Legal Blog

L&M Payment Bond

Cynical people claim that the purpose of insurance companies is not to pay claims, but to receive premiums. However, insurance companies and sureties have a duty to their shareholders to ensure that the claims that they pay are valid. Sureties have an additional constituency when making a decision to pay: the parties indemnifying those obligations (i.e. the contactor that was the principal under the bond and, almost inevitably, its individual guarantors). Accordingly, when the surety in Lopes Limited v. Guarantee Company of North America, a 2019 decision of the Ontario Court of Appeal, thought that sub’s claim against a labour and material payment bond would result in the sub being overcompensated, it fought that claim.

Story

The sub had a subcontract to fabricate, supply, and install HVAC, plumbing, and controls systems for the project.

The general posted a labour and material payment bond and a performance bond through, as is normal, the same surety. The general walked away from the project in mid-build, leaving a trail of unpaid subs. The owner called upon the performance bond and, ultimately, the surety arranged for another general to finish the project.

When the general abandoned the project, it owed the sub $252,000 in unpaid invoices, $66,000 in holdback, and interest. The sub and other unpaid subs registered claims for lien. The sub also claimed against the labour and material payment bond, demanding payment of $441,000. We were not told why the amount claimed against the bond, at least initially, was so much more than the amount seemingly due for the work performed.

The sub had completed 61% of its subcontract scope when the general abandoned the project and the work stopped. At that time, the sub had $483,000 of work yet to complete. That amount, presumably, was comprised of the cost to complete the work and the profit and overhead associated with that completion.

The replacement general called for tenders to finish the project. The sub responded and quoted $932,000 to finish its scope. Notwithstanding that the sub had incomplete work of only $483,000, it was the low, and successful, tenderer. Presumably, no other sub, who might have been able to complete this seemingly unusual scope of work, submitted either a lower bid or, possibly, any bid at all. This is not surprising; subs are loath to pick up a project in mid-stream because they may get stuck with their predecessor’s mistakes.

Arithmetic

By virtue of its success in being awarded the completion of the scope for the startling amount of $932,000, the sub earned a tidy profit of $449,000 (i.e. $932,000 – $483,000), far more than it would have earned had it been able to finish its original subcontract with the general, and been paid, in the normal course.

The lien actions were resolved before the bond action; the sub’s proportionate share of the proceeds was $145,000. The claim against the bond was thus reduced to $184,000 (i.e. unpaid invoices of $252,000 plus holdback due of $66,000 less lien proceeds of $145,000).

Dispute

The surety was not keen to pay the sub anything. After all, although it may have still been owed $184,000, the sub had made an additional profit of $449,000 in completing its incomplete work under its new contract with the replacement general. As far as the surety was concerned, the sub had mitigated its damages in full and was not entitled to a penny more. Conversely, the sub claimed that its profit on the replacement contract was irrelevant to its claim for damages under the bond.

Damages

The surety relied on the following statement of law:

” …following a breach of contract, a person who suffers a loss is entitled, so far as money can do it, to be placed in the position in which he or she would have been had the contract being (sic) performed, provided the plaintiff can prove, on a balance of probabilities, what damages have been suffered. However, the wronged person cannot sit idle and must take all reasonable steps to mitigate the loss related to the breach. Where a plaintiff has taken steps to mitigate its loss, even by taking actions beyond the reasonableness required by the law, any benefit that has reduced or even eliminated its loss must be accounted for in considering the amount of damages that the plaintiff has suffered.”

The surety argued that the subsequent completion subcontract was such a mitigating transaction, going to the root of the sub’s claim. But for the general’s breach of the original subcontract, there would have been no completion subcontract and no profit emanating from it. Accordingly, since the sub actually benefited from the general’s default, it suffered no damages at all.

Decision

The judge agreed that an innocent party had a duty to mitigate its damages arising from a breach of contract. However, he noted that the sub made no claim for the profit it lost because it was not allowed to complete the contract; it claimed only for the work that it performed under the contract. Accordingly, when it entered into the completion contract, the sub was not mitigating its damages for unpaid work; that loss had already crystallised. It was mitigating damages for loss of profit on future work, damages that it had never claimed against the surety.

Appeal

The surety was not pleased with the original decision and appealed to the Court of Appeal. We suspect that it could not stand the thought of having to eat a substantially higher cost under the performance bond for the sub to complete its scope and still pay the sub its claim for prior unpaid invoices under the labour and material payment bond.

The Court of Appeal dismissed the appeal in a short, seven paragraph decision. It summed up its decision as follows:

“Here, the (sub’s) decision to bid on and enter into a new completion subcontract was not an action taken to mitigate the loss consequent on the breach that was (the general’s) failure to pay for the completed work. The (sub) would have secured the benefits flowing from the completion subcontract regardless of (the general’s) failure to pay for the completed work. It was (the general’s) abandonment of the subcontract, not its failure to pay for completed work, that created the necessity for the completion subcontract. In short, as the motion judge correctly held, the (sub’s) successful bid for the completion subcontract was not consequent on (the general’s) failure to pay its invoices.”

Upshot

The sub was in the driver’s seat because, we believe, of a seemingly unusual scope of work. We doubt that it would have been the successful tenderer had its completion work been ordinary run-of-the-mill HVAC or plumbing work. The performance bond protected the owner; the surety had no such protection.

Change the facts a bit. Assume that the sub, rather than the general, went bust. The general would have been in the unenviable position of having to replace the sub. This is another reason why generals should vet their subs before awarding subcontracts to them or, alternatively or in addition, get performance bonds from subs performing complicated work or having large dollar value subcontracts.

 

Image courtesy of hotblack.

Written by Jonathan Speigel, the founding partner of Speigel Nichols Fox LLP, leads the litigation and construction practices.