The Construction Advantage – Issue 5

In our fifth issue of The Construction Advantage, we discuss some potential federal tax legislation, the time of accrual for a statute of limitation on an indemnity obligation, and a payment bond case recently decided by a federal appeals court in Chicago. We hope that this newsletter has been helpful and informative to you so far in 2014. Please feel free to let any of us know if there are specific issues that you may want covered in the future by the Construction Law Practice Group attorneys. Finally, we wish a happy Memorial Day to each one of you and your families.

The Tax Reform Act of 2014
By Mike Bosse

The House of Representatives Ways and Means Committee has released in draft form the Tax Reform Act of 2014. Relevant to the construction industry, the Reform Act would lower the top tax rate for construction businesses from its current rates to 25% regardless of the construction company’s entity structure. This rate would apply to “construction of real property in the United States” as part of the active conduct of a construction trade or business. Additionally, the Tax Reform Act would dedicate $126.5 billion to the Highway Trust Fund to fully fund highway and infrastructure investment through the trust fund for eight years, funding badly needed for our aging infrastructure. The bill also would eliminate the alternative minimum tax for individuals, pass through businesses and corporations, and it was scored by the Joint Committee on Taxation as deficit neutral, meaning that it would not increase the budget deficit. This is potentially important legislation for the construction industry. The Construction Practice Group at Bernstein Shur will monitor it as it progresses and keep you apprised as to whether this tax reform may have increasing support in Congress.

Statutes of Limitation – When Does the Clock Start to Tick?
By Emily Kahn

A case issued in mid-April from the Michigan Supreme Court demonstrates that determining when a statute of limitations starts to run may not be as clear as one would expect. In Miller-Davis Company v. Ahrens Construction, Inc., a general contractor brought an action against a subcontractor for faulty workmanship by the subcontractor when installing a roof system covering a natatorium (a building designed to house a swimming pool). When a moisture problem involving condensation developed, the project architect discovered significant deficiencies in the subcontractor’s work. After the subcontractor refused to repair the deficiencies, the general contractor settled with the owner and completed remedial work, and thereafter sought indemnity from the subcontractor. The trial court concluded that the claim for faulty workmanship was governed by Michigan’s general six year statute of limitations (the same time frame as ME’s general statute) and that, because the date of substantial completion was more than six years after the general contractor filed suit to recover, the claim was therefore barred by the statute of limitations.

The Michigan Supreme Court concluded that the general contractor’s claim was not for the subcontractor’s deficient performance of the original work, but instead was for breach of contract arising out of the subcontractor’s failure to perform its indemnification obligations. The Court held that the statute of limitations began to accrue at the time that the general contractor sought indemnity from the subcontractor, not at the time that the subcontractor actually performed the deficient work. The Court reasoned that while a breach of contract action could not be maintained by the general contractor against the subcontractor for the performance of the non-conforming work, the general contractor could maintain an action within the statute of limitations for subcontractor’s failure to live up to its indemnity obligations as agreed to in the subcontract. The Court found that the date of accrual was either when the general contractor conducted a partial tear off of the roof and discovered the nonconforming work, when the general contractor settled the owner’s claims with an agreement for corrective work, or when an independent engineering firm certified that the general contractor had corrected the subcontractor’s defective work, as each of these events created a liability for which the general contractor could seek indemnification from the subcontractor. Because all three of those events occurred within the six-year statute of limitations, the Michigan Supreme Court held that the general contractor’s claim was not time-barred.

This is a potentially important case that could have a broad impact across many states, including those in New England. In an indemnity situation, it would typically be expected that the date of accrual for statute of limitations purposes would be the date that the substandard or defective work was completed in the field. However, under the analysis used by the court in this case, the statute of limitations period may instead run from when the contractor or subcontractor fails to abide by its indemnity obligations, potentially extending the period for recovery beyond six years from performance of the work. Thus, even if you think a claim is barred by the statute of limitations, you should investigate the situation more deeply to determine whether the claim may still be alive even though the work itself may have been performed in a period outside the application statute of limitations.

Bonds – Not to be Confused with Insurance
By Mike Bosse and Mike Hodgins

In a case decided in early May in the Seventh Circuit Court of Appeals in Chicago, Hanover Insurance Company prevailed in its suit against general contractor Northern Building Company and its principal, to recoup payments made by Hanover under the contractor’s payment bond obligations. This case is the latest clear reminder that payment and performance bonds are not insurance, at all. The case also affirmed the surety’s discretion to settle claims, regardless of a final determination of the contractor’s liability for payment.

In 2008, Northern Building Company won a contract to do work at Midway International Airport under the supervision of a project manager. Northern engaged several subcontractors to perform the work. Hanover Insurance Company issued payment and performance bonds on Northern’s behalf, and Northern and its principal entered into a standard indemnity agreement outlining Northern and its principal’s obligations to Hanover if claims were asserted against the bonds. After performance issues arose, and two subcontractors were not paid, claims were submitted. Hanover stepped into the role of general contractor to complete the project, and paid both subcontractor claims in full. Hanover immediately requested that Northern and its principal post collateral, or pay the surety. Northern refused to comply. Hanover subsequently had to file suit to recover reimbursement of the payments and attorney’s fees incurred, from Northern and its principal.

The Seventh Circuit found that this was a very simple matter that Northern was trying to make complicated. The indemnity agreement was clear and unambiguous, and Northern had breached it on multiple fronts. Northern failed to indemnify Hanover in response to the demand at the time the claims were asserted, and again after the claims were paid. Northern argued that it was not liable to Hanover until a court conclusively found that the subcontractors were owed money and that Northern was responsible for payment. Based upon substantial case law and the plain language of the bonds, the court ruled that the indemnity requirement was triggered at the time a claim was made against the surety bonds. In addition, Hanover had the power and ability to investigate and settle any claims, which they did. Under the Indemnification Agreement, Hanover had the “exclusive right to adjust, settle, or compromise any claim.” The existence of the “claim” triggered Northern’s obligation to indemnify, not a finding of liability.

Northern also offered a desperate argument that the contract was “unfair” because Hanover stood to profit by recovering all of the monies it paid out, while keeping its premium. The Seventh Circuit dismissed this, noting that Hanover was not profiting at all considering that it had to investigate and pay the claims, which had an attendant cost. In closing, the court offered its advice to Northern “to carefully consider how much longer it is wise to drag this case out,” in light of Hanover’s mounting attorney’s fees.

This case is a classic reminder that bonds provided by surety companies are not insurance. The bond is short term protection to the owner and subcontractors. Sureties anticipate that they will ultimately recover from the company or principal on any claims that are paid out, and the surety retains complete discretion and authority to settle those claims, even when defenses to payment exist, if settlement is appropriate. That settlement is final and binding as to the indemnitor contractor. One should not forget that payments made on surety bonds will ultimately end up back on the doorstep of the construction company, and often its individual owners.

We hope that you have found these tips and pointers in the fifth issue of The Construction Advantage helpful to you in your daily business. Each of the attorneys in our Construction Law Practice is available to answer the day to day questions of your business as you work on projects over the summer months.