TRAVELERS CASUALTY SURETY COMPANY v. DASNY

(citation omitted), DASNY has not tendered any evidence to show that Travelers caused DASNY to fail to comply with the Performance Bonds' notice provisions. Moreover, to the extent that DASNY indicates that the basis for its equitable argument was "discussed at length" in the section of its brief devoted to the Breach-of-Contract Counterclaim, DASNY may not rely on its unpleaded alter-ego theory in order to excuse its noncompliance with the bonds' conditions precedent. Accordingly, DASNY's Performance Bond counterclaim is dismissed. C. DASNY's Payment Bond Counterclaim

The first counterclaim, and the final one to be addressed in this Opinion, alleges that Travelers breached its obligations under the Payment Bonds to compensate various subcontractors whom Trataros failed to pay. DASNY further contends that some of Trataros' subcontractors filed mechanics' liens on the Project and subsequently sued DASNY to foreclose on those liens, with the result that DASNY was compelled through a settlement process accompanying that litigation to make payments that should have been made by Travelers.

A payment bond is an undertaking whereby a surety guarantees to an obligee that all bills for labor and materials contracted for, and actually used by the contractor, will be paid by the surety if the contractor defaults. N.Y. Jur. 2d Bonds § 61. Payment bonds "work like insurance policies designed to guarantee payment to the general contractors' suppliers, employees and subcontractors." Quantum Corp. Funding, Ltd. v. Westway Indus., Inc., 4 N.Y.3d 211, 214 (2005) ("Quantum").

Travelers seeks summary judgment on the theory that DASNY is not a proper "claimant" under the Payment Bonds and that DASNY lacks standing to assert a claim for their breach. The Payment Bonds accompanying Contracts 15 and 16 provide:

1. A claimant is defined as one having a direct Contract with the Principal or with a Subcontractor of the Principal for labor, material, or both, used or reasonably required for use in the performance of the Contract. . . .

2. The above named Principal and Surety hereby jointly and severally agree with the Owner that every claimant as herein defined, who has not been paid in full before the expiration of a period of ninety (90) days after the date on which the last of such claimant's work or labor was done or performed, or materials were furnished by such claimant, may sue on this bond for the use of such claimant, prosecute the suit to final judgment for such sum or sums as may be justly due claimant, and have execution thereon. The Owner shall not be liable for the payment of any costs or expenses of any such suit.

(Emphasis added). Travelers further contends that any payments made by DASNY to subcontractors were made voluntarily, such that DASNY cannot avail itself of the doctrine of equitable subrogation to seek reimbursement from Travelers.

The Payment Bonds issued in connection with Contracts 15 and 16 were "statutory" bonds required by New York law. A consideration of the Payment Bond Counterclaim requires an understanding of the purpose of statutory payment bonds as well as an examination of when, if ever, an owner-obligee has legal standing to sue for damages under such bonds.

1. Payment Bonds Under New York Law

New York State Finance Law § 137 provides that, for any "contract for the prosecution of a public improvement for . . . a public benefit corporation," a condition to the approval of such contract is "a bond guaranteeing prompt payment of moneys due to all persons furnishing labor or materials to the contractor or any subcontractors in the prosecution of the work provided for in such contract." N.Y. State Fin. Law § 137(1). Therefore, "issuance of a labor and material payment bond is mandatory on public improvement projects for, inter alia, public benefit corporations such as [] DASNY." Harsco, 752 N.Y.S.2d at 62. "A bond on a public improvement project . . . is deemed issued pursuant to Section 137 and subject to its provisions even where, as here, it does not specifically refer to the State Finance Law." Morin v. Empiyah Co., LLC, 389 F. Supp. 2d 506, 512 n. 7 (S.D.N.Y. 2005); accord A.C. Legnetto Const., Inc. v. Hartford Fire Ins. Co., 92 N.Y.2d 275, 278 (1998).

New York State Finance Law § 137 was first passed in 1938,Quantum, 4 N.Y.3d at 215, and was "modeled on the Federal Miller Act [of 1935], which requires a prime contractor on a Federal project to furnish a bond to insure payment to those who supply labor and material for the project." Harsco Corp. v. Gripon Const. Corp., 752 N.Y.S.2d 59, 63 (App. Div. 2d Dep't 2002) ("Harsco"). The Miller Act in turn was intended to "provide[] an alternative remedy to the mechanic's lien," which is a remedy not available under federal projects "because a lien cannot attach to [federal] government property." Id. In New York, however, mechanics' liens are available to subcontractors on public improvement projects, and thus § 137 is not the sole remedy available for unpaid subcontractors and suppliers. See N.Y. Lien Law § 5.

