March 2004

On December 17, 2003, the United States District Court for the Eastern District of Virginia, issued a Memorandum Opinion in BELL BCI Company v. Old Dominion Demolition Corp., et al., Civil Case No. 03-489-A, holding that "the assignment of settlement authority to the surety in the event of a subcontractor's breach includes the right to settle and release any counterclaim asserted by the subcontractor against the prime contractor." This issue had not previously been addressed by any Virginia cases.

Background

Old Dominion Demolition Corporation ("ODDC") entered into two contracts with BELL BCI Company ("BELL") to perform demolition, disposal, dewatering, excavation, backfill and site preparation work under BELL's corresponding general contracts with the Alexandria Sanitation Authority. Developers Surety and Indemnity Company (the "Surety") issued performance and payment bonds on ODDC's behalf, as principal, under which it guaranteed ODDC's performance as well as payment by ODDC to its subcontractors and suppliers. In addition, American Re-Insurance Company ("AmRe") executed a sitework Reinsurance Agreement under which it counter-secured the Surety's obligations under the performance bond.

ODDC had executed a General Agreement of Indemnity in favor of the Surety under which ODDC:

1. Agreed to indemnify and hold harmless the Surety from and against all liabilities, losses, claims, demands, costs, damages, attorney's fees and expenses of whatever kind or nature incurred by the Surety;
   
   
2. Assigned to the Surety the right in its sole and absolute discretion to determine whether any claims under the bond should be paid, compromised, defended, prosecuted or appealed;
   
   
   
3. Agreed that in the event of a breach of the Indemnity Agreement by ODDC, all of ODDC's rights in and to the subcontracts between ODDC and BELL were assigned to the Surety; and,
   
   
   
4. Designated the Surety as its attorney-in-fact with the right and power, but not the obligation, to exercise all of the rights assigned, transferred, and set over to the Surety by ODDC under the Indemnity Agreement.

BELL brought suit against ODDC, the Surety, and AmRe in the United States District Court for the Eastern District of Virginia after ODDC had been terminated for default on both contracts. ODDC asserted a counterclaim against BELL. The Surety, AmRe, and BELL eventually reached a settlement under which the Surety agreed to make a payment to BELL in full settlement of all claims, including a release of all claims against the Surety and AmRe and a release of all claims asserted by ODDC against BELL. The Surety filed a motion to enforce the settlement and to dismiss ODDC's counterclaim. ODDC objected to the settlement and release of its counterclaims against BELL.

The Court's Ruling

The Court recognized that neither the Supreme Court of Virginia nor the Fourth Circuit Court of Appeals had expressly addressed the question of whether a surety can settle its principal's affirmative claims against a prime contractor. However, the Court found legal support for its ruling in a "remarkably similar" Second Circuit Court of Appeals decision.

The documents and pleadings provided by the parties showed that ODDC had not completed performance of its work and, as a result, BELL had terminated ODDC's subcontract. In addition, contrary to its obligations under the General Agreement of Indemnity, the Court determined that ODDC's failure to pay certain subcontractors and suppliers constituted an event of default under its General Agreement of Indemnity with the Surety and, as a consequence, the Surety became ODDC's attorney-in-fact with the authority to not only settle and resolve BELL's claims against ODDC, but also to settle and resolve ODDC's counterclaims against BELL.

In ruling that the Surety could settle and resolve ODDC's counterclaims against BELL, the Court reasoned that any other result would be commercially unsound because a surety would not find it sensible to accept a contractual right to settle that did not include the authority to settle a subcontractor's counterclaims against the contractor. Without such authority, the surety's right to settle would often be ineffective because the prime contractor would likely be unwilling to settle its claims against the surety without also settling the principal's (i.e. the subcontractor's) counterclaims.

The Court granted the Surety's motion to enforce the settlement and dismissed ODDC's counterclaim against BELL. In responding to ODDC's allegation that the Surety had acted in bad faith, the Court stated that such an argument was more properly asserted as a defense to the Surety's claim against ODDC for indemnification, which the Surety had brought against ODDC's indemnitors in another court. The Court also indicated that ODDC might be able to recover the value of its counterclaim against the Surety in the suit against ODDC's indemnitors.

Comment

A General Agreement of Indemnity typically contains a list of actions and/or events that will trigger a default by the indemnitors. Upon an "event of default," a General Agreement of Indemnity will also typically contain provisions that grant certain rights to the surety. Based on the Memorandum Opinion in BELL BCI Co. v. ODDC, the assignment and attorney-in-fact provisions are crucial in determining whether a surety can settle a subcontractor's claims against the prime contractor. If the indemnitors breach their obligations, the surety may have the right to step in and settle all claims arising out of the principal's default, including any affirmative claims that the principal/subcontractor has against the obligee/contractor.

Based on the Bell BCI Co. decision, it is essential for the principal/indemnitors to understand their obligations under the General Agreement of Indemnity and to comply with these obligations. Otherwise, the surety may settle with the obligee, including settlement of the principal's claims against the obligee, even over the objection of the principal, thus fixing the indemnitor's obligations to the surety.

For more information on this topic, please contact Robert M. Moore, Charlie C.H. Lee, or any of the attorneys in the firm with whom you have an existing relationship.