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U.S. FIDELIY AND GUAR. v. BRASPETRO OIL SERVICES

July 25, 2002

UNITED STATES FIDELITY AND GUARANTY COMPANY AND AMERICAN HOME ASSURANCE COMPANY, PLAINTIFFS,
V.
BRASPETRO OIL SERVICES COMPANY, BANK OF TOKYO-MITSUBISHI, LTD. (FORMERLY KNOWN AS BANK OF TOKYO LTD.-JAPAN), AND LONG TERM CREDIT BANK OF JAPAN, LTD., DEFENDANTS. UNITED STATES FIDELITY AND GUARANTY COMPANY AND AMERICAN HOME ASSURANCE COMPANY, PLAINTIFFS, V. PETROLEO BRASILEIRO S.A.-PETROBRAS, ET AL., DEFENDANTS.



The opinion of the court was delivered by: Koeltl, District Judge.

      FINDINGS OF FACT AND CONCLUSIONS OF LAW

TABLE OF CONTENTS

Introduction ....................................................... 409

FINDINGS OF FACT ................................................... 410

The Parties ........................................................ 410

Brasoil Retained Petrobras to Manage the P-19 and P-31 Contracts ... 414

The P-19 International Bid Process ................................. 415

The P-19 Consortium Underbid the P-19 Project ...................... 416

The Sureties' Issuance of the P-19 Bond ............................ 418

Relevant Provisions of the P-19 Contract ........................... 419

Delays in the Commencement of the P-19 Project ..................... 422

The P-31 International Bid Process ................................. 424

The P-31 Consortium Underbid the P-31 Project ...................... 425

The Issuance of the P-31 Bond ...................................... 425

Relevant Terms of the P-31 Contract ................................ 426

Initial Efforts to Address the Consortia's Cash Flow Problems ...... 428

Changes to the EAP and the Establishment of Blocked Accounts in the First Amendments ................................................. 431

Comfort Letters and Direct Payments for Equipment .................. 434

IVI and the Petrobras Defendants Kept the Sureties Fully Informed of the Developing Crisis ......................................... 436

Critical Problems at the end of 1996 and the Beginning of 1997 ..... 438

Discussions between Petrobras, the Sureties, and the Consortia Regarding the Financial Problems of the Consortia and the Sureties' Obligations under the Bonds ............................ 442

Additional Funds to Continue Work on the Projects .................. 447

Declarations of Default ............................................ 449

Brasoil Did Not Fundamentally Change the P-19 Project, Interfere with Construction, Make Excessive Changes, Fail to Recognize Change Orders, Fail to Grant Extensions of Time or Otherwise Breach the P-19 Contract ......................................... 456
Brasoil Did Not Fundamentally Change the P-31 Project, Interfere with Construction, Make Excessive Changes, Fail to Recognize Change Orders, Fail to Grant Extensions of Time or Otherwise Breach the P-31 Contract ......................................... 462

Accounting Issues .................................................. 464

Marubeni ........................................................... 467

Damages ............................................................ 470

CONCLUSIONS OF LAW ................................................. 472

Jurisdiction ....................................................... 472

Choice of Law ...................................................... 474

The Sureties' Liability under the Performance Bonds ................ 476

Damages ............................................................ 484

The Indemnification Action ......................................... 486

The Tortious Interference Claim .................................... 488

CONCLUSION ......................................................... 409

Introduction

These consolidated cases concern the obligations and liabilities of United States Fidelity & Guaranty Co. ("USF & G") and American Home Assurance Co. ("AHAC") (collectively the "Sureties"), pursuant to performance guaranty bonds that were issued by those companies in connection with two massive naval construction projects in Brazil known as the P-19 and P-31 Projects. The Sureties issued the P-19 Performance Bond in the amount of $110,512,660 on behalf of the construction consortium which was to perform the P-19 conversion, as principal, in favor of Braspetro Oil Services Co. ("Brasoil"), as the obligee. The Bank of Tokyo-Mitsubishi Ltd. ("Bank of Tokyo") and the Long-term Credit Bank of Japan, Ltd. ("LTCB") (collectively the "Japanese Banks"), which had provided funding for the project, were additional obligees on the P-19 Performance Bond under a Dual Obligee Rider to the Bond. The Sureties issued the P-31 Performance Bond in the amount of $168,000,000 on behalf of a similar construction consortium that was to perform the conversion of the P-31 Project, as principal, in favor of Brasoil as the obligee.

The P-19 Project involved the design and conversion of a platform formerly used for oil and natural gas exploration, known as the Treasure Stawinner, into a semisubmersible oil and natural gas production platform. The conversion of the P-19 vessel, which is registered under Panamanian law, was the largest of its kind ever undertaken. The P-31 Project involved the design and conversion of an oil tanker (Very Large Crude Carrier, or "VLCC"), known as the Vidal de Negreiros, into a Floating Production, Storage, and Offloading vessel ("FPSO").

Both the P-19 and the P-31 Projects were plagued by huge cost overruns. Brasoil and its indirect parent, Petroleo Brasileiro S.A. Petrobras ("Petrobras"), claim that these overruns were caused by the construction consortia's substantial underbids on both projects and by market conditions for which Brasoil and Petrobras were not responsible. Therefore, Brasoil and Petrobras claim, they justifiably declared the construction contracts to be in default and called on the Sureties to meet their obligations on the Bonds. When the Sureties failed to do so, Brasoil had the projects completed and now looks to the Sureties for the cost of the completion of the projects and costs of delay for the projects. In addition to many other arguments and theories, the Sureties claim that Petrobras, which was managing the projects for Brasoil, substantially changed the nature of the projects by making numerous changes in the requirements of the contracts, without notice to the Sureties, and that it was these changes, for which the construction consortia had not been compensated, that vastly increased the costs of the projects. The Sureties claim that the construction consortia were not actually in default under the construction contracts and that, because of the substantial changes which changed the nature of the contracts, the Sureties were discharged from any requirement to pay any amounts under the Bonds.

In the Declaratory Judgment Action, No. 97 Civ. 6124, the Sureties seek a declaratory judgment against Brasoil and the Japanese Banks that the Sureties have no obligations or liabilities under the Bonds. Brasoil, joined by the Japanese Banks with respect to the P-19 Bond, denies the Sureties' allegations and counterclaim to require the Sureties to pay the amounts owed under the Bonds. In the Indemnity Action, No. 98 Civ. 3099, the Sureties sue Petrobras, the individual members of the construction consortia, and others, claiming, under numerous alternative theories, that the Sureties are entitled to indemnification for any costs they are required to pay under the Bonds. In the Indemnification action, the Sureties claim that by its domination and control of the construction consortia, as well as pursuant to theories of partnership, Petrobras is liable for the indemnification obligations of the construction consortia to the Sureties. The Sureties also claim that Petrobras tortiously interfered with the payment obligations of the construction consortium on the P-19 Project and Brasoil under a payment bond issued to secure financing provided to the P-19 Project by Marubeni America Corp. ("MAC"). The Sureties have also sued the members of the construction consortia and others, but those claims have been severed pending resolution of the current claims among the Sureties, Brasoil, Petrobras, and the Japanese Banks. This is only a summary of the claims, which are discussed in greater detail below.

The Court conducted a non-jury trial from January 22, 2002 through March 21, 2002. The Court heard additional testimony from experts on Brazilian law on April 10, 2002. Having heard the extensive testimony from the witnesses and having assessed their credibility, and having reviewed the massive documentary evidence in this case, the Court makes the following findings of fact and reaches the following conclusions of law.

FINDINGS OF FACT

The Parties

The Sureties

1. At all relevant times, plaintiff United States Fidelity and Guaranty Company ("USF & G") was a corporation duly organized and existing under the laws of the State of Maryland with its principal place of business in Baltimore, Maryland. In 1998, USF & G was acquired by The St. Paul Companies. (Joint Stipulation of Facts, dated February 1, 2002 ("JS"), ¶ 4.)

2. At all relevant times, plaintiff American Home Assurance Company ("AHAC") was a corporation duly organized and existing under the laws of the State of New York. AHAC maintained its principal place of business in New York City. AHAC is a wholly owned subsidiary of the American International Group ("AIG"). (JS ¶ 5.)

3. At all relevant times, USF & G and AHAC (collectively the "Sureties") each engaged in the general surety bond business. (JS ¶ 6.) USF & G and AHAC each maintained its own separate underwriting and claims functions. (JS ¶ 7.)

