BMD Contractors, Inc. v. Fid. & Deposit Co. of Md., 11–1345.

• Decision Date: 13 July 2012
• Docket Number: No. 11–1345.,11–1345.
• Parties: BMD CONTRACTORS, INC., Plaintiff–Appellant, v. FIDELITY AND DEPOSIT COMPANY OF MARYLAND, Defendant–Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

679 F.3d 643

BMD CONTRACTORS, INC., Plaintiff–Appellant,

v.FIDELITY AND DEPOSIT COMPANY OF MARYLAND, Defendant–Appellee.

No. 11–1345.

United States Court of Appeals, Seventh Circuit.

Argued Sept. 15, 2011.

Decided May 11, 2012.

As Amended July 13, 2012.

Edwin Davis Coots, Brandon Ann Gibson (argued), Attorney, Coots, Henke & Wheeler, Carmel, IN, for Plaintiff–Appellant.

Thomas O. Crist (argued), Attorney, Benesch, Friedlander, Coplan & Aronoff, Cleveland, OH, for Defendant–Appellee.

Before FLAUM, MANION, and SYKES, Circuit Judges.

SYKES, Circuit Judge.

This case requires us to decide an increasingly important question in complex multi-tiered construction contracts—if the property owner becomes insolvent or otherwise defaults in payment, preventing a contractor from paying a subcontractor, which contractor bears the risk of loss? There is an additional wrinkle here because the question arises in a suit on a payment bond.

BMD Contractors, Inc. (“BMD”) was a subcontractor for Industrial Power Systems, Inc. (“Industrial Power”), which was itself a subcontractor for Walbridge Aldinger Company (“Walbridge”), the general contractor overseeing the construction of a manufacturing plant near Indianapolis, Indiana. Industrial Power executed a payment bond with Fidelity and Deposit Company of Maryland (“Fidelity”), making Fidelity a surety for Industrial Power's payment obligations to BMD. The construction project proceeded on schedule for about a year, but the manufacturer then declared bankruptcy, causing a series of payment defaults to flow down the levels of contractors and subcontractors. Walbridge failed to pay Industrial Power, Industrial Power failed to pay BMD, and Fidelity refused to pay BMD. BMD sued Fidelity on the bond.

The subcontract between Industrial Power and BMD contains language conditioning Industrial Power's duty to pay on its own receipt of payment. The district court construed this language as a “pay if paid” clause, which requires Industrial Power to pay BMD only if it receives payment under its own contract with Walbridge. The court rejected BMD's counterargument that the contract language in question is a “pay when paid” clause, which would have controlled only the timing of Industrial Power's payment obligation, not its ultimate duty to pay. The court also rejected BMD's argument that pay-if-paid clauses are void under Indiana public policy. Finally, the court held that Fidelity, as a surety, could assert all the defenses of its principal, Industrial Power, even though the bond itself did not specifically incorporate the pay-if-paid language. Based on these holdings, the court granted summary judgment in favor of Fidelity, and BMD appealed.

We affirm. The Industrial Power/BMD subcontract expressly provides that Industrial Power's receipt of payment is a condition precedent to its obligation to pay BMD. This language is clear and properly construed as a pay-if-paid clause. While the subcontract might have gone further—for example, it might also have said that BMD assumed the risk of the property owner's insolvency—this additional language was not necessary to create an enforceable pay-if-paid provision. We also agree with the district court that pay-if-paid clauses are not void under Indiana public policy. Finally, under basic Indiana surety-law principles—reinforced by the weight of authority from other jurisdictions—Fidelity may assert all the defenses of its principal. Because Industrial Power was never obligated to pay BMD in the first place, BMD may not recover against Fidelity on the payment bond.

I. Background

In early 2007 Getrag Corporate Group created Getrag Transmission Manufacturing, LLC (“Getrag”), for the purpose of manufacturing automobile transmissions for Chrysler at a plant to be built in Tipton, Indiana. Getrag hired Walbridge as the general contractor for the construction of the facility, and Walbridge entered into multiple subcontracts, including one with Industrial Power for mechanical piping work.¹ Industrial Power entered into a second-level subcontract, hiring BMD to perform the piping work required under the Walbridge/ Industrial Power subcontract. BMD, in turn, ordered supplies from Ferguson Enterprises, Inc.

Pursuant to the Walbridge/Industrial Power contract, Industrial Power executed a payment bond with Fidelity. The bond named Industrial Power as principal, Fidelity as surety, and BMD as a claimant. In essence, Fidelity promised to pay what Industrial Power owed to BMD under the Industrial Power/BMD subcontract if Industrial Power did not itself pay what was owed.

