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Ohio Court of Claims Explains Surety’s Obligations After Contractor Default

A surety thinking of funding its bankrupt principal for the purpose of completing a project should take notice of the recent decision in Jutte Elec., Ltd v. Ohio Facilitates Constr. Comm. In the January 17, 2016 decision, the Referee denied a surety’s claim of almost $1M for problems allegedly attributable to the project owner, the Ohio Schools Facility Commission (“OSFC”) (now known as the Ohio Facilities Construction Commission (“OFCC”)). The Referee rejected the surety’s claims on the grounds that the surety failed to prove that its damages were caused by the owner, and that it failed to give timely notice of its claims.

Jutte was the electrical contractor for this multi-prime project involving the construction of academic and dormitory buildings for the Ohio School for the Deaf and Blind. The Court’s decision makes clear that the project was, “[a] mess from the beginning to the end. It was poorly planned, poorly scheduled, poorly administered and…poorly performed.” Shortly after the project commenced, Jutte filed for bankruptcy and was declared in default by the owner, thus triggering an obligation by Jutte’s surety to investigate the claim and determine how to proceed.

As the Court’s decision points out, sureties typically have the right to choose their means and methods upon default of a principal so long as the owner is made whole.

Traditional options include:

  • Formally take over and contract for the project’s completion;
  • Allow the project to be defaulted, let the owner complete, and pay the reasonable costs to complete that are in excess of the contract price; or
  • Provide funds to an insolvent contractor to complete performance. After an extremely limited investigation, Jutte’s surety opted to complete the project by funding Jutte, its bankrupt principal. The Court made several key findings of fact, including (i) that the surety’s investigation was inadequate; (ii) its damages were a result of its inadequate investigation; (iii) the surety did not acquire Jutte’s contractual rights; and (iv) Jutte’s failure to give timely notice of its claims was imputed to the surety, barring the surety’s claims when it attempted to step into the shoes of its principal.

Sureties dealing with a defaulting contractor should be mindful of the key takeaways from this decision:

I. Surety’s Obligation to Adequately Investigate: Upon default, the surety should, at the very least:

  • Thoroughly investigate its underwriting file;
  • Interview its principal (contractor) and review its files;
  • Interview the project owner; and
  • Review all material which may demonstrate any problems on the project. A surety who fails to adequately investigate all project alternatives may be barred from recovery.

II. Rights of a Surety: The Jutte decision provides insight regarding the rights of a surety:

  • A surety’s decision to fund its bankrupt principal, as opposed to formally taking over the project, does not result in the surety obtaining the rights of the principal under the contract.
  • Absent clear evidence, an assignment of contractual rights to another party will not be found.

III. Waiver of Rights: A surety will be bound by a principal’s waiver or failure to give timely notice of its claims.

Should you wish to consult with the author of this article, Alex J. McCallion, Esq., please contact Brennan Manna Diamond’s construction law attorneys at (330) 253-5060.

Objections to the Decision have been filed by the parties and remain pending before the Court. BMD’s construction law attorneys will monitor the decision for future updates.