Section 137 also provides a private right of action to subcontractors and suppliers on public improvement projects who are not promptly paid by the hiring contractor:

Every person who has furnished labor or material, to the contractor or to a subcontractor of the contractor, in the prosecution of the work provided for in the contract and who has not been paid in full therefor before the expiration of a period of ninety days after the day on which the last of the labor was performed or material was furnished by him for which the claim is made, shall have the right to sue on such payment bond in his own name for the amount, or the balance thereof, unpaid at the time of commencement of the action. . . .

N.Y. State Fin. Law § 137(3). The statute provides a one-year statute of limitations for any "action on a payment bond furnished pursuant to this section," which begins to run on "the date on which final payment under the claimant's subcontract became due." N.Y. State Fin. Law § 137(4)(b).

Travelers does not contend that the Payment Bond claim is untimely.

Courts have identified at least two main purposes for the statutory bonding requirement. First, it evidences a legislative intent to benefit and protect subcontractors and suppliers. See Spanos Painting Contractors, Inc. v. Union Bldg. Constr. Corp., 334 F.2d 457, 459 (2d Cir. 1964); Quantum, 4 N.Y.3d at 216;Davidson Pipe Supply Co., Inc. v. Wyoming County Indus. Dev. Agency, 85 N.Y.2d 281, 285 (1995); Harsco, 752 N.Y.S.2d at 62. Second, § 137 protects the State, as owner, as well. Acknowledging that the "interests protected by performance bonds are very different from those protected by payment bonds," the Second Circuit noted that "the utility of a payment bond" is the role it plays in helping "maintain[] the [owner's] property free of any mechanics' liens by unpaid materialmen, suppliers, or laborers." Braspetro, 369 F.3d at 69; see also HNC Realty Co. v. Bay View Tower Apts., Inc., 409 N.Y.S.2d 774, 779 (App. Div. 2d Dep't 1978). The New York Court of Appeals likewise observed that "[a]n additional purpose" of § 137 at the time of its enactment was to "reduce the cost of state projects by encouraging lower-cost bids from contractors."Quantum, 4 N.Y.3d at 215; see also N.Y. Constr. Law Manual § 8:32 (describing the purpose of payment bonds as "protect[ing] the obligee against the claims of unpaid parties" as well as "facilitat[ing] payment for labor done and materials furnished for an improvement").

2. General Principles of Obligee Standing

Before turning to the resolution of the Payment Bond claim under New York law, it is useful to review relevant common law principles. In the traditional scenario — wherein a general contractor is required to procure a payment bond to satisfy payment claims for labor or materials supplied by the general contractor's subcontractors — the project's owner is the obligee (the "owner-obligee"). Despite assuming this special status, however, the owner-obligee may generally not recover damages from the surety under the payment bond, as the bond is intended to provide payment to persons supplying labor and material to the contractor, not to provide a financial recovery to the owner-obligee. Numerous courts have denied recovery to an owner-obligee under a payment bond, or at least observed that "the caselaw generally disfavors" such a suit. Fed. Ins. Co. v. Me. Yankee Atomic Power Co., 183 F. Supp. 2d 76, 81 (D. Me. 2001) ("Maine Yankee") (collecting cases). Indeed, even where an owner-obligee itself purchases labor and materials in order to complete a contract after a contractor's default, the obligee may not make a claim upon the contractor's payment bond in order to recover those costs, because the obligee is not a subcontractor or supplier within the meaning of the payment bond. See 11 Couch on Insurance § 165:15.

"[A] surety bond creates a three-party relationship, in which the surety becomes liable for the principal's debt or duty to the third party obligee." Nat'l Am. Ins. Co. v. United States, 498 F.3d 1301, 1304 (Fed. Cir. 2007) (citation omitted).

