Great American Insurance Company v. Hinkle Contracting Corporation

Filing 31

MEMORANDUM OPINION AND ORDER denying defendant's 15 MOTION to Dismiss or Stay Proceedings Pending Arbitration; directing the Clerk to post a copy of this published opinion on the court's website, www.wvsd.uscourts.gov. Signed by Judge Joseph R. Goodwin on 12/5/2011. (cc: attys; any unrepresented party) (cbo)

IN THE UNITED STATES DISTRICT COURT
FOR THE SOUTHERN DISTRICT OF WEST VIRGINIA
CHARLESTON DIVISION

GREAT AMERICAN INSURANCE COMPANY,
Plaintiff,
v.

CIVIL ACTION NO. 2:11-cv-00396

HINKLE CONTRACTING CORPORATION, et al.,
Defendants.

MEMORANDUM OPINION AND ORDER
Pending before the court is the Defendant’s Motion to Dismiss or Stay Proceedings
Pending Arbitration [Docket 15]. For the reasons discussed below, this motion is DENIED.

I.

Background
A.

Facts and Procedural Posture

Hinkle Contracting Company, LLC (“Hinkle” and “HCC”) entered into a contract with
the West Virginia Department of Transportation to construct portions of the King Coal Highway
project in Mingo County, West Virginia. Hinkle and Chapman-Martin Excavation and Grading,
Inc. (“CME”) then entered into a subcontract for CME to perform grade and drain work on the
project.

Great American Insurance Company (“Great American”) issued a Subcontract

Performance Bond and Subcontract Labor and Material Payment Bond for CME, with Hinkle as
obligee.
On June 2, 2011, Great American filed a Complaint for Declaratory Judgment in this
court. Great American alleges that beginning in September 2010, Hinkle notified CME on
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several occasions of its delays and inadequate performance. To address these issues, Great
American maintains that Hinkle and CME began discussing a change order to the subcontract in
December 2010. The change order was signed in February 2011, and Great American contends
that it “constitute[s] a material change to the terms and conditions of the Subcontract, which
Great American did not agree to, nor consent to, when it wrote its Bond for the Project.”
(Compl. [Docket 1], at ¶ 18.) Great American alleges that on March 15, 2011, Hinkle declared
CME in default under the subcontract because it did not complete its work under the subcontract
and change order. It further asserts Hinkle again declared CME in default on March 22, 2011,
because it did not pay its sub-subcontractors and suppliers. On March 24, 2011, Hinkle notified
Great American of CME’s alleged default. In sum, Great American argues that:
Despite the repeated alleged defaults by CME, HCC failed to put Great American
on notice of such alleged defaults until its letter dated March 24, 2011. Such
failure by HCC to provide notice to Great American of its principal’s, CME,
alleged defaults is in breach of HCC’s obligations to Great American under the
Bond.
(Id. at ¶ 21.) Great American asks this court to declare the Performance Bond void ab initio and
to find that Great American is not liable to Hinkle under it. Alternatively, Great American
requests that the court declare the change order a material alteration to the subcontract and
unenforceable against Great American “in establishing its rights, duties, and obligations arising
out of, or under its Performance Bond.” (Id. at ¶ 31.) Finally, if the court does not grant either
of these requests, Great American seeks a reduction of its liability pro tanto under the
Performance Bond.
Hinkle filed a Motion to Dismiss or Stay Proceedings Pending Arbitration. Hinkle argues
that the Performance Bond incorporates by reference the subcontract’s arbitration clause. The
arbitration clause applies to all disputes “arising out of, or relating to” the subcontract. This

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includes, according to Hinkle, the allegations made by Great American in its Complaint against
Hinkle. In opposing the motion, Great American asserts that while the arbitration clause requires
arbitration of issues related to claims under the subcontract, it does not require arbitration of
claims or defenses unique to the bond. This motion is now ripe for review.
II.

