Left to right: Fred Jacoby, Jeff Mullen and Ray DeLuca of Cozen O’Connor

Construction is a risky business. Construction contracting is an exercise in dealing with risks by allocating them among the various project participants. Most construction contracts contain terms and conditions that shift the risk of nonpayment from the owner downstream to the subcontractor.

Historically, subcontractors look to payment surety bonds as a source of credit for the contractor to ensure that the subcontractor gets paid for its work under the subcontract.  Sureties on these bonds are typically entitled to avail themselves of all of the defenses of the bonded principal, including subcontract terms and conditions that may limit or restrict a subcontractor’s ability to recover for its work. In evaluating the enforceability of such defenses by a surety on public projects, parties need to consider applicable statutes requiring such bonds in the first instance.

This is true for federal construction projects subject to the Miller Act. By way of example, while not necessarily applicable to private surety bonds or those provided pursuant to state law, under the Miller Act, a subcontractor may not be precluded from asserting a claim for delay damages or be forced to await completion of the dispute resolution proceedings between the contractor and the government owner to pursue its claims for payment under the subcontract.  Following is a discussion of recent federal cases addressing a surety’s ability to avail itself of certain contractual defenses in the context of the Miller Act.

The Miller Act

What is commonly known as the Federal Miller Act is codified at 40 U.S.C. Section 3131-3134. The Miller Act requires a contractor contracting with the federal government for a construction project with a prime contract in excess of $100,000 to provide, among other things, a payment bond. At its heart, the Miller Act affords protection to subcontractors that, in private construction, would be available through state mechanics’ lien statutes. Because federal property is not subject to lien, the focus of secondary recourse for payment on these projects is the surety bond posted pursuant to the Miller Act. Individual states enacted equivalent statutes commonly referred to as “Little Miller Act” statutes imposing similar bonding requirements on public works projects at the state level. See, e.g., 8 P.S. Sections 193.1, et seq. (Pennsylvania’s Little Miller Act).

Subcontractor’s Recovery Under the Subcontract

Most construction contracts contain terms and conditions that affect a subcontractor’s right to payment. For example, there are “pay-when-paid” or “pay-if-paid” clauses meant to prevent a subcontractor from suing for base contract amounts or changes until or if the owner has paid the contractor for its work. There are “no-damage-for-delay” clauses that state that the subcontractor cannot recover time-related damages. There are also “pass-through” provisions that state that, where the owner is at fault (for extra work, delays, etc.), the subcontractor’s sole remedy is to pass its claims through the contractor, and the subcontractor’s sole entitlement is to whatever the owner eventually pays to the contractor. Separately, independent of their application in the presence of a Miller Act claim, all of these clauses have been tested in court and, with some exceptions, have been held to be legally enforceable.

Subcontractor’s Recovery Against the Miller Act Bond

Payment bond sureties often rely on these terms and conditions in the subcontract as a defense to a claim of nonpayment by a subcontractor, or for otherwise prohibited damages. In general, a surety assumes only the liability of its principal. In Miller Act cases, however, courts look beyond the principal’s contractual liability, to the Miller Act itself, in defining the limits of coextensive liability between the surety and its principal. In this regard, the Supreme Court has recognized that “[t]he surety’s liability on a Miller Act bond must be at least coextensive with the obligations imposed by the Act if the bond is to have its intended effect,” see United States Sherman v. Carter, 353 U.S. 210, 215-16 (1957). Importantly, the Miller Act trumps conflicting suretyship principles such that a surety can only enforce subcontract terms to limit its liability if those terms are consistent with the Miller Act. See, e.g., United States Marenalley Construction v. Zurich American Insurance, 99 F. Supp. 3d 543, 550 (E.D. Pa. 2015) (“A subcontract term that conflicts with the Miller Act is ineffective in a suit against the surety on the payment bond.”).

Case law from federal courts in a number of jurisdictions has addressed the effect of restrictive subcontract terms in Miller Act claims. As these cases illustrate, courts construe the Miller Act liberally to protect subcontractors, and a subcontractor may have broader rights in an action against the Miller Act bond than it would otherwise have in an action for breach of the subcontract.