4. At all relevant times, Anthony Buono and Kenneth Bazaar headed USF & G's international surety underwriting operations and were responsible for the underwriting of surety bonds on international projects. Mr. Bazaar worked at USF & G from January, 1994 to April, 1997. Mr. Buono worked at USF & G from February, 1994 to July, 1996. (JS ¶¶ S-10.)

5. Gary Wilson is an attorney currently in the private practice of law and was the head of USF & G's surety claims department between 1992 and April, 1998. (JS ¶ 14.)

Petrobras Braspetro and Brasoil

7. Defendant Petrobras Brasileiro S.A.-Petrobras ("Petrobras") is a "mixed economy" corporation, which under Brazilian law means that is it is a joint stock corporation in which the Federal Republic of Brazil owns more than 50% of the voting shares and capital. (JS ¶ 18.)

8. Petrobras was created by government act and is duly organized and existing under the laws of the Federal Republic if Brazil. Petrobras' principal place of business is located in Rio de Janeiro, Brazil. (JS ¶ 19.)

9. Petrobras was established in 1953 pursuant to Brazilian Law No. 2.004, dated October 3, 1953. Petrobras was created to serve as the executor of Brazil's monopoly of its national oil industry. Between 1953 and August 6, 1997, Petrobras held a monopoly in Brazil on the prospecting, production, refining, processing, marketing and transportation of oil, petroleum from other derivatives, natural gas, and other Liquid hydrocarbons, as well as other related activities. Any amendments or revisions of the Charter or By-Laws of Petrobras must be approved by the President of Brazil and/or by the Brazilian Congress. (JS ¶ 20.)

10. Brazilian statutory law and Petrobras' own By-Laws each require that the Federal Republic of Brazil hold a majority of Petrobras' voting capital and total capital. The Federal Republic of Brazil currently holds a majority of Petrobras' voting shares of capital stock and has supplied a majority of Petrobras' paid-in capital. (JS ¶ 21.)

11. Defendant Braspetro Oil Services Company ("Brasoil") is a wholly-owned subsidiary of Petrobras Internacional S.A. Braspetro ("Braspetro"), which in turn is a wholly-owned subsidiary of Petrobras. Braspetro is a corporation duly incorporated and existing under the laws of Brazil, with head offices in Rio de Janeiro. Like Petrobras, Braspetro is financially accountable to the Brazilian Congress. The Administrative Council of Braspetro has exactly the same membership as Petrobras' Administrative Council. (JS ¶ 22.)

12. Braspetro's administrative executive committee, which makes daily decisions concerning the management of the company, is composed of up to six members, including Braspetro's President, who is also Petrobras' President. The President of Petrobras also has veto power over the decisions of the executive committee of Braspetro. (JS ¶ 23.)

13. Brasoil is a corporation duly organized and existing under the laws of the Cayman Islands. (JS ¶ 24.) Brasoil is the obligee on the P-31 Bond and a co-obligee on the P-19 Bond at issue in this case.

14. Brasoil is a wholly owned subsidiary of Braspetro with the exception of qualifying shares owned by the directors of the company. Through Braspetro, Petrobras indirectly owns Brasoil. Brasoil's officers, including its three directors, treasurer, chief engineering officer, secretary, and drilling services officers, are Braspetro and/or Petrobras employees and are paid by Braspetro and/or Petrobras. (JS ¶ 25.)

15. Brasoil and Petrobras are collectively referred to as the "Petrobras Defendants" at various points herein.

Organizational Structure and Personnel of Petrobras

17. Petrobras is managed by its "Diretoria," or executive directorate, all of whose members are officers of Petrobras. Each member of the Diretoria is also a member of the Administrative Council and is responsible for the day-to-day management of particular department(s) or function(s) within Petrobras. (JS ¶ 28.)

18. Petrobras maintains various departments and superintendencies relating to all aspects of its operations, many of which were not involved in the issues and events raised in this case. A list of the most significant Petrobras structures for purposes of this case follows:

(a) SEGEN is the acronym used to denote the Petrobras superintendency in charge of design and engineering aspects of oil and natural gas exploration, production, and transportation facilities.
(b) E & P is the acronym used to denote the Petrobras superintendency in charge of oil and natural gas exploration and production.
(c) SEFIN is the acronym used to denote the Petrobras superintendency in charge of financial services.
(d) SEJUR is the acronym used to denote Petrobras' legal department. (JS ¶¶ 29, 30, 34-37.)

19. Joel Renno was the President of Petrobras between 1992 and 1998. (JS ¶ 41.)

20. Sebastiào Henriques Vilarinho was a member of the Petrobras Administrative Council and Diretoria. At all relevant times, and among his other duties and areas of authority, Mr. Vilarinho was the member of the Diretoria responsible for the administration of SEGEN. (JS ¶ 43.)

21. Alceu Barroso Lima Neto was the general superintendent of SEGEN between August 1995 and 1998. Mr. Alceu managed Petrobras' investments in production, transport, and refining of oil and gas, including pipelines, refineries, and platforms. Mr. Alceu was also designated to manage certain of Brasoil's construction contracts, including engineering and assembly matters. As head of SEGEN, Mr. Alceu supervised over ten Brasoil conversion and construction contracts, including the P-19 and P-31 Projects. (JS ¶¶ 44-46.)

22. Luis Carlos Quintella Freire is an engineer and was the Deputy Superintendent of SEGEN between April 1996 and April 1999, where Mr. Quintella supervised Petrobras' investments in production, transport and refining of oil and gas and Brasoil's construction contracts, including the P-19 and P-31 Projects. (JS ¶ 46.)

23. Paulo Marcio Mauro is an engineer and, at all relevant times, was the Chief of Engineering Services for the Marlim Enterprise of Petrobras. The Marlim Field is an oil field off the coast of Brazil in which the P-19 Project was to be located. (JS ¶¶ 47, 126.)

24. David Almeida Schmidt is an engineer and was the platform coordinator ("COPLAT") for the P-19 Project between mid-1995 and early 1998. (JS ¶ 49.)

25. Arnaldo Samuel Arcadier is an engineer and, between mid-1994 and early 1995, was the coordinator of the Bid Committee and subsequently served as the COPLAT for the P-19 Project from February 1995 until July 1995. (JS ¶ 50.)

27. Antonio Carlos Alvarez Justi is an engineer and, at all relevant times, was the Chief of Engineering Services for the Albacora Enterprise. (JS ¶ 52.) The Albacora Field is also an oil field off the coast of Brazil. The P-31 Project was to be located in the Albacora Field. (JS ¶ 125.)

28. Edison Krummenauer is an engineer, was the Coordinator for the Bid Committee for the P-31 Project, and was the COPLAT for the P-31 Project through September or October 1998. (JS ¶ 54.)

29. Jose Eduardo Loureiro is an engineer and was the Chief of the Engineering and Support Section ("SESGE") for the P-31 Project from the commencement of the P-31 Project through the end of 1996. (JS ¶ 56.)

30. Paulo Henrique Ximenes Duprat provided design supervision on the P-31 Project. Mr. Duprat succeeded Mr. Loureiro as the Chief of SESGE for the P-31 Project in early 1997. (JS ¶ 58.)

31. Marcio Eiras Moraes was at all relevant times the Superintendent of SEFIN. (JS ¶ 59.)

The Banks

32. Defendant The Bank of Tokyo-Mitsubishi, Ltd. ("BTM"), formerly known as The Bank of Tokyo Ltd.-Japan, is a corporation organized under the laws of Japan and has its principal place of business in Tokyo, Japan. (JS ¶ 70.)

33. Shinsei Bank, Ltd. is the successor in interest to the defendant The Long-Term Credit Bank of Japan, Ltd. ("LTCB"). Shinsei Bank Ltd. is a corporation organized under the laws of Japan and has its principal place of business in Tokyo, Japan. (JS ¶ 71.)

34. BTM and LTCB (collectively the "Japanese Banks") are parties to a Loan Agreement dated May 22, 1995 among Brasoil, BTM, and LTCB, in which BTM and LTCB committed to loan Brasoil up to $175 million for the P-19 Project. As part of their collateral for this Loan, the Banks were named co-obligees on the P-19 Performance Bond. Brasoil, the Construction Consortium for the P-19 Project, and the Sureties entered into a Dual Obligee Rider to the P-19 Bond on August 30, 1995, in which the parties named the Banks "obligees" on that Bond. (JS ¶ 72.)

