by Christopher M. Harris, Associate

Sureties that regularly issue Miller Act performance bonds are likely familiar with National Surety Corp. v. United States, 118 F.3d 1542 (1997), in which the United States Court of Appeals for the Federal Circuit held that a contracting officer’s release of contract retainage, prior to receipt of a complete project arrow diagram—a contractual prerequisite to payment of retainage—rendered the government liable to the surety for the amounts prematurely released.  In recognizing the surety’s right to recover these premature payments, the court relied upon the doctrine of impairment and a derivative fundamental precept of surety law: that when the bond principal and obligee modify the underlying contract so as to increase the surety’s bond risks a surety is entitled to a pro tanto discharge for its resulting losses.  As applied in National Surety, the impairment doctrine and its pro tanto discharge measure can be asserted affirmatively, in the form of an overpayment claim, to recover improperly disbursed contract funds.

The United States Court of Federal Claims recently had occasion to reinforce the foregoing principles in the case of Lumbermens Mutual Casualty v. United States, __ Fed. Cl. __, No. 04-1255C, 2009 WL 4640638 (Nov. 25, 2009).  In Lumbermens, however, the surety was first required to overcome a challenge to the court’s jurisdiction over a surety’s impairment and overpayment claims.  As reflected in the court‘s decision, Lumbermens Mutual Casualty (“Lumbermens”) issued Miller Act performance and payment bonds in connection with a contract between Lumbermens’ principal, Landmark Construction (“Landmark”), and the Navy for the construction of military housing units.  The initial contract sum totaled approximately $10 million.  Landmark ultimately abandoned the contract and, consequently, the Navy terminated the contract and called upon Lumbermens to complete the contract work pursuant to the performance bond.  In response, Lumbermens and its completion contractor, Atherton Construction (“Atherton”), executed a takeover agreement with the Navy.  Under that agreement, Lumbermens expressed its intent to fulfill its surety obligations with respect to the project while reserving its rights under the original bonded contract.

Prior to Landmark’s abandonment of the contract and the Navy’s termination of the same, Landmark had completed only 18% of the original contract scope.  The Navy, however, had paid Landmark 40% of the original contract balance, resulting in an overpayment to Landmark of approximately $1.4 million.  Following Atherton’s completion of the work, Lumbermens initiated suit against the Navy in the Court of Federal Claims, under the impairment doctrine, seeking to recover the amount by which the Navy had overpaid Landmark.  Additionally, Lumbermens argued that the Navy had improperly withheld $326,700 in liquidated damages from Atherton as a result of delays for which the Navy was responsible.  Inasmuch as Lumbermens had reimbursed Atherton for all liquidated damages withheld, Lumbermens included in its suit against the Navy a claim for remission of the improperly withheld liquidated damages.  The latter claim was asserted under the doctrine of equitable subrogation.

Tucker Act Jurisdiction Over Lumbermens’ Claims

As its first line of defense, the Navy asserted a jurisdictional challenge to Lumbermens’ suit, contending that the Court of Federal Claims lacked jurisdiction over the surety’s claims, at least to the extent that Lumbermens’ claims arose under the takeover agreement.  Specifically, the Navy argued that Lumbermens failed to satisfy the jurisdictional prerequisites of the Contract Disputes Act (“CDA”), including the requirement that a contractor submit its claim to the contracting officer prior to filing suit.  In making this argument, the Navy assumed, that Lumbermens’ claims arising under the takeover agreement were brought pursuant to the CDA.

Generally, the CDA is a waiver of sovereign immunity, and provides the jurisdictional basis for certain suits against the federal government.  The CDA, however, only provides standing to sue to a “contractor” in direct privity with the federal government.  A completing surety may be able to assert claims against the federal government under the CDA after executing a takeover agreement, so long as under the terms of the takeover agreement, the surety effectively assumes the role of “contractor” on the underlying procurement contract.  Alternatively, a surety may bring its equitable claims against the federal government in the Court of Federal Claims based upon the doctrine of equitable subrogation, under the Tucker Act, which also provides a waiver of sovereign immunity but does not contain the same jurisdictional prerequisites as the CDA.