Analysis
The Federal Arbitration Act (the “FAA”) provides that written agreements to arbitrate in

contracts relating to commerce “shall be valid, irrevocable, and enforceable, save upon such
grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C. § 2. “The FAA
requires a court to stay ‘any suit or proceeding’ pending arbitration of ‘any issue referable to
arbitration under an agreement in writing for such arbitration.’” Adkins v. Labor Ready, Inc.,
303 F.3d 496, 500 (4th Cir. 2002) (quoting 9. U.S.C. § 3). “[A]ny doubts concerning the scope
of arbitrable issues should be resolved in favor of arbitration.” Moses H. Cone Mem’l Hosp. v.
Mercury Constr. Corp., 460 U.S. 1, 24-25 (1983). However, “[b]ecause the FAA is at bottom a
policy guaranteeing the enforcement of private contractual arrangements, we look first to
whether the parties agreed to arbitrate a dispute, not to general policy goals, to determine the
scope of the agreement.” E.E.O.C. v. Waffle House, Inc., 534 U.S. 279, 294 (2002) (internal
citation and quotation marks omitted). While state law controls issues of “validity, revocability,
or enforceability of contracts generally,” Perry v. Thomas, 482 U.S. 483, 492 n.9 (1987), the
FAA “create[s] a body of federal substantive law of arbitrability, applicable to any arbitration
agreement within the coverage of the Act.” Moses H. Cone, 460 U.S. at 24.
A party can compel arbitration under the FAA by demonstrating: “(1) the existence of a
dispute between the parties, (2) a written agreement that includes an arbitration provision which
purports to cover the dispute, (3) the relationship of the transaction, which is evidenced by the

3

agreement, to interstate or foreign commerce, and (4) the failure, neglect or refusal of the
defendant to arbitrate the dispute.”1 Adkins v. Labor Ready, Inc., 303 F.3d 496, 500-01 (4th Cir.
2002) (quoting Whiteside v. Teltech Corp., 940 F.2d 99, 102 (4th Cir. 1991)). The Fourth Circuit
has explained that, “even though arbitration has a favored place, there still must be an underlying
agreement between the parties to arbitrate.” Id. (quoting Arrants v. Buck, 130 F.3d 636, 640 (4th
Cir. 1997)). The resolution of the defendant’s motion turns on the second requirement: whether
the written agreement to arbitrate in the subcontract covers the instant dispute.
determination is a matter of contract interpretation.

This

Am. Recovery Corp. v. Computerized

Thermal Imaging, Inc., 96 F.3d 88, 92 (4th Cir. 1996). Specifically, I apply state law principles
of contract interpretation, while giving due regard to the federal policy favoring arbitration.
Washington Square Sec., Inc. v. Aune, 385 F.3d 432, 435 (4th Cir. 2004).
A number of courts have addressed the question of whether an arbitration provision in a
contract or subcontract binds a surety when it is incorporated by reference in the bond. Some of
these cases do not distinguish between the obligation of a surety to arbitrate its unique surety
defenses versus obligations grounded in the underlying contract or subcontract. In addition, they
typically rely on the federal policy favoring arbitration and the effectiveness of incorporation by
reference. See U.S. Fid. & Guar. Co. v. West Point Constr. Co., Inc., 837 F.2d 1507, 1508 (11th
Cir. 1988) (“We conclude that the incorporation of the subcontract into the bond expresses an
intention of the parties, including [the surety] to arbitrate disputes. Our conclusion is supported
by the strong policy favoring arbitration expressed by Congress in the Federal Arbitration Act.”);
Exch. Mut. Ins. Co. v. Haskell Co., 742 F.2d 274, 276 (6th Cir. 1984) (“[T]he performance bond
incorporates by reference the subcontract, the subcontract incorporates by reference the general