The Construction Contractors: IVI, Sade Vigesa, and IESA

35. Defendant Industrias Verolme-Ishibras S.A. ("IVI") is a corporation duly organized and existing under the laws of the Federal Republic of Brazil with its principal place of business in Curitiba. IVI was the result of a merger effective September 1994 between Emaq-Verolme SA, which owned the Verolme shipyard located in Angra dos Reis (Tr. at 446-47), and Ishikawajima do Brasil Estaleiros SA, which owned the Ishibras shipyard located in Rio de Janeiro. (JS ¶ 73.)

36. Defendant SV Engenharia SA was a corporation duly organized and existing under the laws of the Federal Republic of Brazil. SV Engenharia SA was formerly known as Sade Vigesa S.A. ("Sade Vigesa" or "Sade"). Sade Vigesa changed its name to SV Engenharia S.A. on or about January 31, 1997. (JS ¶ 76.)

37. Defendant Internacional de Engenharia S.A. ("IESA") was at all relevant times a corporation duly organized and existing under the laws of the Federal Republic of Brazil. At all relevant times, IESA was engaged in, among other matters, the business of oil and natural gas process engineering and design. (JS ¶ 95.)

38. IVI and Sade Vigesa entered into a formal consortium agreement on February 1, 1995 for the stated purpose of bidding for and performing the P-19 Project. The consortium agreement authorized IVI to represent the consortium (the "P-19 Consortium") in its dealings with Brasoil. The P-19 Consortium was the successful bidder for the P-19 Project and entered into a construction contract (the "P-19 Contract") with Brasoil for that Project. (JS ¶¶ 135-36, 144.) IESA was a subcontractor on the P-19 Project. (JS ¶ 96.)

39. IVI, Sade Vigesa, and IESA entered into a formal consortium agreement on October 5, 1995. The stated purpose of the consortium (the "P-31 Consortium") was to bid for and perform the P-31 Contract. The consortium agreement authorized IVI to represent the P-31 Consortium in its dealings with Brasoil. The P-31 Consortium was the successful bidder for the P-31 Project and entered into a construction contract with Brasoil for that Project. (JS ¶¶ 162, 164, 168.)

40. Nelson Tanure was the President of Sade Vigesa until about July of 1995, and was President of IVI until August of 1995. (JS ¶ 78.)

41. David Fischel served as President of IVI from August 1995 to May 1997 and managed the P-19 and P-31 Projects on behalf of a company related to Sade Vigesa until May 1997. He was also the President of Sade Vigesa between July 1995 and December 1996. (JS ¶ 79, 88.)

42. Carlos Mauricio Lima de Paula Barros is an engineer and, from June 1995 to December 1996, was the Vice President and a statutory director of Sade Vigesa. Between December 1996 and October 1997, Mr. Mauricio received compensation from a company related to Sade Vigesa for the management services he provided on the P-19 and P-31 Projects. (JS ¶ 80.)

43. Alarico Jose Andrade de Castro is a mechanical engineer and was the Director of Business Development of Sade Vigesa between 1995 and March 1996. In March 1996, Mr. de Castro was appointed Consortium project manager for the P-31 Project. Beginning in December 1996, Mr. de Castro received compensation from a company related to Sade Vigesa for the management services he provided on the P-31 Project. (JS ¶ 81.)

44. Guilherme Pires de Mello is an engineer. He was the P-19 Consortium project manager from June 1995 through his resignation in June 1997. (JS ¶ 84.)

45. David Fischel, Carlos Mauricio Lima de Paula Barros, and Guilherme Pires de Mello were employed by Montreal Engineering before they were brought in by the P-19 Consortium to manage the P-19 Project. (Tr. at 901-02, 905, 2019.)

Brasoil Retained Petrobras to Manage the P-19 and P-31 Contracts

46. Brasoil and Petrobras entered into a series of service agreements whereby Petrobras undertook to provide engineering, supervision, and inspection services with respect to the work carried out in connection with the P-19 and P-31 Contracts. (S-1010; Tr. at 2949-50.)

47. On or about September 19, 1994, Brasoil and Petrobras executed Addendum No. 6 to the Revised Reciprocal Cooperation Agreement Between Petroleo Brasileiro S.A. — Petrobras and Petrobras Internacional SA-Braspetro for Providing Engineering Services dated June 30, 1993 (the "Cooperation Agreement"). (PB-310; Tr. at 2950.) This addendum appointed Petrobras to manage the bidding process for the P-19 Project. (PB-310 ¶ 1.1; Tr. at 2951.) Brasoil agreed to pay Petrobras the sum of $20,000 for its services. (PB-310 ¶ 5.1; Tr. at 2951; JS ¶ 220.)

49. On or about March 18, 1995, Brasoil and Petrobras entered into Addendum No. 8 to the Cooperation Agreement. This addendum appointed Petrobras to manage the international bidding process for the contracting of the conversion of the VLCC Vidal de Negreiros into a FPSO to be known as P-31. Brasoil agreed to pay Petrobras the sum of $20,000 for its services. (JS ¶ 222.)

50. On or about October 26, 1995, Brasoil and Petrobras entered into Addendum No. 16 to the Cooperation Agreement. (PB-325.) This addendum appointed Petrobras to manage the conversion of the VLCC Vidal de Negreiros into an FPSO to be known as P-31. (Id.) In return for its services, Petrobras was to receive a payment of $2.1 million. (Id. ¶ 6.1; JS ¶ 223.)

The P-19 International Bid Process

51. The bidding process for the P-19 Project was conducted in compliance with the requirements of Law 8.666 of June 21, 1993, the Brazilian Public] Bidding Law. (JS ¶ 127; Tr. at 2956-57.) The bidding process was supervised by a bidding commission. (JS ¶ 127; Tr. at 2948-49, 2956-57.) Arnaldo Arcadier served as the coordinator of the bidding commission. (Tr. at 2948; S-14.)

52. A formal Invitation to Bid was published on September 16, 1994. (PB-279 at 1; JS ¶ 126; S-14 ¶ 2.) The contract was for the acquisition and conversion of an existing semi-submersible drill rig to be deployed offshore in the Marlim field. (JS ¶ 126.) The services to be provided included the supply of the platform, materials and equipment; construction and assembly; re-conditioning, maintenance, and adaptation of the platform; conditioning, tests, certification, pre-operation, transport, and assistance in the delivery phase. (Id.; PB-279 at 1.)

53. Pursuant to section 12 of the Invitation to Bid, prospective bidders could submit written questions to Brasoil to clarify the terms of the bid documents and any inaccuracies or discrepancies found in them. (PB-279 at 21; Tr. at 2959-60.) Any doubts not resolved through the clarification process would be subject to Brasoil's exclusive interpretation either at the time of the award of the bid or during the performance of the bid. (PB-279 at 21.) Section 12.3 of the Invitation to Bid further provided that "any doubts arising after presentation of tenders will be subject to the interpretation of Brasoil." (Id.)

54. Prior to the submission of the sealed bids, Brasoil issued seven circular letters responding to requests for clarifications from the prospective bidders. (JS ¶ 128; Tr. at 2960; PB-279 at 73-198.) The letters were distributed to all interested parties. (JS ¶ 128; Tr. at 2960.)

55. The delivery of envelopes with sealed bid proposals took place at 2 p.m. on November 28, 1994. (JS ¶ 129; S-14 ¶ 2.) The bids were opened in three stages. (JS ¶ 130; Tr. at 2962-63; S-14 ¶¶ 3, 5, 9, 13.) In the first stage, the commission examined the financial and technical qualifications of the bidders. In the second stage, the commission determined whether the platforms proposed for conversion by the qualified bidders met the specifications set forth in the Invitation to Bid. The final stage was to open the sealed envelopes with the bid prices. (Tr. at 2962-63; S-14 ¶¶ 5, 10, 11.)

57. The bidding commission disqualified FELS for not complying with § 5.4c and 5.4d of the Invitation to Bid. In the second stage, the commission disqualified Consorcio Sembawang Bethelehem/Sembawang Shipyard because the platform proposed for the conversion did not meet the minimum size requirements stipulated in the Invitation to Bid. (JS ¶ 132; Tr. at 2962-63; S-14 ¶¶ 6, 11.)

