A recent case makes clear the importance of focusing on the fundamentals, such as knowing the rules on who the government is required to pay on a government contract. In The Hanover Insurance v. United States, the U.S. Court of Federal Claims recently found that a surety’s letter to the Government adequately notified it of the contractor’s default of bond agreement, triggering the surety’s equitable subrogation right to payments issued by the Government.
In that case, the surety, Hanover Insurance Company (Hanover), overcame a summary judgment motion filed by the Government, concerning a Veterans Administration (VA) contract awarded to B&J Multi-Service Corporation (“B&J”) for facilities maintenance at a VA facility in West Haven, Connecticut. The Government paid termination for convenience (“T/C”) costs to B&J to which Hanover as surety claimed it was entitled.
The Government asserted that Hanover, as surety to B&J, had not given proper notice of B&J’s default, thereby precluding any Government obligation to pay Hanover directly. The Government argued proper notice was not given because Hanover did not invoke the precise words “the principal is in default” prior to the VA’s payment to B&J. As evident from the court’s opinion, the Government was aware that Hanover was making payments to B&J’s subcontractors. Hanover put the Government on notice that the funds for termination for convenience should not be paid directly to B&J, because Hanover was asserting a subrogation right to the T/C funds. However, the Government ignored the surety and paid the termination for convenience funds directly to B&J.
This decision highlights the bright line rule that “a legally enforceable duty can arise between the government and a surety if the surety notifies the government that its principal is in default of the bond agreement.” The court held that there were no magic words required to put the Government on notice of the surety’s rights. The surety is only required to notify the Government of default or the risk of default, and notice that the surety is making payments on behalf of the contractor is sufficient to trigger the Government’s duties to the surety. The court found that “the agency paid the principal in the face of notice of the principal’s bond default.”
In essence, the Government paid the wrong party. Now the Government is faced with the messy situation of recovering these funds from B&J, possibly through a Government claim under the Contract Disputes Act. At the same time, it appears likely that the Government will end up owing the T/C funds to Hanover under Hanover’s rights of equitable subrogation. This case provides a lesson for all parties in Government contracts – focus on the fundamentals – here, that fundamental is who should be paid.