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Payment bonds are an important means for subcontractors and subconsultants to obtain payments on public works projects. Bonds are essentially debt instruments used to ensure that contractors pay subcontractors for the work they perform. The scope of a payment bond (i.e., what is covered) is defined by contract and/or statute. Disputes often arise because subcontractors and sureties disagree on the scope of the bond.
This month we take a look at one such dispute involving a design subconsultant and how the matter was resolved by an Indiana federal court.
By way of background, the federal statute governing payment bonds, known as the Miller Act, requires prime contractors to post payment bonds for federal contracts worth more than $100,000. See 40 U.S.C. § 3131. Many state legislatures have passed analogous versions of the Miller Act, commonly known as “Little Miller Acts.” See, e.g., Ind. Code § 4-13.6-7-6 (requiring payment bonds for Indiana public projects worth more than $200,000).
In terms of scope, the Miller Act requires a payment bond for the protection of “all persons supplying labor and material in carrying out the work provided for in the contract for the use of each person.” 40 U.S.C. § 3131(b)(2). What constitutes “labor” and “material” present classic ambiguities which lead to difficult cases of interpretation.
For example, see U.S. ex rel. Cobb-Strecker-Dunphy & Zimmerman, Inc. v. M.A. Mortenson Co., 894 F.2d 311, 313 (8th Cir. 1990) (deciding whether furnishing workers compensation qualifies as “labor or material”); and U.S. ex rel. Naberhaus-Burke, Inc. v. Butt & Head, Inc., 535 F. Supp. 1155, 1158 (S.D. Ohio 1982) (interpreting “labor” to require “physical toil, not work by a professional, such as an architect or engineer” except if the architect or engineer “actually superintends the work as it is done on the job site”).
See also U.S. ex rel. Barber-Colman Co. v. U.S. Fidelity & Guar. Co., 19 F.3d 1431, (4th Cir. 1994) (agreeing with Butt & Head court that only on-sight professional services qualify as “labor” within the Miller Act); accord Prime Mech. Serv., Inc. v. Fed. Solutions Group, Inc., No. 18-cv-03307, 2018 WL 6199930, at *3 (N.D.C.A. Nov. 28, 2018).
Similar interpretive problems arise when ambiguity stems from the terms of the parties’ contract rather than a statute. One federal court in Indiana, sitting in diversity, adjudicated such a payment bond dispute in Aztec Eng’g Group v. Liberty Mut. Ins. Co., No. 1:16-cv-01657, 2017 WL 1382649 (S.D. Ind. April 18, 2017), appeal dismissed, Docket No. 17-2129 (7th Cir. June 16, 2018).
Contractual Dispute Over Scope
In Aztec, the subcontractors sued the co-sureties for payment of design and construction work performed for the general contractor. Id. at *1. The co-sureties principally argued that the payment bond did not cover design work. Id. at *8.
The developer of the project at issue entered in a public-private agreement (PPA) with the Indiana Finance Authority to upgrade State Route 37. Id. at *2. Under the PPA, the developer was required to secure a payment bond in an amount equal to 5 percent of the “Total Project Capital Cost” (TPCC). Id. at *3. The TPCC included “D&C Work” defined as “the Design Work and Construction Work.” Id. The definition of “work” in the PPA enumerated services, including “all … design … services.” Id.
The developer then entered into a design-build contract (DBC) with Isolux-Corsan. Id. The DBC required Isolux-Corsan to secure a payment bond as well. Id. The DBC, like the PPA, defined “design and construction work” to include “those obligations pertaining to design and construction … and all other Work that is made the responsibility of Design-Build Contractor under the Agreement.” Id.
After the parties executed the DBC, the co-sureties issued the payment bond. Id. The payment bond was executed “as one of the conditions of the PPA and the DBC.” Id. The payment bond also incorporated “the DBC by reference” and “characterized the DBC as a contract related to the performance of design and construction work for the Project.” Id.
Isolux-Corsan then subcontracted with Aztec to provide engineering services. Id. at *4. The parties’ agreement called for “the performance of professional consulting services in connection with the project and work and services.” Id. Aztec was identified as a “design-consultant” in the agreement. Id. Ultimately, Isolux-Corsan failed to pay Aztec more than $4 million and Aztec filed suit against the co-sureties to obtain payment.
As a threshold determination, the Indiana federal court held that the payment bond covered Aztec’s design work. First, the title of the payment bond section in the PPA read “Design and Construction Security Requirements,” which itself suggested the payment bond covered design work. Id. at *8. Second, the payment bond totaled 5 percent “of the Total Project Capital Cost.” Id. The TPCC included “D&C work,” which, as previously defined, included design work. Id. at *8.
Moreover, even if the payment bond only included “Construction Work” as opposed to “design work,” the PPA defined construction work to include “all Work.” Id. The PPA then defined “Work” to include “design.” Id. The court ultimately found that the language in these documents “unambiguously confirms the parties’ intent that the required payment bond cover both Design Work and Construction Work.” Id.
The court also found that even if it misconstrued the agreement between Isolux-Corsan and Aztec, the payment bond covered all “labor,” the plain meaning of which includes “human activity that provides services,” such as design services. Id. at 9.
Contract May Enhance Statutory Protection
The court dismissed the co-sureties’ argument that Indiana’s statutory scheme does not favor “payment bond protection for design services on public-private agreements.” Id. It argued that parties have the right to contract for greater protections in payment bonds than a statute requires. See id. (“[I]t cannot be said that Indiana has prohibited parties from contracting for such protection.”)
Therefore, the Miller Act and its progeny of Little Miller Acts represent the “floor” of substantive protections for subcontractors. Subcontractors may freely bargain for greater protections than those codified, and the courts in Indiana will give the parties the benefit of their bargains.
Subcontractors and subconsultants need to be mindful of payment bonds since they may serve as a source of payment in the event things go awry with the contractor or consultant, respectively. In interpreting payment bond claims, courts are going to look at the terms of the bond, the applicable Miller Act statute and the parties’ agreements to ascertain the scope of payment bond protection.
In the course of bargaining, subcontractors and subconsultants should strive to explicate the benefits covered in a payment bond. Understandably, this is not always possible because the hands of the subcontractor and subconsultant may be “tied” by provisions in the prime contract or other superseding agreements. The co-sureties in Aztec resorted to “public policy” arguments because the contract language did not support their position.
As the Indiana court’s reasoning shows, those public policy arguments will not be successful if the parties do not contract away the protections provided under the relevant Miller Act statute.