58. After disqualifying FELS and the Sembawang Bethlehem Consortium, the Commission opened the sealed envelopes with the bid prices on January 3, 1995. (S-14 ¶ 13.) Consorcio IVI/Sade Vigesa was selected as the winning contractor based on a low bid of $165,532,660. (S-14 ¶ 16.) The second-place bid was COA's, at $177,888,238. (Id. ¶ 14.)

59. Petrobras had made its own estimate and determined an estimated average bid amount of $172.3 million, within a range having a high end of approximately $200 million and a low of approximately $150 million. (PB-1289; Tr. at 2968-69.) Consorcio IVI/Sade Vigesa's bid was 4.09% below Petrobras' internal estimate. (Tr. at 2968; S-14 ¶¶ 16-17; PB-1289.)

60. On January 19, 1995 the Diretoria of Petrobras recommended to Brasoil that Brasoil enter into a contract with Consorcio IVI/Sade Vigesa (the "P-19 Consortium") for the acquisition and conversion of P-19. (Tr. at 2970-71; S-17 at 2-3.) The contract was to be subject to the precondition that the P-19 Consortium obtain a performance bond in accordance with the terms of the Invitation to Bid. (S-17 at 3; Tr. at 2984.)

61. The P-19 Consortium and Brasoil signed the P-19 Contract (Contract No. 821-2-002-095-2) on February 10, 1995. (JS ¶ 133.)

62. The P-19 contract did not go into effect until after the Consortium obtained the performance bond. (PB-579.) The contractual provision for a performance bond issued by a first rate insurance company was a safeguard for Petrobras. (Tr. at 2988.) The performance bond was of the utmost importance to Petrobras, and the Consortium would not have been permitted to undertake the project without the performance bond. (Id. at 2984, 2987-88.)

The P-19 Consortium Underbid the P-19 Project

63. The Invitation to Bid required bidders to submit a fixed lump sum price for Schedule A services and a flexible estimate with unit prices for Schedule B services. (PB-279 at 12, 581-587.) Schedule A encompassed:

Supply of a semi-submersible platform, converted from an existing vessel, including for this purpose the supply of the vessel, its transportation to job site and the execution of design, procurement, construction and assembly, services in the vessel to restore to an "as new condition", vessel adaptations and modifications, commissioning, testing, pre-operation, certification, and transportation to Campos Basin and start-up assistance. . . .

(Id. at 582.)

64. The schedule B price covered "direct labor support" for offshore start-up assistance. (Id. at 218.) The unit prices in schedule B were also to be used to calculate change orders. (Id. at 224.) The unit prices specified the wages that would be paid to workers by trade and skill. (Id. at 583-86.)

65. The P-19 Consortium submitted a bid of $163,000,000 for the Schedule A work and an estimate of $2,532,660 for the Schedule B work. (Id. at 581; Tr. at 2797.) The total bid price was $165,532,660. (S-14 ¶ 14.)

66. The Consortium initially budgeted the project at approximately $169 million. For competitive reasons, the Consortium chose to reduce this amount to $163 million in its bid. (Tr. at 2827.)

67. The P-19 Consortium budget was plainly inadequate. It contained no provision for any contingency. (Id. at 3829.) The P-19 Consortium hoped to realize a profit by negotiating discounts from suppliers after the Contract was signed. Indeed, the P-19 Consortium budgeted for a twenty percent reduction in vendor prices in the expectation of reduced prices after it had the contract in hand. (id. at 4079.)

68. An important part of the cost of the P-19 Project was the purchase of the vessel to be used for the project. The original contract schedule provided that the P-19 Consortium would be paid $40.75 million (25% of the schedule A price of $163 million) when the platform was delivered to Brasoil prior to conversion. (PB-279 at 589-91.) The P-19 Consortium chose to purchase the Treasure Stawinner for the conversion project at a cost of $55 million. (JS ¶ 225; PB-438 ¶ 4.4.) Consequently, the balance of $14.25 million had to be made up by a savings in some other budget category. (Tr. at 3016-17, 4074-75; PB-760.)

69. The P-19 Consortium's budget either did not provide or made inadequate allowance for other important budget items. (Id. at 3827-31; 4092, 4094.) Shipyard overhead was only budgeted for $15,000 even though the project was scheduled to last twenty-four months. (Id. at 3831, 4092.) In addition, the budget did not include substantial financing charges that the Consortium incurred due to its weak financial condition. (Id. at 4074-76.)

70. The P-19 Consortium obtained its equipment quotes for the bid in or about November 1994, but did not start placing its equipment orders until well after the quotations had expired. (Id. at 4078-79.) The Consortium could have locked in its equipment prices by obtaining binding quotations from vendors (at a price), but it failed to do so. (Id.) Consequently, the Consortium's project costs were extremely sensitive to fluctuations in the price of equipment and materials.

71. Initially 70% of the Schedule A price was tied to the procurement of equipment, materials and the vessel itself. (PB-279 at 589.) At the request of the Consortium, on March 1, 1996 the percentage for procurement was increased to 80% of the Schedule A price through Amendment One to the P-19 Contract. (PB-71 at 1, 6.)

72. Thus, after March 1, 1996, only 20% of the total contract price was subject to the control of the P-19 Consortium. As a result, the Consortium had minimal flexibility to offset overruns on equipment with savings in budget line items under its control.

73. Commencing in or about 1995, there was an increase in the number of platform conversions worldwide and an upturn in demand for production and process equipment. (PB-438 ¶ 4.1; Tr. at 4085-88.) With increased demand, prices for production and process equipment escalated. The P-19 Consortium did not anticipate price increases and had not included a contingency provision in its budget. (PB-438 ¶¶ 4.1, 4.5; Tr. at 2246.) As a result, the Consortium found itself paying far more for essential equipment than it had originally budgeted. (PB-438 ¶¶ 4.4-4.5.)

74. The P-19 Consortium also was hurt by the overvaluation of the Brazilian currency in 1995-97. (PB-438 ¶ 4.2.) The contract price was in United States dollars, but labor and domestic equipment had to be paid for in Brazilian reais. (PB-438 ¶ 4.2.)

75. Many P-19 Project items ended up costing considerably more than the Consortium had budgeted. For example, IVI labor and consumables costs exceeded the budget (even after adjustments for changes) by approximately $15.4 million, an overrun of approximately 139%; shipyard overhead cost approximately $6.8 million, although the budget only anticipated $15,000; turbomachinery cost approximately $4.1 million more than the budgeted amount; the adjusted imported vessel equipment cost was approximately $19.9 million, a 67% overrun; and the adjusted domestic equipment cost was approximately $6.6 million, although the budget did not provide for any such costs. (Tr. at 3828-31, 4090-93.)

The Sureties' Issuance of the P-19 Bond

76. On April 5, 1995, the Sureties issued a Performance Bond, Bond Nos. 29-34902-95-5 (USF & G) and 15-61-23 (AHAC) (the "P-19 Bond"), in the penal sum of $110,532,660, on behalf of the P-19 Consortium, as principal, in favor of Brasoil, as obligee, in connection with the P-19 Contract. (S-72A.) The bond amount reflected the contract amount of $165,532,660 minus the $55,000,000 cost of the Treasure Stawinner, the platform to be converted. The P-19 Bond was in the form of an American Institute of Architects Document A312 ("AIA 312") Performance Bond. On August 30, 1995, Brasoil, the P-19 Consortium, and the Sureties entered into a Dual Obligee Rider to the P-19 Bond, in which they named the Japanese Banks as additional obligees on that Bond. (Id. at 8; JS ¶ 150.)

77. Brasoil paid the Sureties a premium of $2,579,058 for the P-19 Bond. (JS ¶ 151.) The price of the performance bond was not part of the lump sum price for the conversion. (PB-279 at 227-28.)

78. Several provisions of the AIA 312 Performance Bond are particularly important for purposes of this case. Some of those provisions are set out below for purposes of understanding the disputes that arose.

79. Under Paragraph 1 of the Bond, the Sureties (collectively referred to in the Bond as the "Surety") and the P-19 Consortium (referred to as the "Contractor") jointly and severally bind themselves to "the performance of the Construction Contract, which is incorporated by reference."

