An Owner is Ensnared By a Subguard Program

In a recent appellate decision in New York, a developer sued its construction manager for fraudulent misrepresentation that the construction manager had obtained full Subguard™ coverage [subcontractor default insurance or “SDI”] to protect developer against default by the largest subcontractor – concrete superstructure – on a Manhattan hi-rise project. The developer alleged it relied on defendant’s representation and suffered damages when the subcontractor defaulted and there was no SDI for the default.

The court affirmed the trial court’s dismissal of the complaint because (1) the developer was not an insured under the SDI policy (only contractors are named insureds under such SDI policies), thus it could not claim damages under the policy even if it had been in place, (2) the failure of the construction manager to perform a contract duty cannot be transformed into a tort by merely alleging a fraud of its performance, (3) the construction manager had no “special relationship of trust and confidence” with the developer merely from an arm’s length business relationship and thus claims of reliance on the construction manager’s expertise did not give rise to a confidential relationship that might support such a claim, and (4) the developer could not support its claim that it justifiably relied on the representation because the developer did not inquire if the subcontractor was covered and the contract acknowledged that not all subcontractors may be qualified to be admitted into the SDI program.

A few observations – and reminders – are evident.

  • The fact that Owners are not beneficiaries of SDI programs is one of the key differences with surety programs – where bonds are routinely supplemented with dual-obligee riders.
  • The lack of a relationship of “trust and confidence” might have turned out differently if that language – boilerplate in some construction management agreements – did find its way into the contract. This case points out the significance that such language could have on the parties.
  • And lastly, owners should be warned that awarding trade contracts on projects where SDI is the primary security device must be made under circumstances where it is known whether the subcontractor will or will not be qualified under the program. Making an award only to determine later whether the SDI applied or not, and a bond would have to be obtained by the awardee subcontractor, an unlikely possibility if the subcontractor could not get qualified for the SDI program, can – as here – lead to disaster.