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Construction accounting and legal expertise—insights from construction CPAs and attorneys serving on the NASBP Advisory Councils.
NASBP is pleased to showcase, for the benefit of readers of Surety Bond Quarterly, the expertise of some of the outstanding construction CPAs and attorneys who serve on the NASBP CPA Advisory Council, www.nasbp.org/cpaadvisorycouncil/home, and the NASBP Attorney Advisory Council, https://www.nasbp.org/aac/home. Each has responded to a question of interest.
Question: Can bond obligees force sureties into joining their arbitrations against their bond principals?
Last year the California Court of Appeal issued an interesting decision that prompted the question of what potential impact its ruling might have on sureties. The case is Remedial Construction Services, LP v. AECOM, Inc. (2021) 65 Cal. App. 5th 658. In Remedial, a subcontractor on a construction project sued the general contractor. The general contractor moved to compel the subcontractor to arbitrate because the general contractor’s prime contract with the property owner contained an arbitration requirement, and the subcontract incorporated the prime contract by reference. The trial court denied the motion because the subcontract did not directly incorporate the arbitration provision. The court of appeal agreed. The subcontract provision incorporating the prime contract by reference stated as follows:
The contract between Contractor and [Owner] … is hereby incorporated into and made a part of this Agreement by reference. Subcontractor assumes toward Contractor all of the obligations and responsibilities contained in the Prime Agreement or client flow-down provisions … that Contractor assumes towards its Client as they relate to Subcontractor’s performance of the Work. In the event of a conflict between any provision of this Agreement and the Prime Contract the more restrictive provision shall govern.
The court of appeal found that, under the language above, the subcontractor only assumed the general contractor’s duties related to the general contractor’s performance of its work on the Project. The court explained that, to incorporate terms from another document, the incorporation by reference must be clear and unequivocal, it must be called to the attention of the other party, the terms of the incorporated document must be known or easily available to the contracting parties, and the parties must consent. Because the language above did not satisfy these requirements, the court of appeal affirmed the order denying arbitration.
This ruling will likely have an impact on those general contractors who relied on the incorporation by reference language in their subcontracts to require their subcontractors to arbitrate either alone or in conjunction with their arbitrations with their owners.
The question is whether this ruling will have even farther ranging impacts on other parties or other types of provisions for which parties rely on the incorporation by reference language. Focusing for this article on other parties, what immediately comes to mind is the ability of bond obligees to force sureties into joining their arbitrations against their bond principals. As background, virtually every performance bond includes language such as: “Whereas Principal has entered into a contract with Obligee for construction of XXX, which contract is incorporated by reference and made a part hereof as if fully set forth herein.”
Using California as an example on the concepts of incorporation and arbitration, back in 1992, 30 years ago, a California Court of Appeal in Boys Club of San Fernando Valley, Inc. v. Fidelity and Deposit Co. of Maryland (1992) 6 Cal. App. 1266, relying on, among other authorities, federal precedent and the fact that California “has a strong public policy in favor or arbitration as a speedy and relatively inexpensive method of resolving disputes” [Boys Club at 1272], held that the surety was bound by the arbitration provision in the underlying bonded contract because the agreement to arbitrate, although not express, was included in a secondary document, the prime contract, that was incorporated by reference. The court in Boys Club stated as follows:
A contract performance bond will be read with the contract because “’… when a party enters into a contract to do certain work on certain terms, and procures a surety to guarantee the faithful performance of the work, the surety necessarily contracts with reference to the contract as made; otherwise it would not know what obligation it was assuming. And this is particularly so where the bond expressly declares that the contract is made a part of the bond and the terms of the contract are incorporated into the bond ….’” [Citation omitted.]
Boys Club, at pp 1271-72.
It is unclear how, the next time a surety challenges being forced into a California arbitration with its bond obligee and principal, the courts will reconcile Remedial and Boys Club.
See the Q and A’s published in the fall 2022 issue of Surety Bond Quarterly (https://www.suretybondquarterly-digital.com/sbpq/0322_fall_2022/MobilePagedArticle.action?articleId=1820959#articleId1820959.) The NASBP CPA Advisory Council and the NASBP Attorney Advisory Council also provide insights and expertise throughout the year through free NASBP Podcasts, found here: https://letsgetsurety.org/episodes/; timely NASBP Virtual Seminars, found here: https://learn.nasbp.org/; and NASBP Blog posts, found here: https://www.nasbp.org/informed/nasbp-blogs.