80. Under Paragraph 3, if there is no default by Brasoil as the project's Owner,

the Surety's obligation under this Bond shall arise after:
3.1 The Owner has notified the Contractor and the Surety . . . that the Owner is considering declaring a Contractor Default and has requested and attempted to arrange a conference with the Contractor and the Surety. . . .; and
3.2 The Owner has declared a Contractor Default and formally terminated the Contractor's right to complete the contract . . .; and
3.3 The Owner has agreed to pay the Balance of the Contract Price to the Surety in accordance with the terms of the Construction Contract or to a contractor selected to perform the Construction Contract in accordance with the terms of the Contract with the Owner.
The "conference" contemplated in ¶ 3.1 of the Bond is commonly referred to herein as a "3.1 Meeting."
4.1 Arrange for the Contractor, with consent of the Owner, to perform and complete the Construction Contract; or
4.2 Undertake to perform and complete the Construction Contract itself, through its agents or through independent contractors; or
4.3 Obtain bids or negotiated proposals from qualified contractors acceptable to the Owner for a contract for performance and completion of the Construction Contract . . . and pay to the Owner the amount of damages . . . in excess of the Contract Price incurred by the Owner resulting from the Contractor's default; or
4.4 Waive its right to perform and complete, arrange for completion, or obtain a new contractor and with reasonable promptness under the circumstances:
.1 After investigation, determine the amount for which it may be liable to the Owner and, as soon as practicable after the amount is determined, tender payment thereafter to the Owner; or
.2 Deny liability in whole or in part and notify the Owner citing reasons therefor.

82. Under Paragraph 8, "The Surety hereby waives notice of any change, including changes of time, to the Construction Contract or to related subcontracts, purchase orders and other obligations."

83. Typically, a surety undertakes a rigorous investigation of a contractor's financial condition and prior relevant experience before issuing a bond. (Tr. at 4414-15.) This is because in issuing a bond a surety undertakes the risk that the contractor will be unable to complete the project for financial reasons, and the risk that the contractor may not have sufficient financial capability to absorb or answer for any loss that occurs. (Id. at 4416.) A surety reviews the contract to understand the contractual obligations that are being bonded, but a surety typically does not make a determination whether the contractor can actually perform the contract for the specific price bid because the surety lacks the expertise to make that determination. (Id. at 4415-16.)

84. In this case, it does not appear that the underwriters reviewed the construction contracts before issuing the P-19 or the P-31 Bonds. (Tr. at 1377-78; 3302; 4423.) The financial information that the Sureties received should have raised questions about the financial condition of IVI. (Tr. at 4425-36.)

85. The Sureties had various indemnification agreements from various parties that provided them with protection should they be required to make payments under the bonds. As a named principal, defendant Sade Vigesa entered into Agreements of Indemnity in favor of USF & G, as surety, dated August 19, 1994 and February 17, 1995. The stated limit of indemnity under the August 19, 1994 Agreement of Indemnity is $200 million. The stated limit of indemnity under the February 15, 1995 Agreement of Indemnity is $500 million. On February 17, 1995, IVI, Sade Vigesa, and a company that was a significant shareholder of IVI executed another indemnity agreement in favor of the Sureties. On March 22, 1996, other companies, which have been severed for purposes of the current trial, executed an indemnity agreement in favor of USF & G. The stated limit of indemnity under the March 22, 1996 agreement is $200 million. (JS ¶¶ 195-198.)

Relevant Provisions of the P-19 Contract

87. The lump sum (Schedule A) contract price covered all work for the supply of a semi-submersible platform, converted from an existing vessel, including for this purpose, the supply of the vessel; its transportation to the job site; the execution of design, procurement, construction and assembly services in the vessel to restore it to an "as new" condition; vessel adaptations and modifications; commissioning, testing, pre-operation; certification; transportation to the Campos Basin; and start-up assistance. (PB-279 at 582.) The Schedule A price was $163,000,000, as the Consortium had bid. (Id. at 218 § 5.1.1; JS ¶ 143.)

88. Schedule B of the P-19 Contract specified unit prices for labor for offshore services. (PB-279 at 583.) These prices could not change; however the total amount paid under Schedule B was flexible in that it was based on the actual quantities incurred to complete the work. (Id. at 218 § 5.3.) The estimated Schedule B price of $2,532,660 was also in accordance with the Consortium's bid. (Id. § 5.1.2; JS ¶ 143.)

89. The P-19 Contract specified that the prices in schedules A and B were to include profit and overhead. (PB-279 at 218 § 5.4.) The total contract price was $165,532,660 (Id. § 5.1.)

90. The P-19 Contract used a project breakdown schedule ("PBS") or work measurement structure, for progress payments. (PB-279 at 219, 588.) The PBS is a logical and systematic means of dividing a single large project, via a hierarchal structure, into a very large number of individual tasks. Payment is linked to the completion of specified benchmarks. The benchmarks were identified in Annex VI to the P-19 Contract. (PB-279 at 588-597.) The weightings for each task were assigned in accordance with an Analytical Structure of Payments ("EAP"). (Id.; Tr. at 542-43.)

91. Under the P-19 Contract, the Consortium was to invoice Brasoil by submitting a Measurement Bulletin ("BM") which outlined in full detail the services that had been performed the prior month and calculated the percentages that were due under the EAP system. (PB-279 at 219.) Petrobras would confirm that the services had been performed, and approve the BM for payment.*fn1 Petrobras and the P-19 Consortium would often negotiate whether the Consortium was entitled to credit for having achieved a given benchmark.

92. Time was of the essence. Section 6.1 of the P-19 Contract's General Conditions required the Consortium "to comply strictly with the time period stipulated in the Contract in relation to the performance of the work contracted for." (PB-279 at 267.)

93. The P-19 Contract was to be completed within 840 running days (720 on-shore plus 120 offshore). The completion date for the on-shore work was initially set for March 23, 1997, with the offshore portion to be concluded on July 23, 1997. The parties subsequently agreed in Amendment Two to the Contract to extend the completion date for the shipyard services by sixty days to May 24, 1997 and the offshore completion date to September 21, 1997. (JS ¶ 146.)

94. The Contractor was required to provide written notice of "[d]ays on which work is at a standby due to demands for modifications of design on the part of Brasoil, and which manifestly affect the progress of the work or are the result of delays in the supply of materials for which Brasoil is responsible" in order to claim extensions of time due to the fault of Brasoil. (PB-279 at 267 § 6.3.)

95. The P-19 Consortium had 90 days from the signing of the Contract on February 10, 1995 to transfer title to the platform to Brasoil. (Id. at 200, 206.) Therefore, the transfer of the vessel was to take place on or before May 10, 1995.

96. Section 3.13 of the P-19 Contract required the P-19 Consortium to endorse the consistency of the Technical Documentation provided by Brasoil within sixty days of the signing of the Contract. (Id. at 207.) Thereafter, any errors or contradictions became the responsibility of the P-19 Consortium. (Id. at 207 § 3.13.1.)

97. IESA, the P-19 Consortium's subcontractor, issued a "Report on the Basic Design Consistency Analysis," which was received by Petrobras on April 25, 1995. PB-1274; Tr. at 3127.) According to the Report, no serious inconsistencies were found in the basic design and "Petrobras' basic project possesses satisfactory degrees of consistency and scope allowing, without any major difficulty, for its consolidation and subsequent elaboration." (PB-1274 at 10-11.)

98. Offshore production of oil and gas is an inherently hazardous activity. The completed platform was to be stationed approximately one hour's flight offshore for twenty years. (Tr. at 2947, 2980; PB-279 at 78.) There would be no opportunity to remove the platform to shipyards on shore for repair and refit, and the platform had to be capable of operating twenty-four hours a day, seven days a week in a harsh marine environment. Thus, the P-19 Contract required rigorous compliance with technical and safety specifications.

99. The Contract gave Petrobras broad rights to inspect the work on the project and insist on strict compliance with the Contract. (PB-279 at 202, 226, 260, 271-72, 716.)

100. Section 2.3.1 of Appendix III to the Contract required the P-19 Consortium to provide facilities at the job site for a Petrobras supervisory team consisting of "at least 20 and at most 40 persons." (PB-279 at 577.)

101. The P-19 Contract authorized Petrobras to attend expediting and technical meetings with vendors. (PB-279 at 623-24.) Petrobras employees did not participate in the negotiation of the commercial terms of the vendor contracts.