1

Here, the parties ask the court to dismiss or stay proceedings pending arbitration under 9 U.S.C. § 3, rather than
compel arbitration. These same criteria apply, however, in this context.
4

contract and hence the duty to arbitrate.”); Compania Espanola de Petroleos v. Nereus Shipping,
S.A., 527 F.2d 966, 974 (2d Cir. 1975) (“[T]he duty to arbitrate was indeed one of the rights and
obligations under the contract which Cepsa, as guarantor, agreed to assume.”); Developers Sur.
& Indem. Co. v. Resurrection Baptist Church, 759 F. Supp. 2d 665, 668 (D. Md. 2010) (“The
First, Second, Fifth, Sixth and Eleventh Circuits and several district courts have held that a surety
must arbitrate disputes related to a performance bond where the performance bond specifically
incorporated by reference a contract containing an arbitration clause.”); Rashid v. U.S. Fid. &
Guar. Co., Inc., No. 2:91-0141, 1992 WL 565341, at *9 (S.D. W. Va. 1992) (“[Surety] is bound
by the arbitrator’s award against [contractor] at least insofar as it was rendered with respect to
[contractor’s] performance under the contract incorporated into the bond.”); Transamerica
Premier Ins. Co. v. Collins & Co., Gen. Contractors, Inc., 735 F. Supp. 1050, 1051 (N.D. Ga.
1990) (“This case presents . . . a single question of law: does a performance bond that
incorporates by reference a subcontract incorporate an unequivocal arbitration clause contained
in that subcontract?); Cianbro Corp. v. Empresa Nacional de Ingenieria Y Technologia, S.A.,
697 F. Supp. 15, 20 (D. Me. 1988).
In contrast, some cases have explicitly held that disputes over bond obligations must be
arbitrated. See Jewish Fed’n of Greater New Orleans v. Fid. & Deposit Co. of Md., No. 0130371, 2001 WL 1085096, at *2 (5th Cir. Aug. 29, 2001); Commercial Union Ins. Co. v. Gilbane
Bldg. Co., 992 F.2d 386, 389 (1st Cir. 1993); U.S. Surety Co. v. Hanover R.S. Ltd. P’ship, 543 F.
Supp. 2d 492, 496 (W.D.N.C. 2008); Ohio Cas. Ins. Co. v. City of Moberly, Mo., No. 4:05-cv-5,
2005 WL 2491461, at *3 (E.D. Mo. Oct. 7, 2005); Hoffman v. Fid. & Deposit Co. of Md., 734 F.
Supp. 192, 195 (D.N.J. 1990).

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For example, in United States Surety Co. v. Hanover R.S. Limited Partnership, the
contractor and subcontractor arbitrated their dispute. 543 F. Supp. 2d at 493. The surety
participated in the arbitration but sought to limit the scope of its participation by reserving its
right to litigate surety claims and defenses. Id. at 494. The court found that the surety was
bound to arbitrate these disputes as well. Id. at 496. In doing so, the court noted the Fourth
Circuit’s expansive interpretation of the term “arising out of or relating to.” Id. at 495 (citing
Am. Recovery Corp. v. Computerized Thermal Imaging, Inc., 96 F.3d 88, 93-95 (4th Cir. 1996)).
It also explained that surety defenses are at least “related to” the subcontract because the bond’s
purpose is to ensure the subcontractor’s performance under the subcontract and the bond
incorporates the terms of the subcontract. Id. at 495. It further highlighted the Fourth Circuit’s
“heavy presumption” in favor of arbitrability. Id. at 496. Notably, the court did not point to any
other language in the arbitration provision that indicated an intent to limit disputes to those that
implicated the subcontractor’s obligations under the subcontract.
In the Fifth Circuit case Jewish Federation of Greater New Orleans v. Fidelity and
Deposit Co. of Maryland, the surety contended that the district court erred in compelling it to
arbitrate its defense that the performance bond had lapsed. No. 01-30371, 2001 WL 1085096, at
*1 (5th Cir. Aug. 29, 2001). The court began by discussing the presumption of arbitrability
when an agreement contains an arbitration clause. It then explained that “arising out of or
related to” has been interpreted broadly.

