It is an often-repeated rule that a surety “stands in the shoes” of its principal. This means, in part, a surety may assert all of its principal’s rights and defenses as it relates to claims asserted against its bonds. Nevertheless, this rule is not without exception, and these exceptions can be notable. This is particularly true in the context of a Miller Act payment bond on federal construction projects. In fact, in some instances the Miller Act has been construed as precluding a surety from asserting defenses appearing in otherwise valid and enforceable contracts.
Contractual Timing Provisions
The Miller Act, 40 U.S.C. §§ 3131-3134, requires prime contractors on federal government construction projects to post surety bonds guarantying their performance and the payment of their subcontractors and material suppliers. As the Miller Act is a requirement imposed on contractors performing work for the federal government, the rights and remedies available under it are matters of federal, and not state, law. With respect to claims by subcontractors and suppliers, the Miller Act is “entitled to a liberal construction and application in order to properly effectuate the Congressional intent to protect those whose labor and materials go into a public project.” United States ex. rel. McKenney’s Inc. v. Gov’t Tech Servs., LLC., 531 F. Supp. 2d 1375, 1378-79 (N.D. Ga. 2008). Accordingly, courts have long recognized that a claimant may pursue its payment rights against the surety alone without also pursuing the surety’s principal.
In addition, some courts have also noted that if a subcontract term affects “the timing of recovery or the right of recovery under the Miller Act, enforcement of such terms to preclude Miller Act liability contradicts the express terms of the Miller Act.” Id. at 1379. In other words, “[a] contract provision that would deny the subcontractor its federal remedy under the Act cannot be used as a defense by a surety.” Id. Accordingly, subcontract timing provisions purporting to preclude a subcontractor’s right to payment, such as “pay-if-paid” provisions, do “not bar the subcontractor’s recovery against the surety, even though the prime contractor ha[s] not yet been paid.” Id.
Contractual Claims Procedures
These same considerations apply with equal force in the context of pass-through claims. In situations where a subcontractor’s or supplier’s claim may, in fact, ultimately be the financial responsibility of a party other than the surety’s principal, the surety generally may not defer liability under its Miller Act payment bond to the outcome of the claims process pursued by its principal on behalf of a claimant. As noted by one court, “The obligation to pursue and exhaust administrative remedies… is the prime contractor’s obligation alone, and any conflict between these divergent remedies constitutes a business risk which the parties incur by virtue of their different contracts.” United States v. Zurich Am. Ins. Co., 99 F. Supp. 3d 543, 550 (E.D. Pa. 2015). There is obviously an inherent risk of inconsistent results in allowing a claim to proceed against a Miller Act surety while the same claim rights are pursued against either a project owner or a third party. Nevertheless, in implementing the requirements of the Miller Act as intended, courts have deemed such a risk one “that the prime contractor must bear….” United States ex. rel. Tusco v. Clark Constr. Grp. LLC, 235 F. Supp. 2d 745, 760 (D. Md. 2016).
Practical Considerations
The Miller Act’s impact on the applicability of contract-based claim defenses requires thoughtful consideration by claimants, prime contractors, and sureties alike. Claims prosecution and defense strategies need to account for the enforceability of contract terms that defer or make conditional the ability of a subcontractor to seek additional compensation. Likewise, negotiating strategies concerning liquidating arrangements for claims must also take into consideration whether and to what extent subcontract terms can be used to restrict a subcontractor’s claim rights and/or the extent of its recovery.
