U.S. Court of Appeals, Federal Circuit
February 26, 1999
HARTFORD FIRE INSURANCE COMPANY, PLAINTIFF-APPELLANT,
UNITED STATES, DEFENDANT-APPELLEE.
Before Michel, Rader and Schall, Circuit Judges.
The opinion of the court was delivered by: Schall, Circuit Judge.
Hartford Fire Insurance Co. ("Hartford") appeals the March 20, 1998 grant of summary judgment of the United States Court of Federal Claims in favor of the United States in Hartford Fire Insurance Co. v. United States, 40 Fed. Cl. 520 (1998). The court held that Hartford could not, under a theory of equitable subrogation, recover from the government its payments to subcontractors and suppliers under a surety bond because it failed to give the government proper notice that the contractor was in danger of defaulting with respect to sums owed to subcontractors and suppliers. We affirm.
On June 8, 1994, the government awarded a contract for the construction of the Criminal Investigation Division Field Operations Center ("CIDC") at Fort Leonard Wood, Missouri, to K & K Construction Company ("K & K"). The award was under Section 8(a) of the Small Business Act, 15 U.S.C. § 637(a) (setting forth a program that grants assistance to certain minority-owned small businesses). The contract named Edgar Poindexter as the contracting officer.
On June 16, 1994, K & K entered into a subcontract with Rau Construction Company ("Rau"), under which Rau was to perform various administrative tasks on the CIDC project, including obtaining a surety. *fn1 Article 8 of the subcontract provided that if the government found K & K in default of its obligations or if claims were made against the required surety bonds, Rau would have the right to complete the project and resolve any claims against the bonds as representative of the surety. Although the government was not a party to the subcontract, it approved it on July 20, 1994.
In the meantime, Rau and K & K jointly applied for surety bonds from Hartford, an approved surety. In the application, Rau agreed to indemnify Hartford for any loss that Hartford might incur on the bonds. In due course, Hartford issued surety bonds for the project.
Beginning on June 1, 1995, representatives of Rau told Mr. Poindexter that K & K had not deposited the last two progress payments in the designated project account and that Rau believed that subcontractors and suppliers were in danger of not being paid. Rau's representatives met with Mr. Poindexter on June 5, 1995, stating to him that K & K had made over $100,000 in unauthorized withdrawals from project funds and that K & K was placing progress payments in unauthorized bank accounts. In addition, Mr. Poindexter was told that K & K lacked adequate funds to pay its subcontractors and suppliers. Rau asked Mr. Poindexter to intervene in the matter to ensure that K & K paid its subcontractors and suppliers.
On June 30, 1995, the government conducted a final inspection of the CIDC project and approved K & K's request for a final progress payment in the amount of $208,190. On July 3, 1995, Rau's attorney sent a letter to Mr. Poindexter, advising him: (i) that the payment request lacked Rau's approval and therefore violated K & K's subcontract with Rau, (ii) that Rau was concerned that the payment would not be used to pay subcontractors and suppliers, and (iii) that Rau wanted Mr. Poindexter to take immediate action to ensure that K & K's subcontractors and suppliers were paid. Notwithstanding this letter, the government accepted the project as substantially complete on July 6, 1995, and a check in the amount of $208,910 was issued to K & K on July 14, 1995.
Although Mr. Poindexter had made numerous attempts to contact the president of K & K during June and July, it was not until July 14, 1995, that he sent notification that he was recommending termination of K & K from the section 8(a) program. Among other things, Mr. Poindexter wrote, K & K had failed to pay "significant financial obligations." On July 26, 1995, Mr. Poindexter took action to ensure that no further payments would be made to K & K.
By letter dated August 9, 1995, Hartford notified the government of claims received on its payment bond, requesting that any remaining payments be withheld and that, if possible, the government stop payment on the check representing the $208,190 final progress payment. Hartford also asserted a right to equitable subrogation in the event that it should be required to make payments on the bond. Over the following weeks, it became apparent that the final progress payment had not been deposited by K & K into the proper account. On September 26, 1995, Rau's attorney informed the government that Rau had agreed to indemnify Hartford in connection with the project and therefore would be accountable to Hartford for payments by Hartford to subcontractors. In addition, the attorney asked the government not to pay K & K amounts previously withheld as retainages due under the contract. The government ultimately delivered the contract retainages to Hartford. See id. at 522. Thereafter, Hartford paid all of K & K's subcontractors and suppliers under its surety bond. See Hartford Fire Ins. Co., 40 Fed. Cl. at 522.
