Author(s): Steve Matta, Dawn Patterson

Commercial Law is a newsletter devoted to commercial law issues and published by Garan Lucow Miller, P.C.
This issue examines a recent Michigan Court of Appeals decision holding, in a case of first impression, that a surety issuing a performance bond is liable at the time the default in payment to a subcontractor occurs and not when the subcontractor completes its work. There is also a review of another recent Court of Appeals opinion involving purchase agreement termination clauses.

PUBLIC CONSTRUCTION CONTRACT — PERFOR- MANCE BOND PURCHASE AFTER SUBCONTRACTOR COMPLETED WORK — SURETY STILL POTENTIALLY LIABLE

The Michigan Court of Appeals issued a precedentially binding decision holding that a performance and payment bond purchased after the subcontractor had completed its work nevertheless was applicable to the subcontractor’s claim for payment.

In October 1993 the Charter Township of West Bloomfield contracted with Growth Environmental Consulting to perform underground environmental improvement work at two of West Bloomfield’s fire stations. Among the provisions of the contract, Growth was required to test underground storage tanks for contamination which ultimately revealed that contamination was present. Necessarily this required environmental remediation work to be performed. On March 7, 1995, Growth entered into two subcontracts with Leonard C. Carnaghi, Inc., to construct a remediation system at the fire stations. Pursuant to the subcontracts, Growth was to provide labor and material payment bonds.

In May of 1995 Carnaghi completed the work for a total amount of $101,000. On June 26, 1995, Growth entered into a contract with West Bloomfield, which amended the original October 1993 contract to include the additional environmental work. The June contract required Growth to furnish performance and payment bonds.
On August 22, 1995, Growth purchase a payment bond which was issued by the defendant, Amwest Surety Insurance Company. The payment bond guaranteed payment up to the amount of the bond to all subcontractors who furnished labor, material or equipment for use in performance of the June 26, 1995 construction contract.

Shortly after purchasing the bond Growth filed for bankruptcy and failed to make any payment to plaintiff for the work it had done at the fire stations under the subcontracts. Carnaghi (plaintiff), then filed a complaint against the surety company, Amwest, to pay under the payment bond issued. The parties filed summary disposition motions and the trial court granted Amwest’s motion because the payment bond did not relate back to the plaintiff’s work as it had been completed by May 8, 1995, and the payment bond was not entered into until August 22, 1995.

The Court of Appeals reversed and remanded for further proceedings.
The Court first noted that under Michigan statutory authority, MCL 129.201, a principal contractor is required to supply a performance bond and a payment bond to the government unit before construction can begin on any public building project exceeding $50,000 in value. Initially no performance bond or payment was supply by Growth in relation to the October 1993 contract because the costs were less than $10,000. The June 1995 contract, however, provided for payment in excess of $200,000 for remediation work thus requiring Growth to furnish a payment bond. The payment bond was obtain on August 22, 1995, and referenced the June 1995
contra ct.

The Court of Appeals observed that as the case involved a public works construction bond “with its own set of statutory requirements”, cases outside the context of public construction, holding surety bonds could not be retrospective, were inapplicable.

Surveying cases from other jurisdictions, the Court concluded, that in light of the purpose of a payment bond to be solely for the protection of those furnishing labor or material required for use in public construction contracts, the fact that plaintiff had completed its job at the two fire stations did not exonerate the surety from liability under the payment bond. “Rather, the default [which triggers coverage under the bond] occurs when the subcontractor, here plaintiff, was not paid by Growth under the terms of the subcontracts. Thus, there is no retrospective application of the payment bond simply because plaintiff completed its job under the terms of the subcontractors before execution of the payment bon d.”

The Court of Appeals admonished the trial court for misfocusing its analysis: “Instead, the trial court should have focused on the default, that being Growth’s failure to pay plaintiff pursuant to the terms of the subcontracts.” Because it was not possible from the record to determine when the Growth default occurred, the case was remanded for further proceedings.

PURCHASE AGREEMENT TERMINATION CLAUSES

DeMattia Investments, L.L.C. v American Community Mutual Insurance Company and Phillip R. Seaver Title Company (“DeMattia”), is an unpublished opinion which was recently decided by the Michigan Court of Appeals on July 18, 2000 (No. 211749) . DeMattia addresses the issue of terminating a purchase agreement.
In DeMattia, the Buyer and Seller entered into a Purchase Agreement for real property. The Buyer deposited $100,000.00 in earnest money with the Title Company. The Purchase Agreement provided that if at any time prior to the expiration of the Due Diligence Period, the Buyer shall determine, in its sole and absolute discretion, that it is not satisfied with the property, then Buyer shall deliver written notice of such dissatisfaction to Seller thereby terminating the Purchase Agreement. The Purchase Agreement further provided that upon such termination, the Buyer shall be entitled to an immediate return of its earnest money deposit and a full release from any liability under the terms of the Purchase Agreement, a common purchase agreement provision.

In DeMattia, the Due Diligence Period was from June 4, 1997 to December 15, 1997. The terms of the contract allowed an extension of the Due Diligence Period if the Buyer made an additional $100,000.00 deposit on the condition that both the initial and the additional earnest money deposits would be non-refundable if the Buyer terminated the Purchase Agreement. Prior to the expiration of the initial Due Diligence Period, a representative for the Buyer delivered a letter to the Seller indicating that the Township Meeting regarding the zoning of the property was not scheduled until March 18, 1998. In its correspondence of December 11, 1997, the Buyer’s representative expressed that it was not in a position to have the initial $100,000.000 earnest money deposit become non-refundable or to provide an additional non-refundable deposit of $100,000.00. The letter specifically provided “If the Seller…will not allow us additional time with our deposit becoming non-refundable or requiring additional monies, we will have to terminate our agreement….” The Trial Court held that this letter was sufficient notice of termination of the Purchase Agreement and ordered return of the $100,000.00 deposit to the Buyer.

The Court of Appeals agreed in a 2-1 decision that the correspondence of December 11, 1997, adequately terminated the Purchase Agreement and affirmed judgment for the Buyer.

Unpublished opinions from the Court of Appeals are not binding precedent and are generally only persuasive. The majority found that the language cited above from the December 11, 1997 letter adequately terminated the agreement. The majority further held that this language was clear and unambiguous in indicating that termination would occur if the Seller did not extend the Due Diligence Period.

The dissenting opinion found that there was a genuine issue of material fact that the December 11, 1997 was insufficient to terminate the Purchase Agreement and opined that the Trial Court was not correct in ruling in favor of the Buyer. Specifically, the dissent found that the Buyer’s use of the word “will” evidenced the Buyer’s intent not to effectuate a termination of the Purchase Agreement, but “merely as an offer to renegotiate a provision of the contract, together with a threat to terminate the contract in the future if the renegotiations were not successful….”

From a practice standpoint, your termination notice should cite the exact paragraph or language in the agreement to which you are effecting the termination. For example, in DeMattia, the Buyer should have provided a written notice that the Buyer “was not satisfied with its Due Diligence investigation of the property and accordingly terminates the agreement.”

Using language which infers a future action such as the word “will” leaves room for argument and uncertainty. Although the Buyer in DeMattia was fortunate in that the Court found that they did properly terminate the agreement and thus were entitled to a refund of their $100,000.00, a subsequent panel may have a different opinion even on a slight variation of the facts.

If you need any assistance in terminating a purchase agreement or drafting termination provisions, please do not hesitate to contact Steve Matta or Dawn Patterson in our commercial/ residential real estate group at 248-641-7600.