Looking for a Way Out | Phelps Dunbar
Looking for a Way Out
In a dispute between a general contractor and its window subcontractor arising from a $500 million construction project in Manhattan, a question arose concerning the extent to which an insurer providing subcontractor default insurance to the general contractor (as inferable, ensuring the GC against subcontractor defaults) could provoke arbitration against the subcontractor after paying the general contractor’s claim for the subcontractor’s default.
The construction project encountered significant delays, leading the general contractor to issue a notice of default to the window subcontractor and file a claim with the subcontractor default insurer. The claim resulted in a payment of over $14 million from the insurer to the GC. To recover this amount from the subcontractor, the general contractor and the insurer jointly initiated arbitration proceedings against the subcontractor through the American Arbitration Association.
Seemingly central to the case was Section 8.16 of the subcontract, which mandated arbitration for all disputes exceeding $50,000 arising from the subcontract. The provision obligated the subcontractor to arbitrate, including in matters involving “the contractor’s surety” – a provision which the court seemed to latch onto (and which the insurer urged was referring to the insurer), even though there was no surety present in the traditional sense.
In response to the arbitration demand, the subcontractor filed suit in New York state court seeking to permanently stay the arbitration. The subcontractor urged that the insurer, as a mere assignee of the general contractor’s rights in recovery of losses, could not enforce the arbitration provision because the general contractor had only assigned the right to recoup payment, not other obligations under the subcontract.
The court disagreed. The enforceability of the arbitration provision by the insurer as a subrogee entails that the insurer required ALL rights and obligations of the subrogor, the general contractor – including the ability to arbitrate disputes under the subcontract. Citing established case law (“it is well established that ‘[t]he assignee of a contract acquires the assignor’s rights therein, and assumes its obligations including an agreement to arbitrate’”), the court confirmed that an assignee or subrogee assumes the arbitration provisions of an assigned contract and is “subject to any defenses or claims which may be raised against the subrogor,” that is, the assigning party.
As alluded to above, a strange twist in this case is the characterization by the contractor and the insurer of the insurer as “surety.” While the contract referred to a “surety,” subcontractor default insurance is not considered in the industry to be a surety bond. See this article by Andrew Vicknair. Parsing the case decision, though, it appears that the court did not lean heavily on that characterization, instead focusing its holding principally on the legal implications of the subrogor/subrogee relationship.
