U.S. District Court in Michigan Denies Performance Bond Claim for Contractor’s Failure to Meet Conditions Precedent – Also Holds that Surety May Proceed with Overpayment Defense and Counterclaim

Lasalle Group, Inc. v. JST Properties, LLC
2011 U.S. Dist. LEXIS 83548 (S.D. Mich. July 29, 2011)

LaSalle, as general contractor, obtained a contract for construction of a school building in Gulfport, Mississippi. LaSalle subcontracted the concrete work on the project to Gulf Coast. American Contractors Indemnity Company (“ACIC”) provided performance and payment bonds to support LaSalle’s obligations under the subcontract.

During the project, Gulf Coast stopped paying its vendors and subcontractors. LaSalle contacted Gulf Coast to provide notice of formal default under the subcontract. LaSalle also contacted Gulf Coast’s surety bond broker to inform of the situation. Gulf Coast continued its failure to make the necessary payments.

Approximately ten days after contacting Gulf Coast and its broker, LaSalle sent a letter to ACIC stating that: 1) Gulf Coast had failed to properly perform and pay its venders and subcontractors, 2) LaSalle was forced to terminate Gulf Coast’s subcontract, and 3) LaSalle was asserting a claim against the performance bond for completion costs and the payment bond to the extent that it had made payment to certain vendors to Gulf Coast. ACIC denied LaSalle’s claim on the performance bond for failure to comply with several conditions precedent. ACIC also made payments to several of Gulf Coast’s vendors.

LaSalle sued ACIC for failure to honor its obligations under the performance bond. ACIC filed a motion for summary judgment to dismiss LaSalle’s performance bond claim. The performance bond contained three conditions, which ACIC alleged that LaSalle did not satisfy. First, LaSalle failed to notify ACIC and Gulf Coast that it was considering declaring a default. Second, LaSalle prematurely declared default. And, third, LaSalle failed to pay the subcontract balance to ACIC, when it paid the remaining balance to replacement contractors, which it selected without ACIC’s participation.

The United States District Court for the Southern District of Michigan granted ACIC’s motion. The court held that it could not conclude as a matter of law that LaSalle’s failure to satisfy the first two conditions precedent discharged ACIC’s obligations. But the court determined that LaSalle’s failures to satisfy the third condition precedent, by not offering payment of the subcontract balance to ACIC, and by not including ACIC in the selection of replacement subcontractors, discharged ACIC’s obligations under the performance bond.

The court also held that ACIC could proceed with its affirmative defense to LaSalle’s payment bond claim, and its counterclaim, based upon LaSalle’s overpayment to Gulf Coast. ACIC argued that LaSalle’s overpayment reduced the contract balance, which served as ACIC’s collateral with respect to its indemnity and subrogation rights. The court concluded that Michigan law provides that a surety may be discharged from its obligations if an owner makes payment to a subcontractor in circumstances where the subcontractor is not entitled to payment.

Click here for full text of decision courtesy of LexisNexis.

Robert A. Gallagher

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