Eventually, Hartford filed suit in the Court of Federal Claims, alleging that the government acted unreasonably and abused its discretion to Hartford's detriment: (i) by failing to take reasonable steps to determine whether K & K had the capacity and the intention to pay subcontractors and suppliers from the $208,190 progress payment, (ii) by failing to prevent the $208,190 progress payment from being made directly to K & K, and (iii) by failing to take reasonable steps to prevent the $208,190 progress payment from being used for purposes other than paying subcontractors and suppliers. See Hartford, 40 Fed. Cl. at 522. Hartford claimed that, through the doctrine of equitable subrogation, it was entitled to judgment in an amount exceeding $200,000, plus attorneys' fees, interest, and costs. See id. The government moved to dismiss Hartford's complaint for failure to state a claim upon which relief could be granted. In the alternative, it moved for summary judgment.
As noted above, the Court of Federal Claims granted summary judgment in favor of the government. The court acknowledged that, under the doctrine of equitable subrogation, a surety that normally would lack standing to sue can maintain a claim for payments on a contract if the surety finances the project to completion after default by the prime contractor. See id. at 523. The court found that Hartford had financed the CIDC project to completion, but denied recovery because Hartford had failed to give notice of K & K's impending default before the government's disbursement of the $208,190 final progress payment. The court held that such notice was necessary in order for Hartford to prevail on its equitable subrogation claim.
The court further held that notice from Rau was insufficient as a matter of law to satisfy the notice requirement. See id. at 523-24. The court reasoned that only notice from the actual surety will trigger the government's equitable duty to the surety. See id. In addition, the court determined, Rau was not authorized in 1995 to act as Hartford's representative pursuant to Article 8 of the subcontract between Rau and K & K because the conditions for vesting such authority had not occurred. See id. at 523.
Summary judgment is appropriate when there is no genuine issue as to any material fact and the moving party is entitled to judgment as a matter of law. See RCFC 56(c); Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247, 106 S.Ct. 2505, 2509-10, 91 L.Ed.2d 202 (1986). In this case, there are no material facts in dispute.
In Fireman's Fund Ins. Co. v. United States, we acknowledged that a surety's right to subrogation and the government's equitable duty to act with reasoned discretion toward the surety may arise upon a surety's notification to the government that the contractor has defaulted under the surety bond. See 909 F.2d 495, 498 (Fed. Cir. 1990). See also Reliance Ins. Co. v. United States, 27 Fed. Cl. 815, 826 (1993); Ransom v. United States, 17 Cl. Ct. 263, 272 (1989), aff'd, 900 F.2d 242 (Fed. Cir. 1990). However, we rejected a surety's argument that notice by a subcontractor or supplier was sufficient to trigger the government's equitable duty to the surety. See Fireman's Fund Ins. Co., 909 F.2d at 499; see also Reliance Ins. Co., 27 Fed. Cl. at 827 (notice by the surety required even though the government performed its own inspections and received notice of problems from subcontractors).
Hartford contends that the Court of Federal Claims erred in concluding that Rau's notification to the government of K & K's impending default was insufficient to satisfy the requirement of notice from the surety. According to Hartford, as guarantor and indemnitor of the surety bonds, Rau became the "ultimate surety" with interests identical to those of Hartford. Hartford maintains that the government's recognition of the relationship between Rau and Hartford is evidenced by Poindexter's eventual willingness to act on Rau's representations.
Relying on Fireman's Fund, the government responds that its equitable duty to a surety only arises when the surety itself notifies the government of a contractor's impending default. The government suggests that, in the absence of such notification, withholding payment from the contractor might constitute a breach of contract by the government. Accordingly, the government submits, the requirement of notice from the surety protects the government's interest, ensures completion of the contract at the contract price, and prevents the government from becoming entangled in minor disputes between the contractor and its subcontractors.