Accordingly, the court held: “Mindful of the

presumption of arbitrability . . . [surety’s] defense is a ‘controversy . . . related to the Contract’,
and is, therefore, arbitrable under its ‘extremely broad’ arbitration provision.” Id. at *2.
In her dissent, Judge King explained that: “While I agree with my colleagues that Fidelity
is bound to arbitrate any claims demanding construction of the underlying contract incorporated

6

by reference into the performance bond, I would not extend this arbitration requirement to
Fidelity’s personal defenses arising from the provisions of the bond itself.” Id. at *3. Judge
King explained that a better-reasoned line of cases held that:
[I]ncorporation of an arbitration provision from an underlying construction
contract does not bind the surety company to arbitrate with the contracting parties
regarding disputes originating in the provisions of the bond, but instead ensures
that the surety company participates in (or, at a minimum, is bound by the results
of) an arbitration between the contracting parties based on the underlying
subcontract.
Id.
Judge King’s dissent is consistent with the Eighth Circuit’s holding in AgGrow Oils,
L.L.C. v. National Union Fire Insurance Co. of Pittsburgh, Pa., 242 F.3d 777 (8th Cir. 2001). In
AgGrow Oils, an insurance company issued a performance bond guaranteeing the obligations of
a contractor to an owner. Id. at 779. The bond incorporated by reference the construction
contract. Id. A dispute arose among the parties and the surety moved to stay the owner’s
lawsuit, claiming that the owner was required to arbitrate its claim under the performance bond.
Id. at 780.

The court explained that, “[w]ithout question, incorporation of the Construction

Contract clarified the performance obligations of [contractor] that [insurer] as surety undertook
to guarantee.” Id. at 781. But the court said, “it is less clear that the incorporation clause
reflected an intent by [owner] and [insurer] to arbitrate their disputes under the bond – that intent
is not clearly expressed.” Id. Therefore, the court considered the circumstances surrounding the
contract. The court then stated:
[W]e are unwilling to construe an arbitration provision whose obvious purpose
was to clarify the extent of the surety’s secondary obligation as also reflecting a
mutual intent to compel arbitration of all disputes between the surety and the
obligee under the bond. . . . [W]e conclude there was no such agreement to
arbitrate.

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Id. Subsequent opinions have cited this decision approvingly. See Liberty Mut. Ins. Co. v.
Mandaree Pub. Sch. Dist. #36, 503 F.3d 709, 711 (8th Cir. 2007); White River Vill. v. Fid. &
Deposit Co. of Md., Nos. 08-cv-00248, 08-cv-00359, 2009 WL 792728, at *5 (D. Colo. March
23, 2009); A.E.R. Constr., Inc. v. Travelers Cas. & Sur. Co. of Am., No. 3:07-cv-40, 2007 WL
3046324, at *3 (N.D. W. Va. Oct. 17, 2007).
I agree with the result reached in AgGrow—that in these circumstances Great American
is not required under the arbitration clause to arbitrate bond disputes. However, these cases are
fact specific and to determine the scope of the arbitration provision, I find the Fifth Circuit’s
analysis of an arbitration clause in a case involving a fiduciary liability insurance policy
persuasive. Tittle v. Enron Corp., 463 F.3d 410 (5th Cir. 2006). In Tittle, Enron maintained two
liability insurance policies: a primary policy and an excess policy that incorporated the primary
policy. Id. at 413. The primary policy insured, among others, Enron and its officers and
directors. Id. The arbitration provision in the primary policy stated: “Any controversy or dispute
arising out of or relating to this Policy . . . shall be settled by binding arbitration.” Id. at 414.
The remainder of the provision explained the procedures to be followed by Enron and the
insurance company if the parties arbitrated a dispute. It specified that Enron and the insurance
company would each appoint one arbitrator and the third one would be appointed according to
the Conflict Prevention and Resolution Rules. Id.
The underlying lawsuit—a class action alleging breach of fiduciary duty—was brought
by former employees against Enron and its board of directors. Id. at 415. A subset of defendants
reached a proposed settlement with the plaintiffs where the parties agreed to require the insurers
to pay the entire amount of the fiduciary liability policies. Id. In light of competing claims to
the policy proceeds, the insurers intervened in the suit and filed an interpleader complaint to

8

determine the proper distribution of the policy proceeds. Id. The insurers named as interpleader
defendants parties who submitted or could potentially submit claims against the policies, but
were not parties to the proposed settlement. Id. Two of the interpleader defendants, Kenneth
Lay and Jeffrey Skilling, filed a motion to compel arbitration of the interpleader defendants’
competing claims to the policy proceeds. Id. at 416.
Like the instant case, the Fifth Circuit noted that the parties did not challenge the validity
of the arbitration provision.