  • Pay-when-Paid/Pay-if-Paid

For example, it can be said with some assurance that the Miller Act takes precedence over a pay-when-paid or pay-if-paid clause in a subcontract. See, e.g., United States Tusco v. Clark Construction Group, 235 F. Supp. 3d 745, 756 (D. Md. 2016) (surveying cases and noting that “federal courts … have unanimously held that a surety is not entitled to the benefits of its principal’s pay-when-paid or pay-if-paid clause”). There are two general reasons for this. First, the Miller Act gives a subcontractor the right to sue a payment bond’s surety based on the passage of time from completion of the work or provision of materials, not conditioned on payment from the owner to the contractor. The payment bond portion of the Miller Act would be meaningless if it could be defeated by a defaulting owner, a situation where the bond is of the most importance. Second, if the subcontractor were forced to wait to bring a bond claim because the owner had not yet paid the contractor, the mandatory time limit for filing a Miller Act suit in court could expire.

  • Delay Damages

Following on these holdings, the Middle and Eastern District of Pennsylvania, as well as the U.S. Courts of Appeals for the Fifth, Ninth, Eleventh, and District of Columbia Circuits have held that subcontractors can recover the out-of-pocket costs of delay from a Miller Act surety, notwithstanding a prohibition of such damages in their subcontracts. See, e.g., United States Pioneer Construction v. Pride Enterprises, 2009 WL 4429802, at *8-9 (M.D. Pa. Nov. 27, 2009) (collecting cases). More recently, in the 2017 case of United States v. John C. Grimberg, 2017 U.S. Dist. LEXIS 173362 (E.D. Va. Oct. 19, 2017), a federal district court in Virginia agreed with the reasoning of these courts in determining that the surety may not rely on the no-damage-for-delay clause in the subcontract to limit its Miller Act liability. The Grinsberg court found that the no-damage-for-delay clause at issue contravened the text and purpose of the Miller Act because, like pay-when-paid or pay-if-paid clauses, the no-damage-for-delay clause added a condition to the action on the payment bond that a subcontractor can only bring a Miller Act claim if the owner has paid the contractor for the delays.

  • Pass-through Claims

Likewise, another situation often encountered by subcontractors occurs when there is a pass-through provision in the subcontract providing that if the claim relates to actions by the government, the subcontractor is only entitled to whatever relief is granted by the government to the contractor on the subcontractor’s behalf. In the Grimberg case, for example, the pass-through language required the subcontractor to await completion of the dispute resolution proceedings between the contractor and the government pursuant to the procedures provided for in the Contract Disputes Act. See also United States v. Hartford Accident & Indemnity, 2017 U.S. Dist. LEXIS 197749 (M.D. Pa. Dec. 1, 2017). In a more recent federal district court case, Pinnacle Crushing & Construction v. Hartford Fire Insurance, 2018 U.S. Dist. LEXIS 67965 (W.D. Wa. Apr. 23, 2018), the pass-through language was similar and even included an agreement by the subcontractor that it would not take or would suspend any other action commenced pursuant to the Miller Act pending final determination of the upstream dispute resolution proceedings.  These federal courts all held that the pass-through limitation improperly restricted the subcontractor’s Miller Act rights. The reasoning was that the pass-through language essentially acted as a waiver of Miller Act rights—that the government, not a court in a Miller Act suit, would have final say over the claims. In addition, like the pay-when-paid or pay-if-paid argument, if the subcontractor had to wait to file a Miller Act suit until there was a final government decision on the pass-through claims in the upstream action, the Miller Act’s time limits might have expired.

Conclusion

In summary, federal courts in a number of jurisdictions have refused to permit Miller Act sureties to eliminate the right of a subcontractor to payment altogether, or delay it, based upon contractual defenses unless the terms and conditions of the subcontract are consistent with the terms of the Miller Act. These are important decisions to keep in mind for contractors working on federal projects, and they may influence how a state court interprets its own “Little Miller Act.”

Fred Jacoby, Ray DeLuca and Jeff Mullen are construction law attorneys in the Philadelphia office of Cozen O’Connor. Contact them at FJacoby@cozen.com, RDeLuca@cozen.com and JRMullen@cozen.com.