In Lumbermen’s, the court promptly overruled the Navy’s jurisdictional challenge, recognizing that the Tucker Act, rather than the CDA, supplied an adequate jurisdictional foundation for Lumbermens’ claims arising from its takeover agreement.  In reaching its conclusion, the court reasoned that a surety, such as Lumbermens, that executes a takeover agreement purely in its capacity as surety is not acting as a “contractor” for CDA purposes.  Instead, the surety is entering an agreement to fulfill its performance bond obligations.  Based upon this analysis, the court concluded that the CDA had no application to Lumbermens’ suit and that Lumbermens was not required to satisfy the CDA’s jurisdictional prerequisites.

Under National Surety, Lumbermens’ impairment and overpayment claim did not arise from any underlying procurement contract but, rather, arose under equitable principles of suretyship and subrogation.  Moreover, while Lumbermens’ claim for remission of the liquidated damages improperly withheld from Atherton initially arose under the takeover agreement, Lumbermens’ claim against the Navy for reimbursement of such damages was premised upon the theory of equitable subrogation.  Accordingly, the Tucker Act, and not the CDA, supplied an adequate jurisdictional basis for all of Lumbermens’ claims.

Lumbermens’ Impairment and Overpayment Claim

After establishing the basis of its jurisdiction, the Court of Federal Claims then went on to address the substance of the Lumbermens’ claims.  Unlike the contract in National Surety, Landmark’s contract with the Navy did not contain a provision that required the government to withhold retainage.  Not-withstanding this fact, Lumbermens was able to persuade the Court that the Navy’s failure to adhere to certain of the contract’s payment provisions sufficiently altered Lumbermens’ bond risks and impaired Lumbermens’ suretyship rights so as to entitle Lumbermens to recover the full amount by which the Navy overpaid Landmark.

The Navy failed to comply with the contract’s payment provisions in three material respects.  First, as a condition to payment, the contract required Landmark to submit a conforming Schedule of Prices, which was to include a detailed breakdown of contract pricing for each of the various kinds of work.  Despite its submission of multiple versions of the Schedule of Prices, Landmark ultimately failed to submit, and the Navy failed to require, a Schedule of Prices that included sufficiently detailed and contractually required information concerning quantities and prices.  The court determined that the Navy’s failure to require a conforming Schedule of Prices enabled Landmark to pad its invoices and overcharge the government, resulting in substantial overpayments to Landmark and a corresponding impairment of Lumbermens’ collateral interest in the contract balance.

As a second condition to payment, the contract required Lumbermens to submit an updated Network Analysis Schedule with each invoice, detailing progress for each work task and activity during the prior period, including associated materials costs.  While Landmark provided Network Analysis Schedules with its invoices, they failed to adhere to the contract guidelines and were insufficiently detailed to enable the Navy to effectively track progress and costs.  The court determined that the Navy’s failure to require proper Network Analysis Schedules resulted in overpayments to Landmark, for which Lumbermens was entitled to compensation.

As a final condition to payment, Landmark was required to include with each invoice a certification, affirming that, among other things, all requested amounts were due and appropriate and that all amounts previously requested for subcontractors and suppliers had been paid.  While the Navy made eleven progress payments to Landmark, only four of Landmark’s corresponding invoices contained certifications, and only three of the four certifications complied with the requirements of the contract.  The court determined that the Navy’s failure to require the contractually required certifications increased Lumbermens’ risks and contributed to the Navy’s overpayments to Landmark.

Based upon the Navy’s failure to adhere to the foregoing payment provisions, and the resulting overpayments to Landmark, the court concluded that Lumbermens was entitled to recover the full amount of the Navy’s overpayment to Landmark, totaling $1,375,420.11.

The Lumbermens decision supplies additional support to the surety seeking to assert a claim of overpayment or defense based upon impairment of suretyship.  It should be noted, however, that while the prejudice to the surety resulting from the obligee’s overpayment and impairment of collateral is generally apparent in such cases, the surety should be prepared, and in some instances may be required to demonstrate actual loss as a direct result from the government’s conduct.  Additionally, careful attention should be paid in drafting takeover agreement language so as to avoid potential jurisdictional pitfalls. 