102. The platform had to be approved and certified by a classification society. (Id. at 207-08.) Section 3.15.12 of the Contract provided that the classification society "shall be involved in all phases of the work contracted, from the design phase, and including procurement, construction, assembly, commissioning, testing, pre-operation and transportation, up to final Classification/Certification" of the platform. (Id. at 208.) The P-19 Consortium retained Bureau Veritas as the platform's classification society. (Tr. at 3346.)

103. The P-19 Contract expressly provided that "approval by Brasoil of documents referring to Design, Procurement, Construction and Assembly, Conditioning and Pre-Operation does not limit or modify [the Consortium's] responsibility for performance of the object of this Contract." (PB 279 at 205 § 3.3.)

104. Section 3.23 of the P-19 Contract stipulated that materials and equipment acquired for the purpose of the Contract became "the property of Brasoil and shall be exempt from seizure in the event of bankruptcy or bankruptcy protection proceedings involving the [Consortium], the latter being required to notify the Courts of these circumstances." (PB-279 at 209.) The P-19 Consortium was to acquire equipment and materials as a "faithful custodian" and undertook to see to their safekeeping. (Id.)

105. Section 3.23.2 of the P-19 Contract specified that equipment and materials acquired for the purpose of the Contract would be the property of Brasoil, even if it had not yet been received at the job site, if purchase orders had been issued for said equipment and materials. (Id.)

106. Section 9.3 of Appendix VIII required the Consortium to supply certain documents to Brasoil for Brasoil's approval. (Id. at 606.) Sections 9.3 and 9.4 stated that if Brasoil failed to return its comments within fourteen days from the date of receipt, such documents would be considered "released," unless the delay were justified by Brasoil and reported in advance to the P-19 Consortium. (Id.)

107. Section 5.1 of Appendix VIII specified that "all verbal communications, whenever necessary, shall be confirmed later by letter or meeting notes." (Id. at 602.) Section 6.2 further provided that all subjects discussed at weekly technical or administrative meetings were to be formalized by meeting notes, issued immediately after the end of the meeting. (Id.)

Delays in the Commencement of the P-19 Project

108. Section 9.1 of the Invitation to Bid required the winning bidder to provide a performance bond within twenty days of the release of the bidding results. (Id. at 20.) The time limit could be extended at the sole discretion of Brasoil. (Id.) The report of the bidding commission was dated January 9, 1995 (S-14 at 4), 50 the P-19 Consortium was required to procure the bond no later than January 29, 1995.

109. The P-19 Contract was signed on February 10, 1995. (PB-279 at 258.) Section 15.6 of the Contract provided that the performance bond was to be delivered to Brasoil on signature of the Contract. (Id. at 228.) The P-19 Consortium was still attempting to obtain a performance bond when the P-19 Contract was signed. (PB-282; Tr. at 2985-86.)

110. The P-19 Consortium requested extensions of time to obtain the performance bond. (Tr. at 2985-88; S-51.) Brasoil allowed the P-19 Consortium to have the extra time. (Tr. at 2986.)

111. The P-19 Consortium did not obtain the performance bond until April 5, 1995, 54 days after the execution of the Contract. (Id. at 2989; S-72A.)

112. Brasoil issued an Service Authorization, which allowed work on the project to go forward, immediately upon the Consortium's obtaining the bond. (Tr. at 2697-99; PB-579.)

113. The PBS provided for a payment of 25% of the schedule A price ($40.75 million) when the platform was transported to the job site. (PB-279 at 589.) On February 10, 1995, IVI entered into an option agreement with Winner Drilling Ltd. to purchase the Treasure Stawinner drilling platform for $55 million. (JS ¶ 122.) At the time, the Treasure Stawinner was under lease to Petrobras and was engaged in drilling operations off the coast of Brazil. (Tr. at 2977; JS ¶¶ 121, 134.) The higher-than-budgeted price of the platform left a gap of $14.25 million to be financed by the P-19 Consortium. (Tr. at 1038, 3016-17; JS ¶ 241.)

114. The P-19 Consortium entered into an agreement with Marubeni America Corporation ("MAC") to obtain the gap financing. (JS ¶ 242.) MAC made the gap financing contingent upon the P-19 Consortium purchasing turbogenerators from Dresser and turbocompressors from Dresser/Solar using MAC as the purchasing agent. (JS ¶ 242.) The Dresser and Solar equipment was $8 million more expensive than comparable equipment from another vendor. (PB-438 § 4.4.)

115. As security for the equipment financing, MAC required and the P-19 Consortium obtained a payment bond in the amount of $38 million from the Sureties. (JS ¶ 244.)

116. The closing of the purchase of the Treasure Stawinner occurred on June 29, 1995, 79 days after delivery was supposed to have occurred under the Contract and 24 days after Petrobras's manager expected the platform to arrive at the shipyard, in view of the late date of the Service Authorization. (Id. ¶ 245; Tr. at 3021.)

117. Preparatory work began on P-19 in Angra dos Reis at the beginning of July, 1995, nearly five months after the signing of the Contract. (Tr. at 2948.) The initial work involved the removal of drilling equipment. This dismantling work was not completed until November 1995. (Id. at 2712.)

118. On May 22, 1995, Arnaldo Arcadier, Petrobras's P-19 project manager, wrote Amauri Rodrigues, the P-19 Consortium's project manager, to complain "bout the slow progress of the P-19 Consortium in getting procurement organized. (S-77; Tr. at 3006-07.)

119. Throughout the time that Arnaldo Arcadier worked on the P-19 Project, the P-19 Consortium lacked the capacity to procure equipment and materials effectively. (Tr. at 2997.) It lacked an international arm for procurement as well as an internal structure. The Consortium delayed in placing orders for long lead items, such as turbomachinery, and failed to plan adequately for purchases. (Id. at 2997-3001.) Mr. Arcadier wrote several letters to the Consortium expressing the dissatisfaction of Petrobras with the Consortium's procurement function. (Id. at 3001.)

120. In June, 1995, Guilherme Pires assumed the management of the P-19 Project for the P-19 Consortium. (Id. at 2019.) Pires was part of the team that the P-19 Consortium brought in from Montreal Engineering which also included David Fischel and Carlos Mauricio. (Id.)

121. On August 8, 1995, six months after the signing of the P-19 Contract, the Consortium entered into a contract with Mustang Engineering, Inc. ("Mustang") establishing that Mustang would act as procurement agent for the Consortium in the United States. ("JS ¶ 157-58.)

122. The P-19 Consortium did not line up financing for the purchase of imported equipment until October 25, 1995, when IVI and Sade Vigesa signed a Note Purchase and Credit Agreement with Mustang and the Canadian Imperial Bank of Commerce ("CIBC"). Pursuant to this agreement, CIBC agreed to purchase $80 million in promissory notes that IVI and Sade Vigesa issued to Mustang to pay for the purchase of equipment imported from the United States. The promissory notes were guaranteed by the Export-Import Bank of the United States ("Exim Bank") under the Financial Institution Buyer Credit Policy, Consortium IVI-Sade Vigesa, Brasil (FB 157438). (Id. ¶ 159; PB-611.) The notes were payable 360 days after the date of issuance. (PB-611 § 3.1(a).)

The P-31 International Bid Process

123. On March 20, 1995 a public meeting was held initiating the international public bidding process for the award of the Contract for the conversion of the Vidal de Negreiros (the "Vidal"), a Very Large Crude Carrier ("VLCC"), into a Floating Production, Storage, and Offloading ("FPSO") unit called P-31. The notice of the invitation to bid was published on May 15, 1995. Edison Krummenauer, who later served as Petrobras' P-31 project manager, acted as the coordinator of the bidding commission. (JS ¶¶ 120, 160; S-1136.)

124. The bidding process was required to comply with the Brazilian Public Bidding Law (Law 8.666 of 1993). (JS ¶ 160.)

125. IVI, Sade Vigesa, and IESA (the "P-31 Consortium") entered into a formal consortium agreement on October 5, 1995. Under the consortium agreement, the stated purpose of the P-31 Consortium was to bid for and perform the P-31 Contract. The consortium agreement authorized IVI to represent the P-31 Consortium in its dealings with Brasoil. (Id. ¶ 168.)

126. The Vidal was made available for inspection by interested parties from May 27 to June 27, 1995. (Id. ¶ 175.)

127. The P-31 Consortium inspected the Vidal on two occasions. (Id.) As part of its bid, IVI, Sade Vigesa, and IESA each executed a declaration dated August 24, 1995 attesting that it was aware of all the works and installations that would be incorporated on the vessel in the course of the project and of the current condition of the vessel itself. (PB-24.) The declaration was signed for Sade Vigesa by Alarico de Castro as director of business development. (PB-24.) Mr. De Castro was later to serve as the P-31 Consortium's project manager for P-31. (Tr. at 2173-74.)