Nonetheless, an owner-obligee is not always foreclosed from claiming against a surety under a payment bond. The fact pattern at bar — with DASNY seeking what is, essentially, indemnification from Travelers for payments it made to Trataros' subcontractors, after Travelers refused to pay them, and after some of those subcontractors asserted mechanics' liens against DASNY — is one in which some courts have permitted recovery by obligees under a payment bond. See, e.g.,Hayle Floor Covering, Inc. v. First Minn. Constr. Co., 253 N.W.2d 809, 813-14 (Minn. 1977);Tropic Builders, Ltd. v. United States, 475 P.2d 362, 366 (Haw. 1970); Maine Yankee, 183 F. Supp. 2d at 86. Treatises that have considered the question of obligee standing under payment bonds have also endorsed the obligee's right of recovery in situations like those at issue here. "[T]he obligee has no right [on a payment bond] with respect to the claims of laborers and materialmen, unless, through payment, he has become subrogated to their claims." 11 Couch on Insurance § 165:14 (emphasis added); see also id. § 165:24. Indeed, Couch concludes that "where a . . . [payment bond] claimant who is not paid files a mechanics' lien attaching to the owner's property, the bond implies an obligation on the part of the surety to indemnify the owner so that the property will be free of the lien."Id. § 165:14 (emphasis added); see also 17 Am. Jur. 2d Contractor's Bonds § 10 (same). Bruner O'Connor concludes that "[t]he class of protected persons under a payment bond excludes the owner, even though the owner is named as the nominal bond obligee, [as well as] co-prime contractors and lenders, unless they are assignees of the claims of otherwise protected claimants." 3 Bruner O'Connor on Construction Law § 8:163

(emphasis added); see also id. (collecting cases finding the existence of "equitable" assignments).

Even those courts that deny recovery to an obligee seeking remuneration under a payment bond often observe that the outcome depended, in part, on the fact that exceptional circumstances did not exist. In Elm Haven, the Second Circuit, applying Connecticut law, held that summary judgment was "properly granted against [the obligee] on its Payment Bond claim" because the obligee was neither a "claimant" under the bond, nor "was [it] assigned the rights of any claimant." Elm Haven, 376 F.3d at 101. Similarly, in a recent case in Massachusetts, the court denied an owner-obligee's claim against a payment bond surety, but distinguished the foregoing treatise authorities by observing "[t]here [was] no evidence or claim of subrogation presented in this case." American Mfrs. Mut. Ins. Co. v. Sherborn Meadows, LLC, No. 07-11711-DPW, 2008 WL 5396479, at *6 (D. Mass. Dec. 22, 2008). As a final example, in Goodbys Creek, LLC v. Arch Insurance Co. ("Goodbys"), the court rejected an owner-obligee's payment bond claim because the obligee had not shown that it had been forced to pay any of the subcontractors. Goodbys, No. 07-cv-947-J-33HTS, 2008 WL 2950112, at *3 (M.D. Fla. July 31, 2008).

The obligee's theory of harm in Goodbys was not that the surety had failed to pay subcontractors under the payment bond, but rather, that the surety had "wrongfully paid every subcontractor who made a claim against the payment bond."Goodbys, 2008 WL 2950112, at *2 (emphasis added).

3. Obligee Standing Under New York Law

With the foregoing principles in mind, the Court turns to consider the question under New York law. "[The] role [of] a federal court sitting in diversity is not to adopt innovative theories that may distort established state law." Runner v. N.Y. Stock Exch., Inc., 568 F.3d 383, 386 (2d Cir. 2009) (citation omitted). Where a federal court encounters an issue that has not yet been decided by the relevant state's law, the court "must carefully predict how the state's highest court would resolve the uncertainties that [the court has] identified." Id. (citation omitted). "In making this prediction, [the court] give[s] the fullest weight to pronouncements of the state's highest court while giving proper regard to relevant rulings of the state's lower courts." Id. (citation omitted).

There are several reasons to conclude that New York law would recognize the standing of an owner-obligee to sue under a payment bond employing a subrogation theory. First, New York law recognizes a "broad" doctrine of equitable subrogation. Broadway Houston Mack Dev., LLC v. Kohl, 897 N.Y.S.2d 505, 506 (App. Div. 2d Dep't 2010) ("Broadway"). The doctrine of subrogation applies "`to cases where a party is compelled to pay the debt of a third person to protect his own rights, or to save his own property.'" Id. (quoting Gerseta Corp. v. Equitable Trust Co. of N.Y., 241 N.Y. 418, 426 (1926)). The purpose of subrogation is "to shift a debt or obligation to a party who more properly should be accountable in order to prevent unjust enrichment and an unfair result." Hytko v. Hennessey, 879 N.Y.S.2d 595, 600 (App. Div. 3d Dep't 2009); see also Allstate Ins. Co. v. Mazzola, 175 F.3d 255, 258 (2d Cir. 1999).

