Tag: Good Faith

The Power of Incorporation Compels You: Surety Succeeds in Compelling Contractor to Arbitrate Bond Claims Pursuant to Arbitration Clause in Subcontract

In Swinerton Builders, Inc. v. Argonaut Insurance Co., Swinerton Builders, a contractor, sued a surety on bond claims arising from defaults by its subcontractor on a series of work orders. The owner of Swinerton’s mechanical subcontractor on three projects passed away unexpectedly, and the subcontractor was unable to complete its remaining work on the projects.

Swinerton filed a complaint in August 2023 against Argonaut, the subcontractor’s surety, seeking to recover on the payment and performance bonds issued by Argonaut. The complaint also included claims for breach of the covenant of good faith and fraud. Argonaut responded by moving to dismiss based on the arbitration clause in Swinerton’s subcontract. The bonds at issue incorporated by reference the subcontract, including the arbitration provision. The federal district court converted the motion to dismiss to a motion to stay and compel arbitration based on the requirements of the Federal Arbitration Act.

To compel arbitration, the court noted that Argonaut must show that there was an agreement to arbitrate with Swinerton and that the disputes at issue fell under that agreement. Swinerton argued that it only agreed to arbitrate disputes between Swinerton and the subcontractor and that the arbitration provision did not apply to Argonaut, a non-signatory to the subcontract agreement.

The court disagreed with Swinerton and granted Argonaut’s motion. Relying on precedent holding that a surety may be bound by an arbitration provision where the bond incorporates the underlying contract containing the arbitration clause, the court ruled that the same rationale supported the surety’s motion to compel in this instance. The court also did not find persuasive Swinerton’s argument that it should not be compelled to arbitrate where the bonded subcontractor’s default was not disputed. The court determined the alleged breaches of the subcontract would have to be arbitrated.

It is not clear why Argonaut elected to pursue arbitration as opposed to litigating the bond claims. The surety may have been concerned with the bad faith and fraud claims asserted by Swinerton and concluded that arbitrating such disputes would be preferable to a jury trial on those issues. However, the court did note that the arbitrator would retain authority to determine which of Swinerton’s claims were arbitrable under the arbitration agreement, so there remains a risk that some of the claims will be referred back to the court by the arbitrator. Regardless, for parties choosing whether to arbitrate or litigate under their construction contracts, the expansive application of the arbitration provision by the court in Swinerton Builders is another factor to be considered, especially where performance is secured by third-party bonds, guarantees, and other instruments.

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© 2024 Bradley Arant Boult Cummings LLP
For more on Contractors, visit the NLR Construction Law section

The Power of Incorporation Compels You: Surety Succeeds in Compelling Contractor to Arbitrate Bond Claims Pursuant to Arbitration Clause in Subcontract

In Swinerton Builders, Inc. v. Argonaut Insurance Co., Swinerton Builders, a contractor, sued a surety on bond claims arising from defaults by its subcontractor on a series of work orders. The owner of Swinerton’s mechanical subcontractor on three projects passed away unexpectedly, and the subcontractor was unable to complete its remaining work on the projects.

Swinerton filed a complaint in August 2023 against Argonaut, the subcontractor’s surety, seeking to recover on the payment and performance bonds issued by Argonaut. The complaint also included claims for breach of the covenant of good faith and fraud. Argonaut responded by moving to dismiss based on the arbitration clause in Swinerton’s subcontract. The bonds at issue incorporated by reference the subcontract, including the arbitration provision. The federal district court converted the motion to dismiss to a motion to stay and compel arbitration based on the requirements of the Federal Arbitration Act.

To compel arbitration, the court noted that Argonaut must show that there was an agreement to arbitrate with Swinerton and that the disputes at issue fell under that agreement. Swinerton argued that it only agreed to arbitrate disputes between Swinerton and the subcontractor and that the arbitration provision did not apply to Argonaut, a non-signatory to the subcontract agreement.