BMD began work on the project in November 2007. Over the next year, Walbridge paid Industrial Power from the payments it received from Getrag, and Industrial Power paid BMD from the payments it received from Walbridge, in accordance with their respective contracts. In October 2008 Getrag filed for bankruptcy. All work on the project ceased, and a cascade of missed payments flowed down the hierarchy of subcontractors. When this appeal was filed, Getrag owed Walbridge $40 million, Walbridge owed Industrial Power $11 million, Industrial Power owed BMD $1.5 million, and BMD owed Ferguson $700,000.

BMD and Ferguson filed mechanic's liens against the Getrag property, and BMD assigned Ferguson a portion of its rights under the payment bond.² BMD and Ferguson sought to recover the rest of what they were owed from Industrial Power, but Industrial Power refused to pay. BMD and Ferguson turned to Fidelity and demanded payment under the bond, but Fidelity refused as well. BMD and Ferguson then sued Fidelity on the bond.³ The dispute centers on the interpretation and effect of key provisions in the following contracts: (1) the Industrial Power/BMD contract; (2) the Walbridge/Industrial Power contract; and (3) the Fidelity payment bond.

Taking the last of these contracts first, the terms of the payment bond obligate Fidelity to pay “claimants” of Industrial Power under the Walbridge/Industrial Power contract in the event that Industrial Power itself did not pay what was owed. Specifically, the bond provides:

[I]f the Principal shall promptly make payments to all claimants as hereinafter defined, for all labor and material used or reasonably required for use in the performance of the subcontract, then this obligation shall be void; otherwise it shall remain in full force and effect, subject to the following conditions.

The bond then defines “claimant” as “one having a direct contract with the Principal for labor, material, or both, used or reasonably required for use in the performance of the contract.” The bond describes a claimant's right to sue as follows:

[E]very claimant as herein defined, who has not been paid in full before the expiration of a period of ninety (90) days after the date on which the last of such claimant's work or labor was done or performed, or materials were furnished by such claimant, may sue on this bond for the use of such claimant, prosecute the suit to final judgment for such sum or sums as may be justly due claimant, and have execution thereon.

(Emphasis added.)

The Industrial Power/BMD subcontract contains the clause at the heart of this dispute. It states: “It is expressly agreed that owner's acceptance of 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.” Other parts of the subcontract use similar language. For example, Article 2(g) provides that “it is a condition precedent to Contractor's obligation to make final payment to Subcontractor that Owner shall have tendered full payment for Subcontractor's Work to Contractor and that [C]ontractor shall have accepted such full payment from Owner.”

The Walbridge/Industrial Power contract contains a similar provision stating that Industrial Power will be paid only if Walbridge itself is paid. More specifically, Article XXII states as follows:

[Industrial Power] acknowledges that it has considered [Getrag's] solvency and [Getrag's] ability to perform the terms of its contract with [Walbridge] before entering into this Subcontract. [Industrial Power] acknowledges that it relies on the credit and ability to pay of [Getrag], and not [Walbridge], for payment for work performed hereunder. [Industrial Power] is entering into this Subcontract with the full understanding that [Industrial Power] is accepting the risk that [Getrag] may be unable to perform the terms of its contract with [Walbridge]. [Industrial Power] agrees that as a condition precedent to [Walbridge's] obligation to make any payment to [Industrial Power], [Walbridge] must receive payment from [Getrag].

Based on these contract provisions, BMD and Fidelity each filed motions for summary judgment. Fidelity argued that the language we have quoted in the Industrial Power/BMD contract was properly construed as a pay-if-paid clause, which conditioned Industrial Power's duty to pay BMD on its own receipt of payment from Walbridge. Because Industrial Power had not been paid, it could not itself be liable to BMD, and as Industrial Power's surety, Fidelity could not be liable either.

BMD argued that the conditional language in the contract was not a pay-if-paid clause but, rather, a pay- when-paid clause, which governed only the timing of Industrial Power's payment to BMD, not its ultimate obligation to pay. Industrial Power remained liable on the contract, BMD argued, so Fidelity was liable on the payment bond. In the alternative BMD maintained that if the conditional language was a pay-if-paid clause, it was contrary to Indiana public policy and therefore void. Finally, BMD argued that because the payment bond neither incorporated the Industrial Power/BMD contract nor contained a separate pay-if-paid clause, Fidelity was independently liable under the bond, even if Industrial Power itself was not liable under the subcontract.

The district court entered summary...