Second, the New York Court of Appeals recently concluded that a subcontractor who is otherwise entitled to recover under a statutory payment bond may lawfully assign its rights under that bond to a third party, who may then collect directly from the surety. The New York Court of Appeals, observing that § 137 is "silent . . . on who may sue on [a statutory payment] bond," nevertheless held that § 137 "allows subcontractors' assignees to recover payment from bond sureties." Quantum, 4 N.Y.3d at 214. The Court of Appeals thereby rejected the theory that § 137, by identifying a specific class of beneficiaries, had intended that the interests of those class members be non-transferrable. Id. at 217. The court noted it was "comforted in this conclusion by the continued successful functioning of public works and the surety market in those jurisdictions that have maintained long-standing rules allowing for [payment bond claim] assignments." Id. at 218 n. 5; see also 3 Bruner O'Connor on Construction Law § 8:177 (discussing assignment of payment bond rights).

Third, a recent New York case litigated before Suffolk County Supreme Court and the Second Department suggests that New York law is amenable to a subrogation-based recovery in circumstances comparable to those at issue here, even though that case denied recovery to the owner-obligee. In Broadway, the owner-obligee — who had already made all required payments to its prime contractor — also made certain additional payments to the prime contractor's subcontractors. See Broadway, 870 N.Y.S.2d 748 (Sup. Ct. Suffolk County 2008) (trial court decision); Broadway, 897 N.Y.S.2d 505 (appellate decision). The owner-obligee then sued the surety to recover those payments, contending that the surety should have compensated the unpaid subcontractors under the payment bond in the first instance. The trial court concluded on the facts of that case that the owner-obligee was not actually "under a legal compulsion to pay the subcontractors to avoid mechanics' liens" and thus, that the owner-obligee did not have standing under the doctrine of equitable subrogation. 870 N.Y.S.2d at 754, 756. Among other things, while the subcontractors had threatened to file mechanics' liens, they had not yet done so. Id. at 750-51. On appeal, the Appellate Division upheld the Supreme Court's reasoning, ruling that "the party seeking subrogation must show that the act is not merely helpful but necessary to the protection of its interests." Broadway, 897 N.Y.S.2d at 506. In rendering their decisions, neither court suggested the existence of any per se bar to recovery by the owner-obligee based merely on the fact that it was the obligee of the payment bond. See also Hamlet at Willow Creek Dev. Co., LLC v. Ne. Land Dev. Corp., 878 N.Y.S.2d 97, 112 (App. Div. 2d Dep't 2009) ("Hamlet") (permitting recovery based on "novel" argument by a putative subrogee to the rights of a performance bond obligee against both the principal and surety).

Finally, allowing the owner-obligee in the appropriate circumstances to recover under an equitable subrogation theory against a payment bond surety would support one of the purposes of State Finance Law § 137, namely, "`protect[ing] the equity of the owner in his property against the claims of unpaid creditors.'" Braspetro, 369 F.3d at 69 (quoting HNC Realty Co., 409 N.Y.S.2d at 779). Indeed, the rationale underlying the decision of the New York Court of Appeals inQuantum, in which the court permitted assignment of payment bond claims on the basis that such a result would serve the statutory purpose of § 137, applies a fortiori where it is the owner-obligee, rather

than a third-party factoring company, seeking to enforce the terms of the payment bond.

In seeking summary judgment, Travelers argues that "if DASNY intended to assert a claim against Travelers relating to Trataros' purported failures to pay its subcontractors, its proper remedy was to declare Trataros in default of its contracts and bring a claim under the performance bonds" (emphasis omitted). Although this argument appears intuitive, it ignores the fact that performance bonds and payment bonds protect against different risks. Because a contractor might fully perform on its contract with the owner, while simultaneously failing to pay its subcontractors, it does not necessarily follow that an owner could seek redress under a performance bond for the contractor's failure to pay its subcontractors. Indeed, Travelers has not tendered evidence that DASNY would have been able to recover its subcontractor-payment losses this way.

4. Application

Given the foregoing conclusions of law, DASNY's status as "obligee" under the Payment Bond does not, in itself, prevent DASNY from recovering from Travelers for the latter's alleged breaches of the Payment Bond. Instead, the relevant inquiry is whether DASNY can successfully show that it has satisfied the criteria for equitable subrogation. The doctrine of equitable subrogation

DASNY asserts that its right to recovery against Travelers on the Payment Bond Claim is based on "[its] ability to subrogate the rights of Trataros' subcontractors under the Payment Bonds."

is broad enough to include every instance in which one party pays a debt for which another is primarily answerable and which in equity and good conscience should have been discharged by the latter, so long as the payment was made either under compulsion or for the protection of some interest of the party making the payment, and in discharge of an existing liability.

