In today’s contracting world, subcontracts typically contain “pay-if-paid” clauses. In general these clauses require that as a condition precedent to a subcontractor’s right to payment, the contractor must first be paid from the owner for the work the subcontractor performed on the project. Such clauses are regularly relied upon by contractors as a valid defense to a subcontractor’s or supplier’s claim. In most jurisdictions, however, the contractor’s surety is typically not afforded the same defense. For this reason, sureties have largely given up on any effort to assert this defense as a valid means of defending against a payment bond claim.
Nevertheless, there are certain jurisdictions where sureties can successfully maintain this defense. One such jurisdiction is West Virginia, where the Supreme Court of Appeals has recognized the validity of a contractor’s pay-if-paid clause as a bar to subcontractors’ payment bond claims. Wellington Power Corp. v. CNA Surety Corp., 614 S.E.2d 680 (W. Va. 2005).
Facts
Plaintiffs Wellington Power Corp. and W.G. Tomko (the “subcontractors”) contracted with the Dick Corporation (“Dick”) to provide various services for the construction of the West Virginia University Life Sciences Building in Morgantown, West Virginia (the “Life Sciences Building” or “Project”). The relevant subcontracts contained “pay-if-paid” clauses stating that payment for the subcontractors’ services shall be made only from funds actually received from the Owner. Because the construction of the Life Sciences Building was a public Project, Dick obtained a Labor and Material Bond (the “Payment Bond”) from Defendant CNA Surety Corporation as mandated by the West Virginia “Little Miller Act”, naming Dick as principal and the Project Owner as obligee.
The subcontractors ultimately sued CNA under the Payment Bond. CNA filed motions to dismiss the subcontractors’ complaints based on the pay-if-paid provisions in the applicable subcontracts, both of which were denied by the Circuit Court. The subcontractors and CNA then filed separate motions for certification, and the Circuit Court certified the issue to the Supreme Court of Appeals of West Virginia.
On Appeal
Before the Supreme Court of Appeals, the subcontractors argued that: (1) the application of the pay-if-paid condition precedent clause to their action violated West Virginia’s Public Bond Statute; (2) enforcing the pay-if-paid clause would eliminate the purpose of the West Virginia Public Bond Statute, thereby rendering it “useless”; and (3) enforcing the pay-if-paid clause would discourage subcontractors from working on public projects in West Virginia. The subcontractors also argued that they should be allowed to recover against the Payment Bond because it neither contained nor incorporated the pay-if-paid condition and, therefore, CNA did not have the right to rely upon the clause.
The Court of Appeals rejected all of the subcontractors’ arguments. The Court of Appeals found that the strong public policy of freedom of contract and the general principle that a court will enforce a party’s unambiguous agreement was more compelling and outweighed the public policy reflected in the West Virginia Public Bond Statute. The Court of Appeals further noted that public construction projects are generally large-scale operations that require the services of established and experienced subcontracting companies, which fairly can be characterized as sophisticated commercial entities. Due to this sophistication, a court should not intervene simply because a party to a valid and unambiguous contract subsequently seeks to avoid its enforcement.
The Court also rejected the subcontractors’ arguments that the Payment Bond neither contained nor incorporated the pay-if-paid condition. Relying on settled principles of surety law, the Court of Appeals noted that in the absence of limitations or restrictions contained in the contract, the liability of the surety is coextensive with that of the principal, and the surety is not liable to a claimant unless its principal is also liable. Ultimately, because Dick had not received funds from WVU for the subcontractors’ work it was not liable to the subcontractors. Therefore, CNA, as Dick’s surety, likewise could not be held liable.
Nevertheless, it should be noted that even in West Virginia, this expansion of the pay-if-paid defense to payment bond sureties is not without limits. A more recent federal court decision on this same subject limited the applicability of the Wellington decision to disputes involving private or state construction projects and refused to extend the defense to Miller Act payment bonds on federal government construction projects. United States f/u/b Straightline Corporation v. American Casualty Company of Reading, 2007 WL 2050323 (N.D. W. Va. 2007).
Common Sense Points of Emphasis
The Wellington decision provides a surety with defenses under West Virginia law that bond underwriters and claims handlers may not anticipate. The decision highlights some basic considerations that claims handlers should consider in performing an investigation:
- Always review your principal’s contract. This obvious first step to any claim investigation is sometimes overlooked or forgotten. Your principal’s contract may provide unique defenses that have not otherwise been considered.
- Investigate applicable law. Take the time to determine whether applicable state law provides you with any unanticipated defenses under your principal’s contract or your bond.
- Consider the assertion of “pay if paid” defenses. Although many jurisdictions have decided this issue against sureties, the question has not been settled in all jurisdictions.