Sureties that regularly issue Miller Act performance bonds are likely familiar with National Surety Corp. v. United States, 118 F.3d 1542 (1997), in which the United States Court of Appeals for the Federal Circuit held that a contracting officer’s release of contract retainage, prior to receipt of a complete project arrow diagram—a contractual prerequisite to payment of retainage—rendered the government liable to the surety for the amounts prematurely released.  In recognizing the surety’s right to recover these premature payments, the court relied upon the doctrine of impairment and a derivative fundamental precept of surety law: that when the bond principal and obligee modify the underlying contract so as to increase the surety’s bond risks a surety is entitled to a pro tanto discharge for its resulting losses.  As applied in National Surety, the impairment doctrine and its pro tanto discharge measure can be asserted affirmatively, in the form of an overpayment claim, to recover improperly disbursed contract funds.

The United States Court of Federal Claims recently had occasion to reinforce the foregoing principles in the case of Lumbermens Mutual Casualty v. United States, __ Fed. Cl. __, No. 04-1255C, 2009 WL 4640638 (Nov. 25, 2009).  In Lumbermens, however, the surety was first required to overcome a challenge to the court’s jurisdiction over a surety’s impairment and overpayment claims.  As reflected in the court‘s decision, Lumbermens Mutual Casualty (“Lumbermens”) issued Miller Act performance and payment bonds in connection with a contract between Lumbermens’ principal, Landmark Construction (“Landmark”), and the Navy for the construction of military housing units.  The initial contract sum totaled approximately $10 million.  Landmark ultimately abandoned the contract and, consequently, the Navy terminated the contract and called upon Lumbermens to complete the contract work pursuant to the performance bond.  In response, Lumbermens and its completion contractor, Atherton Construction (“Atherton”), executed a takeover agreement with the Navy.  Under that agreement, Lumbermens expressed its intent to fulfill its surety obligations with respect to the project while reserving its rights under the original bonded contract.

Prior to Landmark’s abandonment of the contract and the Navy’s termination of the same, Landmark had completed only 18% of the original contract scope.  The Navy, however, had paid Landmark 40% of the original contract balance, resulting in an overpayment to Landmark of approximately $1.4 million.  Following Atherton’s completion of the work, Lumbermens initiated suit against the Navy in the Court of Federal Claims, under the impairment doctrine, seeking to recover the amount by which the Navy had overpaid Landmark.  Additionally, Lumbermens argued that the Navy had improperly withheld $326,700 in liquidated damages from Atherton as a result of delays for which the Navy was responsible.  Inasmuch as Lumbermens had reimbursed Atherton for all liquidated damages withheld, Lumbermens included in its suit against the Navy a claim for remission of the improperly withheld liquidated damages.  The latter claim was asserted under the doctrine of equitable subrogation.

Tucker Act Jurisdiction Over Lumbermens’ Claims

As its first line of defense, the Navy asserted a jurisdictional challenge to Lumbermens’ suit, contending that the Court of Federal Claims lacked jurisdiction over the surety’s claims, at least to the extent that Lumbermens’ claims arose under the takeover agreement.  Specifically, the Navy argued that Lumbermens failed to satisfy the jurisdictional prerequisites of the Contract Disputes Act (“CDA”), including the requirement that a contractor submit its claim to the contracting officer prior to filing suit.  In making this argument, the Navy assumed, that Lumbermens’ claims arising under the takeover agreement were brought pursuant to the CDA.

Generally, the CDA is a waiver of sovereign immunity, and provides the jurisdictional basis for certain suits against the federal government.  The CDA, however, only provides standing to sue to a “contractor” in direct privity with the federal government.  A completing surety may be able to assert claims against the federal government under the CDA after executing a takeover agreement, so long as under the terms of the takeover agreement, the surety effectively assumes the role of “contractor” on the underlying procurement contract.  Alternatively, a surety may bring its equitable claims against the federal government in the Court of Federal Claims based upon the doctrine of equitable subrogation, under the Tucker Act, which also provides a waiver of sovereign immunity but does not contain the same jurisdictional prerequisites as the CDA.

