In re Technology for Energy Corp.
| Decision Date | 12 May 1992 |
| Docket Number | Bankruptcy No. 3-85-00455,Adv. No. 1-89-0266. |
| Parties | In re TECHNOLOGY FOR ENERGY CORP., Debtor. PUBLIC SERVICE ELECTRIC & GAS CO., & Bechtel Engineering Co., Inc., Plaintiffs, v. TECHNOLOGY FOR ENERGY CORP., & American Insurance Company, Defendants. |
| Court | United States Bankruptcy Courts. Sixth Circuit. U.S. Bankruptcy Court — Eastern District of Tennessee |
John A. Lucas and Jeffrey S. Norwood of Hunton & Williams, Knoxville, Tenn., for Public Service Elec. & Gas Co. & Bechtel Engineering Co., Inc.
G. Rhea Bucy & A. Scott Derrick of Gullett, Sanford, Robinson & Martin, and Lawrence R. Ahern, III of Bass, Berry & Sims, Nashville, Tenn., for Technology for Energy Corp.
Robert L. Crossley and Nicholas A. Della Volpe of Baker, Worthington, Crossley, Stansberry & Woolf, Knoxville, Tenn., and Thomas E. Ray of Ray & Swafford, Chattanooga, Tenn., for American Ins. Co.
The plaintiffs, Bechtel and Public Service, needed a radiation monitoring system for a nuclear power plant in New Jersey. Technology for Energy Corporation (TEC) agreed to build the system. The contract is made up of two purchase orders. For each purchase order, TEC obtained a payment and performance bond from American Insurance. Bechtel and Public Service brought this suit primarily to recover from American under the bonds.
The court and the parties agreed to divide the issues for trial. The first issue is whether American can be liable for more than the penal sums stated in the bonds. This is the court's second opinion on this question. In an earlier opinion the court rejected all the arguments made by Bechtel and Public Service except one. This opinion deals with the remaining argument.
For convenience, the court will refer to the two purchase orders as one contract and the two bonds as one bond. The bonds are the same except that they refer to different purchase orders and have different penal sums. The court will refer to Bechtel and Public Service as Bechtel.
For the purpose of argument, the court assumes that TEC defaulted in its performance of the purchase orders. This brings the court to Bechtel's remaining argument.
The penal sum equals the original contract price of about $3,900,000. Changes in the contract made the contract price increase to about $6,950,000. The bond waives notice of changes in the contract and provides that changes will not release American Insurance from liability under the bond. Bechtel argues that there is a custom of the trade under which the penal sum automatically increased from the original contract price to the much larger contract price that resulted from the changes.
Two kinds of evidence could be used to prove the alleged custom: (1) evidence that the surety business in general follows the alleged custom, and (2) evidence that American Insurance, until it denied liability, dealt with TEC and Bechtel as if the custom exists.
The court begins with basic rules and practices in the surety business. After that, the court takes up the testimony of individual witnesses.
Why does a contractor obtain a payment or performance bond from a surety company, and how does the contractor obtain it? The owner will require the contractor to obtain a bond. The owner decides whether it wants the amount of the bond (the penal sum) to be 100% or 50% or some other percentage of the original contract price. Bonds on some government contracts are commonly 50% bonds.
The contractor will go to an insurance agent to obtain the bond. The insurance agent's job is to help convince a surety company to issue the bond. The insurance agent gathers information a surety company will need to decide whether to issue the bond. For example, a surety needs to know whether the contract involves the kind of work the contractor has done in the past, whether the contractor has the capacity to do the amount of work called for by the contract, the present and past financial condition of the contractor, and the character and personal financial condition of the principals in the business. With this kind of information, the agent attempts to obtain the bond from a surety company.
The surety company's underwriters use the information to decide whether the company should take the risk of issuing the bond. Underwriters consider a wide variety of information about the contractor and the contract.
When a surety issues a bond for a contractor, the contractor becomes one of the surety's accounts. The surety may or may not make a separate underwriting decision on each contract for which the contractor requests a bond. The contractor's account means all the bonds already issued for the contractor and its standing with the surety with regard to obtaining new bonds.
