnity agreements giving the indemnitors (Centerplan and its owners) the opportunity to post cash or collateral in a situation in which Arch wanted to compromise and settle with bond claimants, but the indemnitors preferred to have the surety fight the claims. The court noted case law supporting the view that if such an option is available, but the indemnitors do not invoke it, then there can be no claim of bad faith.

Comment: Although the terms and conditions of the bonds were not significant factors in the court’s decision, it appears that the bonds on the project were similar to, perhaps the same as, the standard bonds developed by a collaboration of industry organizations (including EJCDC) and published by EJCDC. For example, the Arch performance bond appeared to require a conference of owner, contractor, and surety prior to a declaration of default—such a conference is one of the procedural steps required in EJCDC® C-610, Performance Bond, Paragraph 3.1.

The case stresses the importance of the surety’s investigation of the project and the claims. At every turn the surety was able to refute accusations of bad faith by pointing to the thoroughness of its process, which included retaining a firm that specialized in administering bond claims and project completion.