Doing Business in Puerto Rico Blog: Business Coaching, News & Developments

NOT ALL BONDS ARE CREATED EQUAL

A recent case illustrates the vital importance of the wording used in a performance bond. When two separate contractors engage in a joint venture and things go awry, performance bonds linked to their work will come into play. Failing to procure a proper bond can create financial chaos. So before signing above the dotted line, the contractor needs to read beyond the title of the document and learn what are the actual duties and obligations under the bond. See, Constructora Andrade Gutierrez v. American International Insurance, Court of Appeals 1 Cir.

The case involves Puerto Rico law, an insurer and two construction companies; Constructora Andrade Gutierrez (CAG) from Brazil and C&M based in the Dominican Republic. The controversy centered around a performance bond for  construction in Haiti. C & M and CAG originally joined forces to bid on a highway project and - “In the event that their joint venture won the contract, CAG agreed to provide 100% of the guarantees for performance and payment to the Republic of Haiti and C & M agreed to provide a counter-guarantee to CAG for C & M's participation in the project."

Owners of a project typically require from construction companies several types of bonds. To bid, the construction company must post a bid bond guaranteeing it will comply with the terms of the bid if awarded. With the performance bond, the constructor pledges that it will complete the awarded contract faithfully and according to its terms. As required, CAG provided  Haiti with a performance bond. To cover C& M’s obligations with CAG, C & M purchased a bond with American International Insurance Company (AIICO). AIICO’s bond provided in its wording  that  "it was an irrevocable and unconditional guarantee . . . for the completion by the contractor (C&M) of its obligations to (CAG) pursuant to the stipulations of the contract dated May 6, 1996."

AIICO and C&M later entered into a side agreement regarding the performance bond it had issued to the benefit of CAG. It stipulated that C& M had to indemnify AIICO for all losses incurred if CAG executed or demanded payment under the bond. Furthermore, C & M was automatically liable to AIICO for any losses as soon as CAG asserted a claim against AIICO; regardless of whether or not AIICO had made payment. C & M further agreed that AIICO could recover from C & M any disbursements made to CAG it in good faith; whether or not such liability existed.

As the court adeptly defined it – “The sweeping language [could] be reduced to five words: "If we pay -- you pay." With the contract, C & M forfeited whatever possibility it had to control - in some way-   how and when AIICO would pay the bond; at the same time remaining fully accountable for all payments made. SO, if CAG made a claim to AIICO and AIICO decided to pay, C & M had to pay back AIICO; even if C & M understood it had fully complied with its obligations.

During the course of business C & M and CAG tried in vain to settle disputes that ensued. At the end, CAG notified AIICO that C & M was in default and demanded payment. AIICO initially denied payment. CAG sued AIICO  in the U.S. District Court for the District of Puerto Rico, under diversity jurisdiction to recover the amounts that AIICO  refused to pay. AIICO filed a third-party complaint against C & M who in turn asserted cross claims against CAG (later dismissed because of contractual arbitration requirements).

On February 26, 2003, the Court entered summary judgment, against AIICO for $1,407,000, plus other assessments “finding that the bond issued by AIICO was in actuality an unconditional guarantee essentially payable on demand.” AIICO appealed but eventually settled and paid CAG $1.6 million. C & M filed for appeal.

The AIICO bond stated that “We the undersigned, American International Insurance Company of Puerto Rico, hereby establish in the name and for the account of C.M. Constructora, S.A., an irrevocable and unconditional guarantee in the amount of FIVE MILLION SIX HUNDRED NINETY-SIX THOUSAND THREE HUNDRED TWENTY-TWO and 42/100 United States dollars (US$ 5,696,322.42). " The court viewed the phrase "irrevocable and unconditional" not as a performance bond but as  "the typical language of a letter of credit designed to serve as a guarantee to the beneficiary against harm caused by a contractual default, and completely independent of any other contractual obligation."

The court reasoned that “the only conditions for payment [were]. . .: (1) that CAG provide AIICO with “written notification ··· prior to the expiration date” of May 6, 1999, and (2) that such written notification “contain[ ] the amount to be paid” and “stat[e] that the contractor [C & M] ha[d] not performed its contractual obligations."

Never assume the contents  of a performance bond.   While bonds may share a similar purpose, the specific provisions, rights and obligations vary.  Read the fine print. For example some bonds may call for opportunities to  cure before  default can be declared. Others require that a particular procedure be followed. 

The language of the AIICO bond  crippled C & M because, it did not matter whether CAG complied with its end of the deal. If CAG declared C&M in default, AIICO had to disburse the funds automatically; this despite an audit revealing that “CAG was responsible for cost overruns. . .  and that C&M's resulting losses far exceeded the amounts C&M had agreed to pay. . . .” Even under these seemingly lopsided circumstances, C & M could not prevent the Surety from paying the amounts demanded.