Hamlet, 878 N.Y.S.2d at 105-06 (quoting Gerseta Corp., 241 N.Y. at 425-26); see also Broadway, 897 N.Y.S.2d at 506.

Although here the doctrine of equitable subrogation is being used to assert claims against a payment bond surety, more commonly, subrogation is used by a surety. See, e.g., RLI Ins. Co. v. N.Y. State Dep't of Labor, 97 N.Y.2d 256, 264-65 (2002) (discussing surety's ability to subrogate to the rights of the subcontractors whom it compensates under a payment bond).

Applying the foregoing principles to this case, Travelers has failed to carry its burden of demonstrating as a matter of law that DASNY is precluded from recovering under the Payment Bonds. Although Travelers asserts that "any alleged payments from DASNY directly to Trataros' subcontractors or suppliers were made as a volunteer," it has not submitted evidence to

The cases Travelers relies on to support this proposition are inapposite. See Chi. Title Ins. Co. v. Eynard, 377 N.Y.S.2d 895, 896-97 (App. Div. 1st Dep't 1975) (buyer's title insurance company could not recover against the seller the costs of paying off a federal tax lien on seller's former property, because the seller's quitclaim deed contained no warranties and thus, seller was not liable for the amount of the lien); Auto Dealers' Discount Corp. v. Budd, 272 N.Y.S. 893, 894 (App. Div. 4th Dep't 1934) (per curiam) (plaintiff that voluntarily paid automobile storage charges incurred by the f could not invoke subrogation to recover against the sheriff). Likewise, Travelers' reliance onNovak Co., Inc. v. Travelers Indemnity Co. for the proposition that, in Travelers' words, "attempts to expand the scope of a surety's payment bond to purported third-party beneficiaries have been rejected by New York courts" is misplaced. See Novak Co., Inc., 392 N.Y.S.2d 901, 903-06 (App. Div. 2d Dep't 1977) (considering the viability of third-party beneficiary claims under surety bonds). "Third-party beneficiary" and "equitable subrogee" are distinct legal statuses requiring different factual proofs. Finally, Travelers cites law for the proposition that a party which settles before trial cannot later seek contribution from another party. See Merchants Bank of N.Y. v. Credit Suisse Bank, 585 F. Supp. 304, 310 (S.D.N.Y. 1984). DASNY is not, however, claiming contribution, but rather seeking to vindicate, as equitable subrogee, the subcontractors' Payment Bond rights.

establish that fact. In contrast, DASNY has tendered evidence showing that several subcontractors filed notices of mechanics' liens on the Project; that those subcontractors subsequently initiated various lawsuits against DASNY in New York state court to foreclose on those liens; and that DASNY was ordered by the court to participate in a settlement process in an effort to resolve all outstanding subcontractor payment claims. DASNY has submitted the complaints from three of those actions with its summary judgment materials. See LBL Skysystems Corp. v. Trataros Constr., Inc., Index No. 21024-2003 (Sup. Ct. Kings County); Universal Servs. Grp., Ltd. v. Trataros Constr., Inc., Index No. 111651-2003 (Sup. Ct. N.Y. County); R J Constr. Corp. v. Trataros Constr., Inc., Index No. 113225-2003 (Sup. Ct. N.Y. County). Accordingly, because DASNY may be able to recover damages on its Payment Bond Claim under an equitable subrogation theory, and because Travelers has not demonstrated that such a theory is clearly untenable on these facts, Travelers' motion for summary judgment as to this claim is denied.

DASNY's and Travelers' summary judgment materials include,inter alia, notices of two mechanics' liens filed by LBL, each dated June 6, 2002, in the amounts of $1,029,531.58 and $158,953.87; a notice of mechanics' lien filed by Universal Services Group, Ltd. dated October 8, 2002 in the amount of $128,700.00; and a notice of mechanics' lien filed by R J Construction Corp. dated November 18, 2002 in the amount of $2,397,163.00.

The referenced LBL action could not be located in the state court records. LBL did, however, also file a lawsuit in New York County against DASNY, Trataros, and others in 2004. See LBL Skysystems Corp. v. Trataros Constr., Inc., Index No. 401484-2004 (Sup. Ct. N.Y. County).

CONCLUSION

Travelers' February 19, 2010 motion for summary judgment is granted in part. The Breach-of-Contract Counterclaim and Performance Bond Counterclaim are both dismissed, while the Payment Bond Counterclaim survives. DASNY's February 19, 2010 motion for summary judgment is granted in its entirety. A separate scheduling Order accompanies this Opinion.

SO ORDERED: