Fort Worth COA Holds Arbitral Agreement Was Incorporated by Reference in Performance Bond Dispute

In Granite Re Inc. v. Jay Mills Contracting Inc., No. 02-14-00357-CV (Tex. App. – Fort Worth, March 26, 2015), the City of Granbury, Texas hired a contractor, Jay Mills Contracting (“JMC”), to design and install a boardwalk and several docks. After that, JMC contracted with another company, North American Marine Industries (“NAMI”), to complete the project. At the time, JMC and NAMI entered into a blanket contract that included an arbitration clause. The arbitral provision required that all disputes arising out of the contract would be subject to arbitration. The agreement also stated NAMI was required to furnish JMC with a performance bond and that there were no third party beneficiaries to the contract.

Before JMC signed the parties’ blanket contract, NAMI executed a performance bond for almost $300,000 with Granite acting as the surety. The performance bond incorporated the work order between JMC and NAMI by reference. On the same date that JMC signed the blanket agreement, JMC and NAMI signed a work order to their blanket agreement.

A few months later, NAMI apparently stopped all work on the project and ceased doing business. In March 2014, JMC filed a lawsuit in Hood County seeking damages from NAMI and Granite in its capacity as NAMI’s surety. After NAMI filed for bankruptcy protection, JMC proceeded with a case against Granite for breach of the performance bond. At no point was JMC’s case against Granite premised on the company’s blanket agreement or work order with NAMI.

Soon after, Granite filed a motion to compel the dispute to arbitration. According to Granite, the arbitration provision included in JMC’s blanket contract “was incorporated into the performance bond through the work order.” In addition, Granite claimed that “JMC’s claims were subject to the arbitration clause based on direct-benefits estoppel and JMC’s status as a third-party beneficiary of the performance bond.” The trial court denied the surety’s motion and Granite filed an interlocutory appeal with Texas’ Second District in Fort Worth.

On appeal, Granite argued the Federal Arbitration Act (“FAA”) applied to the case. Since JMC did not oppose this assertion, the appellate court stated it would apply the federal law to the dispute. Next, the court said the burden was on Granite to demonstrate a valid agreement to arbitrate existed and the parties’ dispute fell within the scope of that agreement. In order to determine whether a valid arbitral clause existed, the court stated it “primarily must determine the parties’ intent as expressed in the terms of the contract.”

According to the Second District, Granite successfully “carried its burden to show that there was a valid arbitration agreement as between JMC and Granite.” The court stated:

…the language in the work order clearly indicated that the parties to the bond—NAMI and Granite—intended to incorporate the terms of the work order and, necessarily, the blanket agreement into the performance bond. Additionally, the blanket agreement specified that each work order included the blanket agreement; thus, the work order automatically included the terms of the blanket agreement, including the arbitration clause. Indeed, federal 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. See U.S. Fid. & Guar. Co. v. W. Point Constr. Co., 837 F.2d 1507, 1508 (11th Cir. 1988); Exch. Mut. Ins. Co. v. Haskell Co., 742 F.2d 274, 276 (6th Cir. 1984); Developers Sur. & Indem. Co. v. Resurrection Baptist Church, 759 F. Supp. 2d 665, 669–71 (D. Md. 2010); see also Greta A. McMorris & Lawrence Lerner, To What Extent is a Surety Bound by Arbitration and Forum Selection Provisions in its Principal’s Contract?, 33 Constr. Lawyer 22, 26–27 (2013). Such is the case here.

Therefore, we conclude the performance bond contained a valid arbitration clause applicable to Granite and JMC through the doctrine of incorporation by reference. Because we so conclude, we need not address Granite’s arguments that the arbitration clause was enforceable through the equitable doctrines of direct-benefits estoppel or third-party beneficiary.

The Fort Worth Court of Appeals then examined whether JMC’s claims against Granite fell within the scope of the arbitration provision. After stating the FAA favors arbitration, the court said:

JMC’s breach-of-contract claim against Granite clearly relates to NAMI’s alleged failure to fully perform under the blanket agreement and work order, which triggered Granite’s obligations under the performance bond. In other words, JMC could not pursue its breach-of-contract claim without reference to NAMI’s performance (or lack of performance) under the blanket agreement and work order. JMC’s breach-of-contract claim against Granite, therefore, fell within the scope of the clause.

The appellate court also dismissed JMC’s claim that its cause of action was exempt from arbitration:

JMC argues that its claim seeking indemnity is exempted from arbitration under the exemption provision. But there is an enforceable arbitration agreement as between JMC and Granite under the doctrine of incorporation by reference and because JMC’s claims fall with the broad scope of the arbitration clause. Therefore, the exception stated in the clause, interpreted narrowly in favor of arbitration, does not apply to JMC’s claims against Granite.

Because a valid agreement to arbitrate existed between the parties as a result of the doctrine of incorporation by reference and JMC’s claims fell within the scope of that agreement, Texas’ Second District Court of Appeals in Fort Work reversed the trial court’s decision and remanded the case with instructions to compel the dispute to arbitration.

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