If the surety company decides to issue the bond, the surety company or the agent must collect the premium. A surety company must file its premium rates with the state insurance commission. In simplified terms, the surety calculates the original premium by multiplying the original contract price by the appropriate premium rate.
If the contract price goes up during the contractor's performance of the contract, the surety is entitled to collect an additional premium from the contractor. The surety is entitled to more premium because the increase in the contract price indicates an increase in the surety's risk of loss.
If the surety collects an additional premium when the contract price increases, the insurance agent is entitled to an additional commission.
The surety usually makes a final adjustment of the premium after the contract is completed. The surety is entitled to more premium if the final cost is more than the original contract price, and the contractor is entitled to a refund if the final cost is less than the original contract price. Small adjustments may be ignored. For example, the surety may not charge or refund a premium of less than $50.
The bond itself does not say anything about the premium. It does not tell how the original premium is calculated. It does not say that the contractor will be liable for more premium if the contract price goes up. It does not say that the contractor will be entitled to a refund if the final contract price is less than the original contract price.
The contractor generally does not submit a written bond application that might include a promise to pay the premium.
There appear to be two sources for the surety's right to collect the premium. First is the bond rate manual. Second is the indemnity agreement between the surety and the contractor.
The bond rate manual is a standard manual used by sureties to calculate premiums. It explains how to calculate the original premium and how the premium is affected by increases and decreases in the contract price.
The indemnity agreement requires more explanation. Between the surety and the contractor, the bond is a credit transaction, not insurance. If the contractor defaults and surety pays the owner or completes the contract, the surety has a claim against the contractor. In legal jargon, the surety has a right to indemnity from the contractor. The surety may also have an indemnity agreement with third-party indemnitors, that is, indemnitors other than the contractor.
One witness, who has many years experience in the business, testified that the general indemnity agreement between the surety and the contractor includes an agreement by the contractor to pay the bond premium.
The penal sum of the bond is usually 100% of the contract price, but this does not mean the premium is calculated on the penal sum. It is still calculated on the contract price. The premium for a bond is the same if the penal sum is 50% or 100% of the contract price.
The premium may be based on the penal sum when it is a small percentage of the contract price. For example, if the penal sum is only 20% of the contract price, then the penal sum may be used to calculate premium instead of the contract price.
Changes in the contract may give the surety a defense that the witnesses called "exoneration" or "cardinal change." The court prefers cardinal change as a clearer description. If the owner and the contractor change the bonded contract too much, then the surety is released from the bond. In other words, a cardinal change in the bonded contract releases the surety.
Susie Benson is the insurance agent that helped TEC obtain the bond from American Insurance. She was the bond manager at the first agency where she began working in 1973 and at other agencies where she worked before 1980. In 1980 she and another person were hired to set up the Knoxville office of a nationwide insurance agency, Marsh & McLennan. While employed by Marsh & McLennan, Ms. Benson helped TEC obtain the bonds from American Insurance.
She dealt mostly with Jim Zorns. He was an underwriter in the Nashville office of Fireman's Fund and frequently came to Knoxville. Mr. Zorns was with Fireman's Fund, not American Insurance Company, but American is one of several companies in the Fireman's Fund group of insurance companies. When the parties mentioned Fireman's Fund or its employees, they were treating them as American Insurance and its employees.
When Ms. Benson learned of the large increase in the contract price, she was excited at the prospect of collecting another commission. She was emphasizing collecting the additional premium in order to collect the additional commission.
She talked with or wrote to Mr. Zorns about the increase in the contract price and collection of the additional premium. Mr. Zorns, as the underwriter, might not have been pleased by the increase in the contract price because it indicated major changes in the contract. Mr. Zorns wanted to know each component of the changes, not just the total amount, because the bond covers the contract. He needed to know what the contract was.
Mr. Zorns told her that American would not bill the additional premium unless Bechtel would pay it. Plaintiff's Exhibit 11 is a handwritten...
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