BMD Contractors, Inc., (“BMD”) was a mechanical piping subcontractor to Industrial Power Systems, Inc. (“Industrial Power”), which was in turn a subcontractor for the
general contractor overseeing the construction of an automobile transmission
manufacturing plant for Chrysler near Indianapolis, Indiana. The project owner was Getrag Transmission Manufacturing, LLC. (“Getrag”).
In connection with the project, Industrial Power executed a payment bond with
Fidelity and Deposit Company of Maryland (“Fidelity”).
The project proceeded for a year when the manufacturer Getrag declared bankruptcy. Work on the project ceased, and Getrag and its contractor and subcontractors defaulted on their payments under their respective contracts, causing a series of payment defaults to flow down the levels of contractors and subcontractors.
BMD and its subcontractor filed mechanics’ liens against Getrag’s property, and BMD
assigned to Feguson a portion of its rights under the payment bond. Both Industrial Power and its surety, Fidelity, refused to pay BMD and Ferguson for their work, and both BMD and Ferguson sued Fidelity on the bond.
The subcontract between BMD and Industrial Power contained language the district court construed as a “pay if paid” clause, requiring Industrial Power to pay BMD only
if it received payment under its own contract with the general contractor. The language of the subcontract stated that BMD “expressly agreed” that the 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.” The district court rejected BMD’s argument
that the language at issue was in fact a “pay when paid” clause, which would
only have addressed the timing of payment, rather than whether payment must be
made at all.
On appeal, the Seventh Circuit Court of Appeals, sitting in diversity and applying Indiana law, made its best prediction of how the Indiana Supreme Court would decide the case. It first discussed the difference between pay when paid vs. pay if paid clauses.
BMD argued that because the subcontract provision at issue did not
contain language stating that BMD assumed the risk of nonpayment, it could not
be deemed a pay if paid clause. The court rejected this argument, holding that “transfer of risk” language is not necessary to create an enforceable pay if paid clause. The key language, instead, was the condition precedent language, which the Seventh Circuit found was sufficient, and noted has been deemed sufficient by the majority of courts that have evaluated such language. The court further rejected
BMD’s argument that pay if paid clauses are void under Indiana public policy,
observing that Indiana courts will not find a violation of public policy unless
the language of the implicated statute is clear and unambiguous. BMD relied upon a statute voiding waivers of payment bonds, holding that a provision in a contract that requires a person to waive a right to a claim against a payment bond before the person was paid for labor or materials, is void as a matter of law. The court held that this provision was inapplicable to the contract language at issue since nothing in the BMD subcontract required it to waive its rights to payment under the payment bond.
Rather, the subcontract allocated the risk of nonpayment.
Finally, BMD argued because the payment bond did not expressly incorporate the terms of the BMD subcontract, Fidelity could be liable to BMD even though Industrial Power was not liable under the subcontract. The court said this violated basic tenets of common surety law, under which the surety possesses the defenses of its principal.
BMD Contractors, Inc. v. Fidelity and Deposit Company of Maryland, 2012
U.S. App. LEXIS 9558 (7th Cir. May 11, 2012).