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Warning to Federal Government Prime Contractors and Their Sureties: No Notice to Cure Means No Right to a Setoff

A recent decision from the 5th Circuit Court of Appeals, JEMS Fabrication, Inc. v. Fidelity & Deposit Co. of Maryland (April 2014) highlights the importance of reading, understanding and complying with contractual terms in order to ensure proper compensation (or, in this case, reimbursement).

In JEMS Fabrication, JEMS, a structural steel supplier on a U.S. Corps of Engineers project, filed suit pursuant to the Miller Act against Benetech (the general contractor) and Benetech’s two sureties for monies JEMS claimed to be owed for work on the project.

The project itself involved the renovation and redevelopment of pumping stations at various sites located along the Mississippi River. The Corps hired Benetech as general contractor, and Benetech hired JEMS to supply structural steel and a $54,000 custom building. In all, the subcontract, which included shop drawings and onsite labor, was valued at $2.38 million. During construction, however, Benetech ultimately supplied the onsite labor. In addition, according to Benetech, JEMS did not provide certain materials required by the subcontract, and Benetech therefore had been forced to procure materials from other suppliers at a cost of roughly $400,000. In all, Benetech paid JEMS nearly $1 million, and claimed JEMS was due no more.

JEMS filed suit against Benetech and its sureties, and the inevitable disputes arose as to whether JEMS was entitled to the monies it sought, whether offsets were available for shoddy or defective performance, or whether some other contractual defense existed that would reduce or even eliminate liability.

Benetech and its sureties argued that they were entitled to a setoff against any amounts due under the subcontract because Benetech had purchased materials that JEMS should have supplied. The trial court rejected this argument, noting that the subcontract required Benetech to give JEMS notice of any efficiencies and an opportunity to cure before incurring costs on its own. Benetech had failed to give such notice to JEMS, which eliminated its ability to seek reimbursement for the $400,000 spent in materials.

Ultimately, the court entered judgment in JEMS’ favor and against Benetech and its sureties, awarding JEMS nearly $500,000. The sureties appealed this decision (Benetech did not participate in the appeal), arguing that the notice and opportunity to cure required by the subcontract should not apply, and/or was not binding on them, as they were not party to the subcontract itself.

The appellate court rejected these arguments, noting that “while a Miller Act surety is not a party to a contract between a subcontractor and a contractor,” the sureties “nonetheless stand in the shoes of the contractor and [are] bound by [their] dealings for these purposes.” Therefore, the sureties, like Benetech, were “bound by the terms of the Contract, including its ‘notice and cure’ provisions.” This case underscores, yet again, how critical it is to be aware of, to understand—and most importantly, to follow—any contractually agreed-upon procedures to ensure that monies spent in the rush to complete a project are properly compensable after the fact. Equally significant, this decision is a reminder to sureties that their rights are only as good as those of the contractors they guarantee. In the words of the JEMS court, even though sureties are not a party to a subcontract, they “nonetheless stand in the shoes of the contractor and [are] bound by its dealings.”

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