128. The P-31 bidding commission issued fifteen circular letters responding to requests from the parties for clarification of the bidding documents. The circulars were distributed to all interested parties and bidders. (JS ¶ 173.)

129. On August 24, 1995 seven consortia, made up of fourteen companies, submitted bids on the P-31 Project. (S-1136 ¶¶ 5.1, 5.2; S-291 at U 2434.)

130. In its report dated August 28, 1995, the bidding commission found that the P-31 Consortium was the low bidder. The P-31 Consortium bid was $163,000,021. (S-1136 at 3.)

131. The P-31 Project was to be completed within 810 running days. The signing of the Contract was to be conditioned on the P-31 Consortium's obtaining a performance bond meeting the conditions set forth in the Invitation to Bid. (Id.; JS ¶¶ 170, 182.)

132. The bidding contest for the award of the P-31 Contract was entirely transparent, fair, and above board. (Tr. at 3518-21.)

133. On August 25, 1995, Brasoil entered into a contract with a consortium made up of IVI and Sade Vigesa to convert the Cairu, a VLCC similar to the Vidal, to an FPSO called P-32. (S-1476.) That Consortium was the lowest bidder on the project with a contract price of $93,000,710. (Id. at 10.)

134. IVI was also involved in constructing two other Petrobras/Brasoil projects known as P-25 and P-34. (JS ¶¶ 187, 189.) Despite serious concerns about the concentration of five significant projects with IVI (P-19, P-25, P-31, P-32, and P-34), Petrobras and Brasoil were required by Law 8.666 to award the projects to the lowest qualified bidder. (Tr. at 244-246, 3248.)

135. On October 25, 1995, the Sureties issued a Performance Bond for the P-31 Contract in the face amount of $163,000,021, with Brasoil as the obligee. (JS ¶ 163.)

136. On October 25, 1995, the P-31 Consortium and Brasoil signed the P-31 Contract (Contract No. 846-2-024-95-1). The Service Authorization was issued the same day. An on-shore completion date of August 16, 1997 and a final contract completion date of January 11, 1998 were established. (JS ¶¶ 164, 167, 182.)

The P-31 Consortium Underbid the P-31 Project

137. The P-31 Consortium submitted a bid that seriously underestimated the reasonable costs that would be necessary to complete the project. The P-31 Consortium prepared a budget document prior to the bid that showed in detail two budgets with total prices of $169.7 million and $195 million. (PB-856; Tr. at 2243-44.) The budget document also notes a "floor" figure of $161,250,292.50 and a "ceiling" figure of $174,829,264.50, without detail. The P-31 Consortium staff initially recommended that the Consortium bid the project for $169,000,000, but upper management reduced the bid to $163,000,021 on the day the bid was submitted. (Tr. at 2244, 3808.) No factor for contingencies, overhead or profit was included even in the $169 million proposal by the staff and therefore not in the still lower bid of $163,000,021 determined by the Board. (Id. at 2247, 3814.)

138. David Fischel, president of IVI and Sade Vigesa, admitted that the P-31 Consortium counted on negotiating steep price discounts from suppliers once it had a contract in hand. (Id. at 1022, 2166).

139. The substantial underbid was exacerbated by market conditions that resulted in an increase in the cost of equipment as a rsult of an overheated market. Moreover, IVI's poor financial condition resulted in increased costs because of difficulties in obtaining favorable prices and credit facilities. Thus, while the P-31 Consortium expected to earn a profit based on its ability to negotiate better prices with suppliers, exactly the opposite result occurred. The P-31 Consortium itself acknowledged in November, 1996 and April, 1997 that there were substantial reasons for the increased cost of the P-31 Project that had nothing to do with any fault of Petrobras or Brasoil. The P-31 Consortium's stated reasons for the discrepancy between the budget and the actual costs include: (1) IVI's poor financial condition, resulting in lack of credit and lack of negotiating leverage with suppliers, (2) the fluctuation of the real against the dollar; (3) an increased demand for supplies, resulting in higher prices; (4) the Consortium's decision to purchase equipment on skids, which increased prices; and (5) the inability of some suppliers to comply with the Contract's technical specifications. (S-342; PB-217.)

140. The P31 overruns and delays were caused principally by the P-31 Consortium's own practices and by market forces that were not the fault of Petrobras or Brasoil. The principal reasons that the P-31 Consortium did not complete the P-31 Project within the Contract price were the following: (1) an unrealistically low bid that failed to provide for significant items and a heating up of the offshore market; (2) poor project planning; (3) IESA's delay in the issuance of construction drawings and material requisitions; (4) failure to manage suppliers; (5) delays in the manufacture and delivery of equipment; (6) deficient shipyard infrastructure; (7) labor strikes and inefficiency; and (8) damage to the turbocompressors. (Tr. at 4069-97.)

The Issuance of the P-31 Bond

142. Like the P-19 Bond, the P-31 Bond was on the AIA 312 form. The P-31 Bond included the same Clauses 1, 3, 4, and 8 discussed above with respect to the P-19 Bond. (S-123.)

143. As discussed above, there is no evidence that the Sureties actually reviewed the P-31 Contract before issuing the P-31 Bond.

144. By October, 1995, the financial situation of IVI had worsened, but the Sureties proceeded to issue the performance bond despite that financial condition. (Tr. at 4433-34.) In addition, IVI was working on 5 Brasoil projects simultaneously (P-19, P-25, P-31, P-32, P-34), and in September, 1995, USF & G had issued a bond for the P-32 (Cairu) Project in the amount of $93 million. (Id. at 511-12; JS ¶ 188.)

Relevant Terms of the P-31 Contract

145. The P-31 Contract was an engineering, procurement, and construction contract ("EPC Contract") to be performed on a turn key, lump sum basis. As set forth in Section 1.1. of the P-31 Contract, the object of the Contract was the performance by the contractor of the services and procurement necessary to convert the VLCC Vidal de Negreiros into a floating production, storage and offloading unit ("FPSO") for oil and gas. (PB-820 at 489.)

146. The Contract was to be completed within 810 days of Brasoil's issuance of a Service Authorization (660 onshore, 60 for pre-operation of the oil and gas systems offshore, and 90 days for provision of support for the assisted operation phase). (Id. at 506.) The completion date for the onshore work was initially scheduled for August 16, 1997, with an offshore completion date of January 11, 1998. (Id. at 506, 518.) The parties subsequently agreed in Amendment Three to extend the Contract duration by ninety-three days. (Id. at 1557-58.) The deadline for completion of the onshore services was moved back to November 17, 1997, and the offshore phase was moved back to April 14, 1998. (Id.; JS ¶ 167.)

147. The P-31 Consortium's total price of $163,000,021 was compiled from five schedules consisting of fixed prices and unit prices. (PB-820 at 880; JS ¶ 170.)

148. Annex VIII to the P-31 Contract provided for periodic progress payments in accordance with an intricate PBS. (PB-820 at 881-888.) The PBS provided measurement criteria for payment under the EAP based on the completion of specified activities (such as detailed engineering design and the procurement of equipment.) (Id at 883.) 51% of the lump sum amount on Schedule A was to be paid when procurement milestones were met for equipment and materials. (JS ¶ 178.) of this total for procurement, 40% (i.e., 20.5% of the overall schedule A price) was tied to the procurement of the turret system. (Id.) The turret system was a complex component which was to anchor the Vidal, provide a location for risers to be attached to the vessel from the oil and gas wells on the bottom of the ocean, and function as a pivot around which the vessel could change its orientation in the sea. (Tr. at 911-12, 3436.)

150. Section 3.15 of the Contract required the Consortium to endorse the technical consistency of the Basic Engineering Design documents supplied by Brasoil within sixty days from the commencement date of the services under the Contract. (PB-820 at 496 § 3.15.) Thereafter, there could be no grounds for subsequent claims in relation to the inadequacy or lack of precision of the Basic Engineering Design documents. (Id.) The P-31 Consortium issued a Basic Design Consistency Analysis-Vidal Project: letter report on December 28, 1995. (PB-268.)

