Federal Circuit Court of Appeals Holds that a Payment Bond Surety that Discharges a Contractor’s Obligation to Pay a Subcontractor is Equitably Subrogated to the Rights of Both the Contractor and Subcontractor and May Bring Suit Directly Against the United States

National American Insurance Company v. United States
No. 2007-5016, 2007 U.S. App. LEXIS 20058 (Fed. Cir. August 23, 2007)

The US Court of Appeals for the Federal Circuit upheld the lower court’s grant of a motion for summary judgment. The Court held that a payment bond surety is equitably subrogated to the rights of the contractor whose debt it discharges, and thus can pursue a claim directly against the government.

The case arose out of a contract between Innovative PBX Services, Inc. (“Contractor”) and the United States Small Business Administration (the “government”) for the replacement of a telephone system at the Department of Veterans Affairs Medical Center. The Contractor subcontracted part of the work to Nortel Communications Systems, Inc. (“Subcontractor”). As required by the Miller Act, the Contractor executed payment and performance bonds in favor of the government with National American Insurance Company (“Surety”) as the surety. After completion of the contract work, the Subcontractor notified the Surety that it was owed approximately $675,000 for labor and materials that the Contractor had failed to pay for. The Subcontractor then instituted a Miller Act claim under the payment bond against the Surety, which the Surety settled. The Surety also notified the government that no addition payments should be made to the Contractor in light of the Miller Act claim and requested that all remaining contract funds be held for the Surety’s benefit. The government, however, did not follow the Surety’s request and made its final contract payment to the Contractor. As a result, the Surety filed a complaint against he government seeking damages of $280,000.

The Court of Federal Claims granted summary judgment in favor of the Surety holding that: (1) as a surety that had made payments on a payment bond and satisfied all outstanding claims, the Surety was equitably subrogated to the rights of the Contractor; (2) the Tucker Act’s waiver of sovereign immunity extended to the Surety as the equitable subrogee of the Contractor; and (3) the government violated its duty as stakeholder in the payment bond by making final payment to the Contractor after being notified that the Surety was asserting its right to the remaining contract funds.

The government appealed to the Federal Circuit arguing that a payment bond surety only stands in the shoes of the subcontractor who it has paid, and thus, under Department of the Army v. Blue Fox, Inc., 525 U.S. 255 (1999), cannot pursue a claim directly against the government. The government relied on a statement in Ins. Co. of the W. v. United States(“ICW”), 243 F.2d 1367, 1370 (Fed. Cir. 2001), that “a surety who discharges a contractor’s obligation to pay subcontractors and is subrogated only to the rights of the subcontractor” and “has no enforceable rights against the government.” The Federal Circuit, however, affirmed the Court of Federal Claims, characterizing the passage in ICW upon which the government relied as dicta (given that the case involved only the consideration of a performance bond surety’s rights).The Court held, consistent with prior precedent such as Balboa Ins. Co.v. United States, 775 F.2d 1367 (Fed. Cir. 2001) that a payment bond surety that discharges a contractor’s obligation to pay a subcontractor is equitably subrogated to the rights of both the contractor (who has privity with the government) and the subcontractor, and may pursue a cause of action directly against the government.

Click here to view full opinion as PDF (provided with the permission of LexisNexis).

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