The court disagreed with Swinerton and granted Argonaut’s motion. Relying on precedent holding that a surety may be bound by an arbitration provision where the bond incorporates the underlying contract containing the arbitration clause, the court ruled that the same rationale supported the surety’s motion to compel in this instance. The court also did not find persuasive Swinerton’s argument that it should not be compelled to arbitrate where the bonded subcontractor’s default was not disputed. The court determined the alleged breaches of the subcontract would have to be arbitrated.

It is not clear why Argonaut elected to pursue arbitration as opposed to litigating the bond claims. The surety may have been concerned with the bad faith and fraud claims asserted by Swinerton and concluded that arbitrating such disputes would be preferable to a jury trial on those issues. However, the court did note that the arbitrator would retain authority to determine which of Swinerton’s claims were arbitrable under the arbitration agreement, so there remains a risk that some of the claims will be referred back to the court by the arbitrator. Regardless, for parties choosing whether to arbitrate or litigate under their construction contracts, the expansive application of the arbitration provision by the court in Swinerton Builders is another factor to be considered, especially where performance is secured by third-party bonds, guarantees, and other instruments.

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© 2024 Bradley Arant Boult Cummings LLP
For more on Contractors, visit the NLR Construction Law section

Contractual Good Faith: Having Rights Doesn't Necessarily Mean You Can Use Them

Recently in The National Law Review an article by Anthony C. Valiulis and Melinda J. Morales of Much Shelist, P.C. regarding Contractual Rights:  

It can be a painful lesson to learn: just because you have discretion to do something under a contract does not mean you can exercise those rights anytime you want. Why is that? The covenant of good faith and fair dealing, implied in every contract, requires that a party vested with discretion exercise it reasonably and not arbitrarily, capriciously or in a manner inconsistent with the reasonable expectations of the parties. The purpose of this duty is to ensure that parties do not take advantage of each other in a way that could not have been contemplated at the time the contract was drafted or do anything that would destroy the other party’s right to receive the benefit of the contract.

The City of Woodstock learned this lesson the hard way in a recent Illinois Appellate Court decision. Reserve at Woodstock, LLC v. City of Woodstock, decided in September 2011, involved a 10-acre piece of property annexed to the City of Woodstock pursuant to a 1993 annexation agreement. In addition to zoning the property as residential (for 20 lots) and binding the parties for 20 years, the agreement contained a provision that no change could be made to any ordinance, code or regulation during the term of the agreement that would affect the zoning classification or uses permitted on the property. However, the agreement also gave Woodstock the right to re-zone the property for agricultural uses or de-annex the property if it was not developed within five years of annexation (i.e., the development window). Ultimately, the property was not developed within the specified period.

Reserve at Woodstock purchased the property from the original owner in 2005 and requested approval of a 20-lot plat in 2006. Woodstock’s Plan Commission issued a report stating that the plat complied with both the annexation agreement and relevant city ordinances, and recommended approval of the plat. However, the Woodstock City Council denied approval despite the fact that Reserve had invested hundreds of thousands of dollars in connection with its efforts to get the plan approved, met all of the municipality’s demands for impact studies and other assurances, and presented evidence that the plat was fully compliant.

Reserve sued the City of Woodstock, which responded by rezoning the property as agricultural and taking certain other steps that caused the property to be de-annexed. Although Woodstock had the right to take such action under the annexation agreement, the court nonetheless held that city’s actions violated the implied covenant of good faith and fair dealing.

What does this mean for you and your business? First, bear in mind that this implied covenant exists in every private contract, as well as those involving a municipality. And discretion is common in certain types of contracts, such as in contracts for the purchase and sale of goods. Thus, if you have an agreement that gives you the right to perform within certain parameters or limits, the covenant of good faith and fair dealing should guide how you exercise that right.

Ask yourself whether your decision will deprive the other party of their expectations under the contract, and think twice before acting. Relying on the contract language may not be enough, so it is wise to discuss the matter with legal counsel. When it comes to contracts, an ounce of prevention is always better than a pound of cure.

© 2012 Much Shelist, P.C.