Should Sureties Be Required To Arbitrate Disputes From Bonded Contracts Containing Arbitration Clauses?
One of the complaints about arbitration versus litigation is that, too often, the complaining party cannot proceed against all interested parties in the same proceeding. This causes delay, additional expense and the risk of different tribunals coming to inconsistent decisions. For example, is a surety is bound to arbitrate if the bonded contract contains a mandatory arbitration provision? If so, is every aspect of the dispute with the surety subject to arbitration?
Ohio law is fairly clear respecting the first question. If the bond states on its face that it incorporates the bonded contract and the bonded contract contains an arbitration provision stating that arbitration is required for all disputes relating to the bonded contract, the surety will bound to arbitrate the dispute. See City of Piqua v. Ohio Farmers Insurance Company (Miami Co. 1992), 84 Ohio App.3d 619, 617 N.E.2d 780. Since parties can only be required to arbitrate where they have agreed to do so, it appears that in those cases where the bond does not expressly incorporate the underlying contract, the surety would not be bound to arbitrate.
Regarding the question of whether a surety must then arbitrate all disputes relating to its bond obligations, no Ohio cases appear to have addressed this question. A federal court in a recent West Virginia case, however, has addressed this issue and split the baby, holding that some surety defenses are subject to arbitration and some are not. Great American Insurance Company v. Hinkle Contracting Corp., 2011 WL 6029966 (S.D. W.Va. Dec. 5, 2011). The court ruled that where a bond incorporates the bonded contract containing an arbitration provision, all surety defenses that the contractor could have asserted must be arbitrated. Surety defenses based on surety law or the bond alone, however, e.g., limitations periods stated in the bond, notice requirements in the bond, whether the contractor took action that, under applicable law, made the bond void, are not subject to arbitration. In the Hinkle case, the only disputed issue was whether the contractor improperly entered a change order that would have materially increased the surety’s exposure without its consent and whether that made the bond void. The court held that that issue was a “bond” related one and had to be litigated in court and not arbitrated. Since that “bond” issue was the only disputed issue, the result was that that one issue would be litigated. Two separate dispute resolution proceedings, one for contractor defenses and one for surety defenses, were not necessary.
Nonetheless, if the rule stated in Hinkle were generally applied, owners and contractors could easily find themselves needing to engage in two separate dispute proceedings simultaneously regarding the same subject matter. That is a problem. There could easily be common factual issues that could be decided inconsistently. There could be duplicative document production and duplicative depositions. As a practical matter, such duplication makes little sense. Also, as a legal matter, if the underlying contract states that all disputes relating to the contract are subject to arbitration and the bond incorporates the contract, even “bond” based defenses relate to the contract. The only purpose of a performance bond, for instance, is that the surety will perform the contract requirements if the contractor does not.
Let’s hope Ohio does not follow this line of reasoning. Both practically and legally, effective dispute resolution requires all interested parties to participate in the same proceeding.
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