by Todd W. Blischke, Partner

If a tree falls in the forest and no one is around to hear it, does it make a sound? That riddle may be the subject of debate for eternity. But another riddle—if a State Supreme Court in a region surrounded by trees renders an opinion that defies well-established surety law, will any other court in the land hear it—appears well on its way to being solved.

Almost two years ago, in Colorado Structures, Inc. v. Ins. Co. of the West, 167 P.3d 1125 (Wash. 2007), the Washington Supreme Court in a majority decision held that the obligee on a form AIA A311 performance bond could recover its project completion costs, as well as its attorney fees, from the surety despite the fact that it did not formally declare the principal in default.  The Colorado Structures case rocked the surety world.  Now that the dust has settled, we analyze the fallout.

The Shot Heard Round The Surety World

The dispute in Colorado Structures arose when a subcontractor hired to help build a sewer system for a new Wal-Mart store, Action Excavation and Paving, fell behind schedule and made other critical errors.  Despite its shortcomings, Colorado Structures chose not to terminate Action, but instead supplemented Action’s workforce in order to finish the project. Colorado Structures sent several letters to Action’s surety regarding problems on the job.   In one letter, Colorado Structures indicated to the surety that the city had rejected some of Action’s pipe work because it was installed in the wrong location.  In a series of other letters, Colorado Structures informed the surety that it believed Action had breached its subcontract and notified it of the plan to supplement.  As obligee on the bond, however, Colorado Structures never formally declared Action to be in default.

The AIA A311 performance bond at issue in Colorado Structures contained three provisions relevant to the Court’s analysis.  Paragraphs A and B of the bond set forth the basic obligations of the surety, stating, in relevant part, “. . . the condition of this obligation is such that, if Principal shall promptly and faithfully perform said subcontract, then this obligation shall be null and void; otherwise it shall remain in full force and effect.” Paragraph C of the bond listed the options of the surety following a declaration of default, providing as follows:

Whenever Principal shall be, and 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, subject to the provisions of paragraph 3 herein, or;

(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 subject to the provisions of paragraph 3 herein;

In reaching its decision, the Colorado Structures Court found the surety liable pursuant to its basic obligations under paragraphs A and B of the bond, while brushing aside the obligee’s duty to declare a default as a prerequisite in accordance with paragraph C.  By doing so, the Court condoned the obligee’s deprivation of the surety’s express right to exercise its performance options.  This marked a disturbing departure from deep-rooted legal authority.

Life As We Knew It Before Colorado Structures

Prior to Colorado Structures, the generally accepted rule was that an obligee had to declare a principal to be in default before the surety’s performance bond obligations are triggered. One of the most commonly cited cases for this proposition is L & A Contracting v. Southern Concrete Services, 17 F.3d 106 (5th Cir. 1994), which the Washington Supreme Court declined to follow.

Almost two years have elapsed since the Colorado Structures opinion was issued, and research indicates that no courts have followed the Evergreen States’ lead in rejecting L & A.  In fact, the only court that has directly addressed Colorado Structures, flatly disregarded the reasoning of the four justice majority.

Order Restored

In Hunt Construction Group, Inc. v. National Wrecking Corporation 542 F.Supp.2d 87 (DC Cir. 2008), the court was confronted with a set of facts similar to those in Colorado Structures. The prime contractor, Hunt, hired National to perform excavation work on a hotel project. Hunt believed that National was lagging behind in its work, so it unilaterally decided to accelerate the performance of one of its other subcontractors to help stave off an overall delay on the job.  This action apparently cost Hunt over $800,000.  Three months after National completed its work and vacated the site, Hunt sent a letter captioned “Default Notice” to National and another to its sureties providing “formal notice” of a default by their principal.

Hunt relied upon Colorado Structures in arguing that a surety’s liability is not conditioned on a declaration of default.  The court performed an in-depth evaluation of the decision, but ultimately stated it “respectfully declines to adopt the reasoning of Colorado Structures” since doing so would “turn a performance surety into a commercial guarantor—an undertaking well beyond the limits of the surety bond.” As hard as it tried to be “respectful” in doing so, the Hunt court noted that the Washington Supreme Court failed to appreciate the inter-relationships between the various provisions of the performance bond, which, when considered together, mandate that the obligee fulfill its duty to declare a default before it can “access the surety’s purse.”

Other courts addressing the declaration of default issue post-Colorado Structures have ignored this authority completely, instead electing to follow the more established, well-reasoned approach employed in L & A.  Such cases include, CC-Aventura, Inc. v. Weitz Co., LLC, 2007 WL 2986371 (S.D. Fla. 2007) and Memphis-Shelby County Airport Authority v. Ill. Valley Paving Co., 2007 WL 2904539 (W.D. Tenn. 2007).

With the exception of the Memphis-Shelby case, the post-Colorado Structures decisions have involved private disputes between general contractors, subcontractors and their sureties. In those cases, courts were deciding which private entities should bear losses on construction projects gone awry.

Desperate Times Do Not Call For Desperate Measures

The current economic downturn has affected the nation in countless ways.  Businesses and individuals have faced unprecedented challenges.  Public agencies, with dwindling tax revenues, have also been hit hard.  As an example, the State of California was recently forced to issue IOUs, a step it had not taken since the Great Depression

Lady Justice is supposed to be blind.  The identity of parties to a lawsuit and their financial condition (except in rare situations not pertinent to this discussion) are not to be considered by the judge or jury.  Unfortunately, some courts take a more results-based approach and have been criticized.

Public agency obligees will no doubt cite Colorado Structures when asserting performance bond claims after failing to give proper notice of a default.  When they do so, current economic conditions may make courts more likely to adopt the aberrational Colorado Structures decision as a backdoor means to replenish the public coffers at the expense of sureties.  A more reasoned and convenient approach, however, would be to follow L & A and require a declaration of default before providing “access to the surety’s purse.”

Conclusion

Not far from the home of the Washington Supreme Court in Olympia lies the last volcano to erupt in the lower forty-eight states, Mount St. Helens.  When she blew her top in 1980, the effects were devastating and widespread.  A column of volcanic ash rose 80,000 feet into the atmosphere and deposited dust over eleven states.  Fortunately, the fallout from Colorado Structures has not been so far-reaching.  The one court that squarely addressed the decision, decisively rejected its reasoning.  Other courts presented with similar fact patterns, have simply ignored the opinion.

One big tree - Colorado Structures - came down in the Pacific Northwest two years ago, but so far it appears that no other courts heard a sound. Will the empty public coffers, caused by the economic downturn, prevent an increase in the volume?


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