Broker Not Liable for Problems With Insurance Policy Application

Sealink brought action against insurance broker Frenkel & Company alleging that it was denied coverage under marine insurance policy placed by its broker, because  of the broker's alleged negligent misrepresentation of past casualties associated with its vessel the M/V Sealink Express. Sealink alleged that the broker had failed  to adecuately explain and advise on the terms and conditions of Sealink's insurance policies. The Court dismissed the case on the grounds that under Puerto Rico law a broker has no duty to review an insurance application for truthfulness or accuracy of the information contained therein before sending it to underwriters. In such cases, the broker was simply carrying out the instructions given by the assured. It was up to the assured who knew all the circunstances material to the risk- to disclose the facts to the underwriter; rather than waiting for the underwriter to ask.  By failing to disclose material facts, the underwriter could void the policy.  Sealink v. Frenkel & Co., US District Court Puerto Rico, Civil No. 04-1709 (DRD), July 31, 2006.

In this case, the insurance application was  almost entirely prepared by Sealink's President an CEO. He signed the application warranting that the information  was complete and accurate. He also signed  acknowledging that  the  underwriters were relying "on the information and representations listed  in determining acceptability, rates, and conditions of coverage. . . ;"  that any misrepresentation or omission would be “ground for immediate cancellation of coverage and denial of claims;” and that  Sealink was “under a continuing obligation” to notify underwriters of any material alteration to the “nature, extent or size” of the operation. The broker  verified that the application was signed but did not review its contents.

Sealink's vessel suffered a fire and was declared total loss.  The Insurance Company later denied coverage and voided the policy because Sealink had allegedly engaged in:

(1) material misrepresentations on the application related to the affiliation with an entity involved in bankruptcy proceedings; (2) failure to disclose uncommonly high number of detentions by the U.S. Coastguard due to the poor maintenance and structural damage to the vessel; (3) failure to disclose threats of physical violence made by the crew while on the Dominican Republic during a wage dispute; (4) material misrepresentation or failure to disclose the true market value of the vessel; and (5) material failure to disclose grounding and repeated instances of contact damage and casualty loss history.

Sealink sued its insurance broker blaming it for the voidance of the policy. The Court ruled that  maritime law was  not at  issue because the contract was one to procure the insurance. It did not involve the (maritime) insurance itself. The issue was grounded on Puerto Rico law, between the broker and the assured; not the insurance company.

The query the Court must now address is, under a broker-assured relationship, whose responsibility is it to properly fill out the insurance application and ensure the accuracy and completeness of the information contained therein. From the text of the Insurance Code of Puerto Rico, the Civil Code of Puerto Rico, and interpretations of the Supreme Court of Puerto Rico, the Court can only conclude that it is the sole responsibility of the assured to complete the insurance application and ensure its accuracy.

This case illustrates what can happen when an assured fails to provide all the facts in an insurance application. Besides paying the premium,  the other obligations an assured has are - to provide accurate and timely information and; "notify the insurer or broker of any claims covered by the insurance policy in a timely manner; and make truthful and complete representations on the insurance application of material matters."

Bars Liable For Drunk Drivers' Actions

A bar that sells alcohol to a visibly intoxicated person who subsequently causes damages while driving a car will be liable for the damages caused.  It must be shown however that the establishment was at fault or acted negligently and that there was a causal link between the sale of the alcohol and the damage caused. This is the ruling and opinion of Puerto Rico' Supreme Court in the case of  Ana Lopez v. Leonor Porrata, decided October 4, 2006.

The Court decided to ‘legislate’ the civil responsibility that comes with the profitable business of selling alcohol to drivers.  It relied on the ever resilient and mutating sec. 1802 of the Civil Code, 31 L.P.R.A. 5141. This law provides that “a person who by an act or omission causes damage to another through fault or negligence may be held liable” and must redress the damage caused by the wrongful or negligent act. Negligence arises in many forms including lack of prudence and disregard for the security of others and in  cases like this- by selling drinks irresponsibly knowing the risks associated.   The court argued that a barkeep could reasonably foresee that an intoxicated patron leaving the establishment would likely be driving a car and create  a security risk for himself and others.

Insurance Companies in Puerto Rico May Market Their Products Over the Web

Puerto Rico's Legislature recently enacted Act No. 196 of September 7, 2006 that allows insurance companies to market their insurance products over the Internet and instructing the Insurance Commissioner to facilitate the process by enacting industry regulations.  The law becomes effective 90 days after its enactment.