In Lumbermen’s, the court promptly overruled the Navy’s jurisdictional challenge, recognizing that the Tucker Act, rather than the CDA, supplied an adequate jurisdictional foundation for Lumbermens’ claims arising from its takeover agreement.  In reaching its conclusion, the court reasoned that a surety, such as Lumbermens, that executes a takeover agreement purely in its capacity as surety is not acting as a “contractor” for CDA purposes.  Instead, the surety is entering an agreement to fulfill its performance bond obligations.  Based upon this analysis, the court concluded that the CDA had no application to Lumbermens’ suit and that Lumbermens was not required to satisfy the CDA’s jurisdictional prerequisites.

Under National Surety, Lumbermens’ impairment and overpayment claim did not arise from any underlying procurement contract but, rather, arose under equitable principles of suretyship and subrogation.  Moreover, while Lumbermens’ claim for remission of the liquidated damages improperly withheld from Atherton initially arose under the takeover agreement, Lumbermens’ claim against the Navy for reimbursement of such damages was premised upon the theory of equitable subrogation.  Accordingly, the Tucker Act, and not the CDA, supplied an adequate jurisdictional basis for all of Lumbermens’ claims.

Lumbermens’ Impairment and Overpayment Claim

After establishing the basis of its jurisdiction, the Court of Federal Claims then went on to address the substance of the Lumbermens’ claims.  Unlike the contract in National Surety, Landmark’s contract with the Navy did not contain a provision that required the government to withhold retainage.  Not-withstanding this fact, Lumbermens was able to persuade the Court that the Navy’s failure to adhere to certain of the contract’s payment provisions sufficiently altered Lumbermens’ bond risks and impaired Lumbermens’ suretyship rights so as to entitle Lumbermens to recover the full amount by which the Navy overpaid Landmark.

The Navy failed to comply with the contract’s payment provisions in three material respects.  First, as a condition to payment, the contract required Landmark to submit a conforming Schedule of Prices, which was to include a detailed breakdown of contract pricing for each of the various kinds of work.  Despite its submission of multiple versions of the Schedule of Prices, Landmark ultimately failed to submit, and the Navy failed to require, a Schedule of Prices that included sufficiently detailed and contractually required information concerning quantities and prices.  The court determined that the Navy’s failure to require a conforming Schedule of Prices enabled Landmark to pad its invoices and overcharge the government, resulting in substantial overpayments to Landmark and a corresponding impairment of Lumbermens’ collateral interest in the contract balance.

As a second condition to payment, the contract required Lumbermens to submit an updated Network Analysis Schedule with each invoice, detailing progress for each work task and activity during the prior period, including associated materials costs.  While Landmark provided Network Analysis Schedules with its invoices, they failed to adhere to the contract guidelines and were insufficiently detailed to enable the Navy to effectively track progress and costs.  The court determined that the Navy’s failure to require proper Network Analysis Schedules resulted in overpayments to Landmark, for which Lumbermens was entitled to compensation.

As a final condition to payment, Landmark was required to include with each invoice a certification, affirming that, among other things, all requested amounts were due and appropriate and that all amounts previously requested for subcontractors and suppliers had been paid.  While the Navy made eleven progress payments to Landmark, only four of Landmark’s corresponding invoices contained certifications, and only three of the four certifications complied with the requirements of the contract.  The court determined that the Navy’s failure to require the contractually required certifications increased Lumbermens’ risks and contributed to the Navy’s overpayments to Landmark.

Based upon the Navy’s failure to adhere to the foregoing payment provisions, and the resulting overpayments to Landmark, the court concluded that Lumbermens was entitled to recover the full amount of the Navy’s overpayment to Landmark, totaling $1,375,420.11.

The Lumbermens decision supplies additional support to the surety seeking to assert a claim of overpayment or defense based upon impairment of suretyship.  It should be noted, however, that while the prejudice to the surety resulting from the obligee’s overpayment and impairment of collateral is generally apparent in such cases, the surety should be prepared, and in some instances may be required to demonstrate actual loss as a direct result from the government’s conduct.  Additionally, careful attention should be paid in drafting takeover agreement language so as to avoid potential jurisdictional pitfalls.

The information or opinion provided in this article is the author's own and not necessarily that of Watt, Tieder, Hoffar & Fitzgerald, LLP. The author is solely responsible for the information and opinion that he or she has provided. The information contained herein does not replace seeking specific legal counsel to directly address individual client needs.