By: Richard E. Guttentag, Esq., Stearns, Roberts & Guttentag, LLC

As previously reported, the case of Allegheny Cas. Co. v. Archer-Western/Demaria Joint Venture III, 2014 WL 4162787 (M.D. Fla. August 21, 2014), involved a dispute between a General Contractor (“Contractor”) and a performance bond Surety (“Surety”) on a construction project.  In addition to the court’s ruling that a surety’s liability under a performance bond was generally limited to the penal sum of the bond (discussed in a prior article), this case also analyzed the issue of whether the Contractor intentionally misrepresented material information to the Surety resulting in the Surety issuing a performance bond to a subcontractor.

As part of the Surety’s underwriting process to determine the Subcontractor’s creditworthiness and ability to perform the job, the Surety asked the Contractor to submit an “All Rights” letter on the Surety’s form. The Surety’s form included language that the Subcontractor’s bid was “in line, in that it was less than 10% lower than the next responsible bidder’s price.”

The Contractor’s All Rights letter omitted the statement that the Subcontractor’s bid was in line and less than 10% lower than the next lowest bid, as the Subcontractor’s bid was approximately 25-30% lower than the next lowest bid.  However, the Contractor indicated in the letter that it possessed no facts or information which would lead the Contractor to believe that the Subcontractor would have any problem completing the job according to the plans and specifications, on schedule, and while paying its bills.

Although the Surety noticed that the statement that the bid was ‘in line’ was absent from the All Rights letter, the Surety interpreted the Subcontractor’s bid was in line based on the Contractor’s representation that it possessed no information that Subcontractor would be unable to perform. Based on the All Rights letter and its own investigation, the Surety issued a performance bond to the Subcontractor.

Subcontractor was unable to complete its work and defaulted. The Surety agreed to complete the Subcontract under a Takeover Agreement with the Contractor. After several months, the Surety informed the Contractor that its expenses on the project had exceeded the penal sum of the bond, and stopped work on the project.  The Contractor and Surety filed numerous claims against each other in connection with the bond, one of which was the Surety’s claims against the Contractor for intentional misrepresentation.

A party suing for fraudulent misrepresentation must prove: 1) that a party made a false statement about a material fact, 2) the party knew that the representation was false, 3) the party intended that another person would act in reliance on the misrepresentation, and 4) damages caused by reliance on the misrepresentation. The Surety argued that the Contractor fraudulently misrepresented material information by affirmatively stating that it did not possess any information indicating that the Subcontractor would have a problem completing the project, and by failing to disclose that the Subcontractor underbid the project. The Surety explained that it would never have issued the bond had it known that Subcontractor’s bid was 25-30% lower than the next lowest bid.

In opposition, the Contractor argued that it did not make a false statement by omitting the language that the bid was “in line”.  The Contractor explained that it omitted this language because including such language would have been inaccurate. The Contractor further argued that the Surety should have requested clarification on the bid spread issue, had a duty to perform its own investigation of Subcontractor’s creditworthiness, that the Surety had superior knowledge of the Subcontractor’s financial situation, and relied on that knowledge in issuing the bond. Finally, the Contractor argued that the statements in the All Rights letter were mere opinions, rather than facts that could form the basis for a fraudulent misrepresentation action.

Under the laws governing construction bonds, an obligee (i.e. the person in whose favor the bond is written) may not misrepresent to the surety any material information about the transaction between the obligee and its debtor. A misrepresentation is material if, but for the misrepresentation, the bond would not have been issued, or if the misrepresentation might increase the extent of the surety’s liability. Further, an obligee has a duty to disclose material information to potential sureties seeking information about a would-be principal’s financial condition.

That being said, an obligee does not have a duty to search for information on behalf of the surety, or to perform research that a surety itself should conduct in its underwriting process. An obligee has no duty to warn the surety that the posting of the bond may not make business sense. Further, a party cannot recover for fraudulent misrepresentation if it has the opportunity to conduct an investigation but failed to do so.

The Court ruled that the Contractor’s statement that it possessed no facts or information which would lead the Contractor to believe that the Subcontractor would have any problem completing the job, was a false statement of fact, and not an opinion.  Thus, the Surety could pursue an action for fraudulent misrepresentation. However, because there was conflicting evidence as to whether the Surety actually relied on the false information supplied by the Contractor in issuing the bond, the Court denied the Surety’s motion for summary judgment, thereby requiring a trial to decide the issue.

This case demonstrates that if a contractor fails to disclose all known financial information of its subcontractor and the subcontractor’s ability to perform its work on a project, pursuant to the subcontractor’s surety’s request during the underwriting process, the contractor could be exposing itself to a claim for intentional misrepresentation.

About the Authors: Richard E. Guttentag is a partner with Stearns, Roberts & Guttentag, LLC, and is Board Certified in Construction Law by the Florida Bar. Mr. Guttentag exclusively in construction law including construction lien claims and defense, payment and performance bond claims and defense, bid protests, construction contract preparation and negotiation, and construction and design defect claims and defense. He can be reached for consultation at [email protected].

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