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Notice of Potential Default Was Sufficient to Trigger Equitable Duty

A motion to dismiss an equitable subrogation claim was denied by the Court of Federal Claims because the surety alleged sufficient facts regarding the notice it gave the government about the contractor's potential default. The surety contended the government wrongfully disbursed progress payments to a construction contractor to which it issued Miller Act performance and payment bonds. The surety sought to recover the payments by relying on the doctrine of equitable subrogation, which allows a surety to step into the shoes of a defaulting contractor and assert the contractor's rights in seeking reimbursement of its costs. The government moved to dismiss for failure to state a claim upon which relief could be granted, arguing the surety did not provide sufficient notice to the contracting officer of a default by the contractor on the particular bonded contracts at issue. According to the government, its equitable duty to act with reasoned discretion to protect the surety's interests was never triggered.
Letter Expressed Concern

However, a letter the surety sent to the CO before the disbursement of the progress payments met the threshold for providing adequate notice of a potential default on the bonded contracts, which obligated the government to protect the surety's interest in the contract funds. The letter listed the bonded contracts in its caption and requested the government to make no further disbursements, in accordance with the surety's "rights of equitable subrogation."Although the letter never expressly alleged an actual or potential default, it explained the surety had learned about claims and "unpaid bills" on another bonded project involving the same contractor. The letter also indicated the surety believed the contractor had become financially unstable. The court construed all reasonable inferences in favor of the contractor and concluded a competent CO would have understood the letter to express the surety's concern over the contractor's ability to complete performance and pay subcontractors for the contracts referenced in the caption. The letter, therefore, could only be read as notice of the contractor's potential default. (Insurance Company of the West v. U.S., FedCl, 52 CCF 78,997)

(The news featured above is a selection from the news covered in the Government Contracts Report Letter, which is published weekly and distributed to subscribers of the Government Contracts Reporter. )


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