STAYING LITIGATION AGAINST A PAYMENT BOND SURETY PENDING THE OUTCOME OF ARBITRATION INVOLVING THE GC AND SUB

canstock3275078The all-too-common dilemma: If the subcontract includes an arbitration provision, but the payment bond does not, can the subcontractor pursue a simultaneous lawsuit against the payment bond surety while there is an arbitration proceeding involving the general contractor? And, can the general contractor or the payment bond surety stay the litigation pending the outcome of the arbitration involving the subcontractor?

 

Hofer, Inc. v. Fidelity and Deposit Co. of Maryland, 2014 WL 644598 (N.D. Fla. 2014), is an interesting opinion that involves this very dilemma. In this case, a payment dispute arose where the subcontractor claimed it was owed money for work it performed for an apartment project and the general contractor claimed the subcontractor was not owed money for deficient work. A familiar fact pattern! The subcontract contained an arbitration provision. Before arbitration came into play, the subcontractor filed a lawsuit against the payment bond. (The payment bond was not an unconditional payment, but rather, a conditional payment bond meaning that if the owner did not pay the general contractor, the subcontractor would have lien rights, not payment bond rights.) After the lawsuit was filed, the general contractor demanded arbitration with its subcontractor pursuant to the subcontract. The payment bond did not contain an arbitration provision nor did it incorporate by reference the subcontract’s arbitration provision. Thus, there was no way the surety could be compelled to arbitration. After the arbitration proceeding commenced, the payment bond surety moved to stay the lawsuit pending the outcome of the arbitration proceeding involving the subcontractor and general contractor. Naturally, the subcontractor contested this motion–it was the party that initiated the dispute first.

 

The Northern District maintained that it is has discretion whether to stay the litigation pending the outcome of the arbitration. It explained that there is a heavy presumption that litigation can proceed at the same time as arbitration when the litigation involves a nonarbitrable claim (a claim not subject to arbitration such as the payment bond claim), but “if the arbitrable issues are crucial for the determination of nonarbitrable claims, a court has discretion to stay the litigation.” Hofer, supra, at *1. In other words, if the arbitration is going to resolve issues that are important to the litigation, a court has the discretion to stay the litigation pending the outcome of arbitration.

 

A payment bond surety is entitled to most of the contractual defenses of its bond-principal general contractor. Therefore, it would be entitled to the same defenses / arguments that the general contractor was raising against the subcontractor pertaining to deficient work. So, if the general contractor prevails in its arbitration, the subcontractor’s claim against the payment bond surety could become moot. Because the payment bond was a conditional bond, the surety and general contractor could argue that the subcontractor does not have a payment bond claim because the owner never paid the general contractor for the subcontractor’s work and the subcontract contained a pay-if-paid provision. However, it does not appear this argument was asserted so perhaps the owner did pay the general contractor and the general contractor simply withheld the amount of the back-charge. To this point, the Northern District maintained, “Nothing in the record suggests that whether Apex [general contractor] has been paid for Hofer’s [subcontractor] work will be an issue in the arbitration process.” Hofer, supra, at *2. Indeed, the only issue in arbitration was whether the general contractor paid the subcontractor the proper amounts due under the subcontract. This means that the fact that the payment bond was a conditional bond instead of an unconditional payment bond was of no true significance in this dispute. This is important because since most payment bonds are unconditional payment bonds (that are not conditioned on the payment of the owner and where pay-if-paid is not a defense), the rationale in this case would apply to unconditional payment bonds.

 

The Northern District found that even though the subcontractor was not bound to arbitrate its dispute with the payment bond surety, the litigation should nonetheless be stayed because i) the subcontractor agreed to resolve its disputes with the general contractor through arbitration and ii) the predominant issue in the dispute, that being whether the general contractor owed the subcontractor money, was being decided by the arbitration proceeding.

 

Although the actual facts of the dispute were not discussed, it seems apparent that once the subcontractor filed the lawsuit against the payment bond, the general contractor affirmatively demanded arbitration pursuant to the subcontract in furtherance of having the dispositive facts of the dispute decided by an arbitrator instead of through litigation. This was a good strategy because the general contractor and subcontractor agreed to have such disputes decided by arbitration. Even though the payment bond surety was not bound by the arbitration provision, the surety is typically defended by the general contractor and is raising most of the same defenses the general contractor would raise such as deficient work. Now, because the court had discretion as to whether to stay the litigation or allow it to proceed simultaneously with the arbitration, this is a risk the general contractor took by virtue of the subcontract. It is a risk because if the Northern District denied the surety’s motion to stay, the general contractor could have likely had the facts of this dispute determined by litigation instead of arbitration (depending on which case was tried first) which could have made portions of the arbitration moot.

 

So, what could have been done to prevent this scenario? A couple of thoughts to create the argument to avoid a simultaneous litigation and arbitration:

 

  1. In drafting the arbitration provision in the subcontract, ensure that it includes the general contractor’s surety. The provision could state something to the effect that if the subcontractor initiates a claim against the general contractor’s surety, the surety, at its option, can invoke and demand arbitration pursuant to this arbitration provision as the surety is an intended third party beneficiary of the right to demand arbitration in this provision. The key is that if the subcontractor files suit and the general contractor/surety prefer arbitration, they have a contractual provision that would make it compelling to dismiss the litigation or, more likely, stay it pending the outcome of arbitration.
  2. The other option, although far, far less common, is to include in the bond that the dispute resolution procedure is the same as in the subcontract of the claimant. There may be arguments around such a provision and the surety may not want its fate determined in an arbitration where there are not any appellate rights (and, perhaps, it may have concerns over the indemnification it is receiving from the general contractor).

 

For more information on arbitration provisions, please see: http://www.floridaconstructionlegalupdates.com/deference-given-to-arbitration-agreements/ and http://www.floridaconstructionlegalupdates.com/appreciating-the-risks-or-frustrations-of-arbitration/.

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.