On May 11, 2012, the U.S. Court of Appeals for the Seventh
Circuit issued a decision in BMD Contractors, Inc. v. Fidelity
and Deposit Company of Maryland (No. 11-1345), affirming a
lower court summary judgment in favor of a surety on a payment
bond.
The case arose from the construction of an automobile transmission
manufacturing plant. Before construction was completed, the owner
filed bankruptcy, resulting in missed payments that flowed down the
chain of contractors. BMD, a second-tier subcontractor, sued on a
payment bond. The surety prevailed because its principal, with whom
BMD contracted, was not liable for payment under the
"pay-if-paid" provision in the subcontract:
"It is expressly agreed that the owner's acceptance of the
subcontractor's work and payment to the contractor for the
subcontractor's work are conditions precedent to the
subcontractor's right to payments by the
contractor."
The Court rejected arguments that the conditional language in the
subcontract should be construed as a "pay-when-paid"
clause which governs the timing of payment, but not the ultimate
obligation to pay.
Sitting in diversity jurisdiction and applying Indiana law, the
Court made its best prediction of how the Indiana Supreme Court
would decide the case. While Indiana courts had not previously
decided the specific issue, based on prior decisions the Court
concluded that the condition precedent language in the subcontract
was sufficient to create a pay-if-paid provision under Indiana
law.
The Court also rejected arguments that such provisions are void
under Indiana public policy, given Indiana's "strong
background presumption favoring freedom of contract" and the
clearly stated language in the subcontract. The surety could assert
all defenses available to its principal, including the pay-if-paid
provision, and was not liable under the payment bond.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.