Rather, they disputed its scope and whether claims among

individuals covered under the policy (as opposed to claims between the insurance company and
the insured) fall within the arbitration provision. The court noted that under Texas law, a
contract must be read in a manner that renders contract terms internally consistent. Id. at 419.
Applying this principle, the court found that “the scope of the Arbitration Clause is limited only
to disputes, arising out of or related to the policies, that include an Insurer and one or more
insureds.” Id. at 420. The court explained that the provisions setting out the procedures for
arbitration consistently refer to Enron and the insurer. It highlighted that, “the very procedures
that the Arbitration Clause requires Enron and the Insurers to follow once binding arbitration has
been invoked would be logical only in the case of a dispute where an Insurer is adverse to one or
more of the insureds.” Id. As an example, it cited the provision that requires Enron and the
insurer to each appoint a member of the arbitration panel. The lack of procedures for disputes
between the insured individuals, “indicates that the parties to the policies intended the dispute
resolution procedures to apply only to the disputes for which procedures are provided – i.e., only
to situations where there is a dispute with an Insurer.” Id. at 421.
The court then explained that, “[a] dispute ‘arises out of or relates to’ a contract if the
legal claim underlying the dispute could not be maintained without reference to the contract.”

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Id. at 422. The court found that the dispute among the insured individuals arose out of or related
to the insurance policies because the policies are the source of the insureds’ legal rights to the
proceeds. Id. However:
the Arbitration Clause contains further language limiting its scope to such
disputes that include an Insurer and one or more insureds, notwithstanding the
broad construction that some courts have given to “arising out of or related to”
language in arbitration clauses in cases where the applicability of the clauses to
specific parties was not an issue.

Id. The court determined that the dispute was wholly among insured individuals and therefore it
fell outside the arbitration provision. Id. at 423.
Applying this analysis to the instant case, I note that under West Virginia law:
Where possible, all parts of the contract will be construed as to give force and
validity to all of them, and to all the language used. A desire to effectuate the
intentions of the parties creates the necessity of looking to the constituent
elements of the contract, elucidating one by the other, and reconciling them, if
practicable, to one common intent or design present to the minds of the
contracting parties.
Justice v. Stuyvesant Ins. Co., 265 F. Supp. 63, 65 (S.D. W. Va. 1967) (internal citations
omitted); see also White v. AAMG Constr. Lending Ctr., 226 W. Va. 339, 346 (2010) (“It is wellsettled law that ‘a contract must be considered as a whole, effect being given, if possible, to all
parts of the instrument.’” (citing Clayton v. Nicely, 116 W. Va. 460 (1935))).
The arbitration provision in the subcontract states: “All claims, disputes, controversies
and matters in question (hereinafter “Claims”) arising out of, or relating to, this Agreement or the
breach thereof . . . shall be resolved by mediation followed by arbitration or litigation at HCC’s
sole option.” (Compl. at Ex. A, § 16.1.) The West Virginia Supreme Court of Appeals has not
defined “related to,” but it has discussed the meaning of the term “in connection with,” under
Virginia law, as used in a forum-selection clause. Caperton v. A.T. Massey Coal Co., Inc., 225