The government is correct that this case is controlled by Fireman's Fund. It is a distinction of little consequence that the asserted notice in Fireman's Fund was provided by a subcontractor, whereas the notice in this case was provided by an entity (Rau) having a separate status as guarantor of the surety bonds. A capacity to provide notice triggering the government's equitable duty to Hartford could only arise by virtue of a specific legal relationship between Rau and the government, which did not exist.
The government was neither a party to the subcontract between Rau and K & K, nor was it a party to the indemnity agreement between Rau, Hartford, and K & K. It is true that Rau's obligations and interests were similar to those of Hartford in ensuring that subcontractors and suppliers were paid. Rau's obligations, however, were owed to Hartford for the benefit of Hartford and K & K. The government was not in privity of contract with Rau, and was not an intended third party beneficiary of Rau's contracts with Hartford and K & K. Fireman's Fund squarely bars Hartford's claim. *fn2
Hartford argues that Article 8 of the subcontract between Rau and K & K conferred upon Rau authority to provide notice on behalf of Hartford. The government maintains, and Hartford does not deny, that under Article 8 of the subcontract, Rau's authority to act as Hartford's representative could arise only when the government determined that K & K was in default or when claims were made against the bonds. Hartford argues, however, that when presented with information that would have unquestionably supported a finding of default, the government took no action. Hartford further maintains that the only reason no claims were made against the payment bond is that Rau paid the subcontractors from its own funds. Moreover, according to Hartford, the government had represented that it would act on Rau's information, eventually did so by withholding the retainage payment, and never stated that it would be willing to act only if the information was provided by Hartford. Under these circumstances, Hartford submits, the government should not now be allowed to successfully maintain that Rau had no authority to act as Hartford's representative.
The government does not agree that the action it ultimately took against K & K constituted implicit acknowledgment of Rau's authority to represent Hartford. The government asserts that it withheld the retainage payment only after receiving notice from Hartford. In addition, the government asserts that K & K's performance on the CIDC project had been satisfactory until that time. To the extent that a dispute about possible default existed, the government states that Hartford was not concerned enough to notify the government. According to the government, "[w]hen the surety evaluated the situation and took the appropriate action to protect its interests, the process worked as intended."
We conclude that Article 8 of the subcontract provided no legal basis for Rau to serve as Hartford's representative in this case. The government is correct that Article 8 was to take effect only when the government determined that K & K was in default or when claims were made against the bonds. These conditions had not occurred by the time that the $208,190 final progress payment was made. It does not matter whether Rau's notification provided the government with information that would have supported a finding of default. Insofar as the government was concerned, K & K's performance had been satisfactory when the government made the progress payment, and no formal claims had yet been made upon the bonds. It is also irrelevant whether the reason that no claims had yet been made was that Rau had paid the subcontractors from its own funds. The government's primary concern was properly with the project, which at that time was substantially but not entirely complete.
In Fireman's Fund, we held that, in the absence of proper notice from the surety, the government acted within its discretion in attempting to encourage contract completion by making a progress payment to a contractor rather than finding it in default. We stated:
"During performance, the Government's role is substantially different from that of a mere stakeholder of a final contract payment. The [Government] has an important interest in the timely and efficient completion of the contract work. In furtherance of this interest, the Government contracts for a broad range of rights which are designed to promote continuation of the contract work. These provisions give the Government considerable discretion and flexibility in administering the contract. Public policy supports this flexibility in light of the various unforeseen circumstances which may hinder performance." Fireman's Fund Ins. Co., 909 F.2d at 498 (quoting Argonaut Ins. Co. v. United States, 434 F.2d 1362, 1367, 193 Ct. Cl. 483 (1970)).
The government's interest in completion of the CIDC project conferred upon it substantial discretion to delay a finding of default. The government's exercise of this discretion did not constitute an acknowledgment of authority in Rau to represent Hartford. Because the conditions of Article 8 had not been met when the government made the progress payment at issue, Rau was without authority to act as Hartford's representative under Article 8.
For the foregoing reasons, the grant of summary judgment in favor of the government is affirmed.
Each party shall bear its own costs.