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Enforcing Public Contracts against a Surety

How the WA Supreme Court Raised the Cost of Public Contracts

September 27, 2017

Overview

This summer, the Washington Supreme Court ended a long dispute within the construction industry and issued an opinion finding that a performance bond is, in essence, an insurance contract. The court made clear that a public owner who must sue to enforce coverage of a performance bond is entitled to Olympic Steamship fees.  This case, King County v. Vinci Construction Grands Projects/Parsons RCI/Frontier-Kemper JV, No. 92744-8 (“Vinci”), may significantly change the landscape for contractors performing public contracts and public agencies administering public contracts.

In addition to awarding attorney fees to a public owner who must sue to enforce a bond, a majority of the court seems to gut the requirement that a public agency must make an offer of settlement as required under a public works statute. Instead, the Court held that the attorney fee provision of the statute is not the exclusive fee remedy, and that parties to a public works contract may pursue fees based on contract, statute, or other equitable principles without having to make a settlement offer. Lastly, the Court determined that the County’s attorney fees to dispute bond coverage could not be separated from its attorney fees on the breach of contract claims, and so the County was entitled to both.

The facts in Vinci were not in dispute. The joint venture contracted with King County to expand the County’s wastewater treatment system. When the contractors failed to meet the contract deadline caused by unforeseen site conditions, the County terminated the contractors and brought a claim against the performance bond. The contractors contended that they were not in breach of the contract because the delays were the fault of the County and further alleged that the County had breached the contract by terminating the contractors. The sureties agreed with the contractors and refused to cover the County’s claim against the performance bond and complete the project.

The County sued the contractors and one of the surety companies. The other sureties intervened in the lawsuit and adopted the contractors’ breach of contract defenses for refusing to perform on the bond. The trial court held in favor of the County and awarded it damages for $130 million for the contractors’ breach. The trial court further awarded the County nearly $15 million for its attorney fees because the contractors defaulted under the contract and the sureties had wrongfully denied coverage on the performance bond. The Court of Appeals affirmed the trial court’s holding. The sureties appealed to the Washington Supreme Court, which affirmed the decision of the Court of Appeals.

The Court’s decision resolves a long-standing issue: Olympic Steamship fees apply equally to surety bonds as insurance contracts. In determining this, the Court looked at the disparity of bargaining powers between the contractor and the surety. Yet a performance bond involves a surety, the contractor (principal), and public agency (obligee). The dissenting opinion argued that the critical difference between a bond and a take-it-or-leave-it insurance policy is that the obligee (in this case, the County) dictates the terms of the bond, so there can be no disparity in bargaining power between the surety and the public obligee. However, the majority of the court disagreed and found that the County was entitled to its attorney fees under the equitable remedy provided in Olympic Steamship.

The Court’s allowance of attorney fees for coverage disputes in performance bonds is significant because it could have the unintended consequence of making bonds more difficult to obtain for contractors as well as making bond premiums on public projects cost prohibitive. Many small contractors have difficulty obtaining bonds on projects; thus, this decision can make it even more problematic for those smaller contractors trying to perform more public contracting work.

The Vinci court’s second key holding may have more far-reaching consequences in the construction industry. The Court found that the attorney fee provisions of the public works statute are not the exclusive remedy for awarding fees. The majority in Vinci found that there was no language in RCW 39.04. et al. suggesting that the statutory fee provision excludes all other means of recovering attorney fees. It emphasized that the state legislature, in its final bill report, acknowledged that attorney fees may be awarded as authorized by statute, contract, or other equitable common law grounds. Therefore, the prevailing party in a public works dispute may pursue attorney fees based on contract, statute, or other equitable principles (such as the one delineated in Olympic Steamship).

Prior to this ruling, the only way a prevailing party could recover its attorney fees was to comply with RCW 39.04.240, which requires the party seeking to recover its fees to make a settlement offer. If the offer is not accepted then, at trial, the party making the offer has to do as well as or better than the offer it made to settle the dispute. The statute is intended to encourage parties to public contracts to resolve their disputes before engaging in a costly and time consuming trial—in Vinci, the trial lasted nearly three months and the County’s attorneys were financed with public funds. Now, the Vinci Court’s ruling opens the door to other approaches for contractors and public owners to obtain their attorney fees. It may deter parties from making offers to settle disputes that arise under a public works contract—causing parties to engage in costly litigation at the taxpayers’ expense instead of reaching a resolution.

It is also important to note that Olympic Steamship fees are an equitable remedy that are awarded to an insured seeking to enforce an insurance contract. This remedy is not necessarily reciprocal, meaning that the contractor and sureties defending a bond coverage claim may not be entitled to their fees if they prevail. Thus, in cases where a court finds that the surety properly denied a bond claim, this does not necessarily mean that the surety or contractor will recover its attorney fees for defending that claim. Arguably, the public agency has no risk in having to pay the opposing party’s attorney fees for litigating the issue of coverage if the surety denies the public agency’s claim against the bond.

The Court’s holding in Vinci could potentially increase the number of bond claims we see because there is no downside for the public agency to bring a bond claim and litigate the issue of whether the surety should have covered the bond claim (the only upside is if the public agency, as obligee, is the only party that benefits from possibly recovering its attorney fees). There is a distinction, however, between a coverage dispute (whether a surety should pay at all) and a claim dispute (how much the surety should pay). If the dispute between the public agency and the surety only involves the amount that the surety must pay, then Olympic Steamship attorney fees will not apply, and to recover attorney fees, the public agency has to comply with RCW 39.04.240.

Lastly, the Court ruled that the fees in Vinci were not segregable because the sureties had adopted the contractors’ defenses to the County’s claim that the contractors breached the contract as the defense to their refusal to cover the bond claim. Thus, because the surety’s defense was that the contractors did not breach the contract, the issues of whether the contractors breached and whether the surety should have covered the bond claim became so intertwined that no reasonable segregation could be made between the claims, and the County was entitled to all of its attorney fees associated with the case—a $15 million price tag. Public agencies may be incentivized to terminate contractors and bring bond claims instead of attempting to work through difficulties that typically arise on large public works contracts.

The immediate impact of the Vinci holding—for contractors, public owners, and taxpayers—is that the cost of performance bonds on public works projects will likely increase, thereby increasing the overall cost of public contracts in Washington.

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