10

W. Va. 128, 147 (2009). It explained that the term “in connection with” is “quite broad.” Id.
More specifically, it defined the term as “the condition of being related to something else by a
bond of interdependence, causality, logical sequence, coherence, or the like; relation between
things one of which is bound up with, or involved in another.” Id. (citing II THE OXFORD
ENGLISH DICTIONARY 838-39 (1970)). The court noted the similarity between the terms “in
connection with” and “in relation to,” and cited a Third Circuit case that stated: “To say that a
dispute ‘arises in relation to’ the [contract] is to say that the origin of the dispute is related to that
agreement, i.e., that the origin of the dispute has some ‘logical or causal connection’ to the
[contract].” Id. at 148 (citing John Wyeth & Bro. Ltd. v. CIGNA Int’l Corp., 119 F.3d 1070,
1074 (3d Cir. 1997)). Likewise, the Fourth Circuit has stated that “arise out of or related to”
language is “capable of an expansive reach.” Am. Recovery Corp. v. Computerized Thermal
Imaging, Inc., 96 F.3d 88, 93 (4th Cir. 1996). It “embrace[s] every dispute between the parties
having a significant relationship to the contract regardless of the label attached to the dispute.”
Id. (citing J.J. Ryan & Sons v. Rhone Poulenc Textile, S.A., 863 F.2d 315, 321 (4th Cir. 1988)).
The phrase “related to” is broad, but as Justice Scalia noted in a case concerning ERISA
preemption, “applying the ‘relate to’ provision according to its terms [is] a project doomed to
failure, since, as many a curbstone philosopher has observed, everything is related to everything
else.” Cal. Div. of Labor Standards Enforcement v. Dillingham Constr., N.A., Inc., 519 U.S.
316, 335 (1997); see also N.Y. State Conference of Blue Cross & Blue Shield Plans v. Travelers
Ins. Co., 514 U.S. 645, 655 (1995) (Souter, J.) (explaining that if “‘relate to’ were taken to
extend to the furthest stretch of its indeterminacy” then it would have no limiting principle, “for
‘really universally, relations stop nowhere.’”).

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Here, there is a strong argument that Great American’s dispute with Hinkle is “related to”
the subcontract, under the above definitions, because the bond and the subcontract are
interdependent since the bond’s purpose is to guarantee the subcontract. Said differently, the
origin of the dispute between Great American and HCC has a causal connection to the
subcontract because the dispute would not exist but for the subcontract. But, like the Fifth
Circuit in Tittle, I am instructed under West Virginia contract law to look to the entirety of the
subcontract and bond to determine whether the “arise under or relating to” language is limited in
any respect.
The Performance Bond states that CME entered into a subcontract with Hinkle and
incorporates that subcontract by reference. Under the bond, if the principal, CME, “promptly
and faithfully” performs the subcontract, then Great American’s obligation toward Hinkle is
void. (Compl. at Ex. A.) If, however, Hinkle declares CME in default, then Great American
may remedy the default or after reasonable notice, Hinkle or Great American may arrange for the
completion of the CME’s obligation under the subcontract. If Hinkle completes the work and the
cost exceeds the balance of the subcontract price, then Great American pays Hinkle the excess
but not more than an amount stated on the bond. On the other hand, if Great American
completes the work, then Hinkle reimburses Great American for the portion of the balance of the
subcontract price required to complete the subcontract. The bond also states that, “Any suit
under this bond must be instituted before the expiration of two years from date on which final
payment under the subcontract falls due.”

(Id.)

As I see it, the obvious purpose of the

incorporation by reference was “to clarify the extent of the surety’s secondary obligation.”
AgGrow Oils, L.L.C. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 242 F.3d 777, 782 (8th Cir.
2001).

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As stated above, the dispute resolution provision provides that all claims “arising out of,
or relating to” the subcontract are to be arbitrated or litigated at HCC’s option. (Compl. at Ex. A,
§ 16.1.) According to § 16.2(e), “HCC, Subcontractor and Subcontractor’s surety agree that the
disputed Claim shall be resolved in the appropriate forum selected by HCC at its sole discretion.”
(Id. § 16.2.) It continues by specifying that:
If Subcontractor or its surety first commences a court action with respect to a
dispute which HCC desires to have determined by an arbitration proceeding, or if
Subcontractor or its surety first commences an arbitration proceeding which HCC
desires to have determined by a court, HCC shall commence the arbitration
proceeding or court action desired by HCC within thirty (30) calendar days after
receiving service of Subcontractor’s complaint or arbitration demand. If, at any
time, even after suit may have been filed by either party, but prior to
commencement of trial, HCC becomes involved in litigation or arbitration with
another party or parties involving questions of fact or law common to the dispute
between HCC and Subcontractor to the extent that (a) in Subcontractor’s absence,
complete relief cannot be accorded among those already parties, or (b) disposition
of such other action may as a practical matter, impair or impede HCC’s or
Subcontractor’s ability to fully prevent its incurring multiple or otherwise
inconsistent obligations, then Subcontractor and its surety may be joined by HCC
in such other litigation or arbitration proceedings for complete resolution of all
disputes and controversies arising under this Agreement and that upon such
joinder, any pending action between HCC and Subcontractor shall be dismissed.
(Id.) (emphasis added). The next subsection explains that if the amount in controversy of a
dispute is over $250,000, then an arbitration panel will be comprised of three independent and
impartial individuals with experience in the construction industry or construction law.

