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Schnader Attorneys Achieve Significant Victory for Surety Client Federal Insurance Company

On March 31, 2011 by Schnader in Construction

Schnader attorneys achieved a significant victory for Firm client, Federal Insurance Company (Federal), in a case before the U.S. District Court for the Southern District of New York (Southern District) resulting in the dismissal of $5 million in claims. On March 29, the court issued a ruling in Federal Insurance Company v. Turner Construction Company, which granted Federal’s motion for summary judgment, denied a cross motion for summary judgment brought by the New York Economic Development Corporation (EDC), and dismissed $5 million in claims asserted by Turner Construction and the EDC. The decision is a seminal holding in the area of suretyship law.

Schnader’s team included Theodore L. Hecht, Cynthia A. Murray and Scott D. St. Marie, with Thomas F. Giordano and Matthew J. Kelly, Jr. in a supporting role. 

The case arose in September 2007, when Federal was called on by Turner Construction Company (Turner) to perform on a $21 million performance bond it had issued to a subcontractor, in connection with a project to lengthen, widen and modernize a Hudson River pier to enable larger cruise ships to dock at the New York Cruise Terminal on the west side of Manhattan. The project was sponsored by EDC, a nonprofit company that acts as a development consultant for the City of New York, with Turner serving as the construction manager. Federal refused Turner’s demand on the performance bond, asserting that the EDC, Turner and the subcontractor had entered into a material modification of the bonded subcontract, and that Turner had wrongfully terminated the subcontractor. 

By way of brief background, in August 2007, a month prior to Turner’s termination of the subcontractor, the EDC, Turner and the subcontractor had entered into a memo of understanding (“the August MOU”), which provided for certain new performance milestones and also provided that the subcontractor would receive no further payments until its name was cleared in a pending U.S. Attorney’s investigation in Virginia. The parties to the August MOU did not request Federal’s consent prior to this agreement and did not notify Federal that the August MOU had been signed. The result of the payment stoppage was predictable; the subcontractor missed the next milestone, and was then terminated by Turner, at the direction of the EDC.

Two months after the termination, Federal filed an action in the Southern District seeking a determination that Federal was not liable to Turner under the performance bond. Turner counterclaimed for $5 million in completion costs, which claim was subsequently assigned by Turner to EDC. 

After extensive discovery, cross-motions for summary judgment were submitted, with Federal arguing that the August MOU constituted a material modification to the bonded subcontract and that, in the absence of consent or even notice to Federal, Federal was discharged from the performance bond, entitling Federal to summary judgment. Turner and EDC argued that Federal was not discharged from the performance bond, that the subcontractor had defaulted on the performance milestones, that Federal had in fact become aware of – and had not objected to – the August MOU soon after it was executed, and therefore Federal was liable for $5 million in excess completion costs incurred by Turner and EDC.

In a 27 page decision, Judge Keenan sided with Federal, determining that the August MOU had effected a material alteration of the subcontract, virtually guaranteeing that the stoppage of payment to the subcontractor would result in an inability of the subcontractor to perform, with the likelihood that Federal would be called on to take over the project under the performance bond. In addition, the Court reviewed in detail how EDC had failed to follow the proper channels for obtaining the necessary funding for the subcontract, noting:

The onus of registration was on EDC – which is not a party to the subcontract – in order to fund project work. It is undisputed that, at the time it approved the subcontract, EDC never told Turner, [the subcontractor], or Federal about the necessity of registration with the Comptroller. EDC itself overlooked any registration requirement, allowing [the subcontractor’s] work to progress for over a year without submitting the subcontract to the Comptroller.

In so doing, the Court appears to suggest that EDC’s actions in effecting Turner’s termination of the subcontract may have been largely dictated by the EDC’s need to camouflage subcontract funding problems the EDC itself had created.

As a result, the Court granted Federal’s request for a motion for summary judgment and dismissed all claims against the performance bond on the ground of material alteration of the underlying subcontract. Judicial decisions discharging commercial sureties from liability under bonds are a relative rarity. For that reason, Judge Keenan’s decision is likely to have a significant impact in the suretyship field. More important, however, is the favorable impact the decision will have for Firm client Federal.