In

addition, “Subcontractor and HCC shall each appoint one member of the panel, who shall be
neutral. The third member shall be appointed by the two selected neutrals or, failing agreement,
according to the aforementioned Rules.” (Id.)
These provisions reveal a limit to the “arising out of, or relating to” language. In Tittle,
the court found that the arbitration procedures demonstrated that the arbitration clause was not
intended to cover disputes between individuals covered under the insurance policy. 463 F.3d at

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420. In contrast, here the arbitration procedures demonstrate that the surety and the contractor
intended to arbitrate some, but not all, disputes. A surety maintains a defense to its duties
pursuant to the underlying obligation (here, the subcontract) under three scenarios: (1) when the
underlying obligation has been discharged by performance in accordance with its terms by the
principal; (2) when the principal has a defense to the underlying obligation that can be asserted
by the surety; and (3) when the surety has available a suretyship defense. RESTATEMENT (THIRD)
OF THE

LAW: SURETYSHIP

AND

GUARANTY § 19 (1995). The first two scenarios implicate the

terms of the underlying subcontract and the rights and obligations of the principal. The third
scenario provides defenses to a surety that are independent of the subcontract. A dispute over
whether the surety has a defense under the third scenario originates in the bond, not the
subcontract. In such a bond dispute, the subcontractor does not have a stake in the outcome
because it arises from obligations that the obligee owes the surety, independent of obligations
between the principal and the obligee that the surety guaranteed.
As evidenced by the italicized language from Section 16.2 of the subcontract, the
arbitration provisions are based on the assumption that the subcontractor would be involved in
the dispute or at least that the surety would be asserting defenses available to the subcontractor.
(Compl. at Ex. A, § 16.2.) Additionally, the provision stating that only the subcontractor and
Hinkle appoint members to the arbitration panel provides strong evidence that the parties
intended the contractor’s and subcontractor’s interests to be adverse in any arbitrated dispute.
Accordingly, I FIND that the arbitration provisions, read in their entirety and in the
context of the relationship among Hinkle, CME, and Great American, were not intended to “bind
the surety company to arbitrate with the contracting parties regarding disputes originating in the
provisions of the bond.” Jewish Fed’n of Greater New Orleans v. Fid. & Deposit Co. of Md.,

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No. 01-30371, 2001 WL 1085096, at *3 (5th Cir. Aug. 29, 2001). As discussed above, the main
contention of the Complaint is that Hinkle failed to notify Great American of allegations of
default and the change order, which “constitute[s] a material change to the terms and conditions
of the Subcontract, which Great American did not agree to, nor consent to, when it wrote its
Bond for the Project.” (Compl. at ¶ 18.) Therefore, I FIND that this dispute does not fall within
the scope of the arbitration provision in the subcontract because it is a bond dispute and does not
maintain defenses under the first two scenarios outlined above. The defendant’s Motion to
Dismiss or Stay Proceedings Pending Arbitration is DENIED.
The court DIRECTS the Clerk to send a copy of this Order to counsel of record and any
unrepresented party. The court DIRECTS the Clerk to post a copy of this published opinion on
the court’s website, www.wvsd.uscourts.gov.

ENTER:

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December 5, 2011