151. The P-31 Consortium was responsible for retaining a classification society to inspect and certify the platform. (PB-820 at 489.) The P-31 Consortium hired the American Bureau of Shipping ("ABS") as the classification society for the vessel. (Tr. at 4145.) All work on the vessel had to be approved by ABS. (JS ¶ 180.)

152. Appendix V to P-31 Contract Annex III included a detailed vendor list with the names of approved suppliers for each item of equipment. (PB-820 at 622-64.) Brasoil was obligated to accept equipment made by these vendors that met the specifications set forth in the Contract. (JS ¶ 181.)

153. Brasoil had the contractual right to participate in technical discussions with vendors and to accompany the P-31 Consortium on expediting visits and inspections. (PB-820 at 591-93 §§ 3.14, 4.3, 5.5; Tr. at 1017.)

154. If the work fell behind schedule due to the fault of the contractor, Brasoil had the right to demand that the contractor employ a larger work force, work overtime, and/or provide additional tools and equipment to the extent necessary to eliminate the delay and permit the work to be completed on the specified date without any alteration of the Contract prices. (PB-820 at 507 § 8.3.)

155. Appendix I to P-31 Contract Annex VIII, entitled "Procedures of Equipment Repair," set forth detailed "as new" procedures for the equipment to be retained on the Vidal and reconditioned. (Id. at 899-985.) The object of the reconditioning was to "recover the original working conditions (similar to a new equipment) and allowing its use for the FPSO operational life-time" of twenty years. (Id. at 900 § 1.)

156. Under the P-31 Contract, only the project managers were allowed to issue correspondence in the name of their respective companies and "all verbal communications, whenever necessary, shall be confirmed later by letter or meeting notes." (Id. at 556-57 §§ 2.2, 3.1.)

157. Weekly meetings were to be held between Brasoil and the P-31 Consortium to discuss technical and administrative matters. (Id. at 557 § 4.1.) All the subjects discussed in the engineering meetings "shall be formalized by meeting notices, issued immediately at the end of each meeting." (Id. § 4.2.)

158. Like the P-19 platform, the P-31 was expected to be stationed approximately one hour's flight offshore for twenty years. ("Tr. at 2947, 2980.) There would be no opportunity to remove the unit to shipyards on shore for repair and refit. (Id. at 3109-10.) It had to be capable of operating twenty-four hours a day, seven days a week in a harsh marine environment. Thus, the P-31 Contract required rigorous compliance with technical and safety specifications. (PB-820.)

159. The Contract conferred broad rights on Petrobras to supervise and inspect the progress and quality of the work. (Id. at 506-08 § 8.) Annex VII required the P-31 Consortium to provide facilities for the Brasoil inspection team (Id. at 846-50), which it envisioned would consist of between fifteen and thirty people at the job site (Id. at 848). An additional six inspectors were to be stationed at the engineering office. (Id. at 847.)

160. Brasoil did not have the right to terminate the P-31 Contract for convenience. (Tr. at 1040.)

Initial Efforts to Address the Consortia's Cash Flow Problems

161. As of early November, 1995, the P-19 Consortium was having difficulty paying for essential supplies and services for the P-19 Contract. Suppliers, including the classification society, were threatening to curtail services to the P-19 Project unless payments were made. (PB-957.)

162. On November 14, 1995 Guilherme Pires, on behalf of the P-19 Consortium, wrote to Paulo Marcio Mauro of Petrobras requesting that the schedule for progress payments for the P-19 Project be changed. Mr. Pires claimed that the working capital of the consortium had been depleted by the need to arrange gap financing for the difference between the amount allocated in the Contract for the purchase of the platform (25% of the contract price) and the $55 million that the Consortium paid for the Treasure Stawinner. (S-127.)

163. On December 6, 1995, Sade Vigesa President David Fischel met with the Diretoria of Petrobras to explain the cash flow problems facing the P-19 and P-31 Consortia and to seek financial assistance from Petrobras. In a letter written the same day, Dr. Fischel confirmed the substance of his discussion with the directors. (S-136.)

164. Dr. Fischel admitted that IVI was suffering from negative financial influences common to the naval construction industry in Brazil including high costs resulting from labor disputes, losses from changes to the foreign exchange rate, and excessive personnel as a result of job stability agreements entered into in the past. (Id. at 1.) To resolve these problems, IVI had decided to undertake a drastic restructuring. This restructuring would involve: (1) transforming the company into small business units; (2) tailoring current staffing to actual project needs; (3) negotiating with workers to produce a stable and economical work relationship; (4) negotiating and rescheduling commitments with suppliers; (5) concentrating offshore work at the Verolme shipyard; and (6) suspending new naval construction contracts until all the above mentioned measures were implemented and consolidated. (Id. at 2.) To achieve these objectives, Dr. Fischel asked Petrobras for an advance of $15 million to be repaid in five equal installments. He further proposed that the Consortia would establish separate bank accounts for the projects and account to Petrobras every month on the origin and investment of funds in the account. (Id.)

165. On December 20, 1995, Alceu Barroso Lima Neto, the head of Petrobras' engineering department ("SEGEN"), sent an internal memorandum to Petrobras director Sebastiào Vilarinho in which Mr. Alceu discussed the requests made by David Fischel and recommended various initiatives to resolve the problems caused by the concentration of projects with IVI and IVI's recurrent financial problems. (S-154A.) He observed that there was no guarantee that a loan of $15 million to IVI would resolve the IVI group's financial problems. Mr. Alceu proposed that Petrobras establish blocked accounts ("contas vinculadas") similar to those used in the construction of ships to guarantee that resources related to the projects would be used for the jobs. He also observed that it would be better if the Petrobras/Brasoil projects that had been awarded to IVI but had not yet commenced — the P-32 (Cairu) and the P-31 (Vidal) — be transferred to other contractors. Mr. Alceu recommended that the termination of these contracts be negotiated with IVI with the prospect of financial support and the implementation of the blocked accounts as the incentive.

166. Mr. Vilarinho met with Nelson Tanure several times in December, 1995. Mr. Tanure agreed to relinquish the P-32 Project in exchange for Petrobras adjusting the EAPs of the P-19, P-31, and P-34 Contracts to ease the contractual cash flow problems of IVI and Sade Vigesa. The parties also agreed to establish blocked accounts so that funds paid to the Consortia would be used solely to complete the Petrobras projects. (Id. at 465-66; 3252-55.)

167. Mr. Tanure refused to relinquish the P-31 Project, and told Mr. Vilarinho that he needed P-31 to complete P-19 and P-34. (Id. at 184, 194, 197, 3255.)

168. The Sureties have argued repeatedly that the Petrobras Diretoria made a secret decision in December, 1995 or January, 1996 to continue to fund the P-19 and the P-31 Consortia to completion of the Projects, regardless of the costs of the Projects, and not to declare a default on the Projects or to notify the Sureties of a default. (Sureties' Proposed Findings of Fact ¶¶ 31-41(f).) The Sureties claim that the Diretoria made the alleged decision because Petrobras understood that declaring a default or changing contractors could seriously delay completion of the Projects, thereby causing a loss of revenues due to delayed oil and gas production. In support of this theory, the Sureties rely primarily on Mr. Vilarinho's deposition testimony. (Tr. at 210-19.) The Sureties also argue that the consequence of this decision was that Petrobras ran the Projects like cost plus contracts, rather than lump sum contracts, and that there was no cost discipline. Therefore, according to the Sureties, the Projects were substantially changed from the projects that the Sureties had bonded and the Sureties should be released from their obligation. The Sureties rely heavily on the testimony of their engineering and construction expert, Theodore Trauner, with respect to the alleged change in the nature of the contracts. (Id. at 2458-67, 2470-74.)

169. As discussed in greater detail below, having considered all of the evidence, including the contemporaneous documents and the evidence of the way in which the Projects were actually funded and administered, and having assessed Mr. Vilarinho's credibility, the Court finds that there was no decision (secret or otherwise) to fund the P-19 and P-31 Consortia to completion irrespective of the costs of the Projects. (Id. at 214-15, 218-19, 3256, 3268.)

170. Moreover, in December, 1995 and January, 1996 there was no legal basis to declare a default on the P-19 and P-31 Projects and the Sureties have pointed to none. Neither the P-19 nor the P-31 Projects could simply be taken away from the respective Consortia, and when Mr. Vilarinho proposed to Mr. Tanure that IVI give up the P-31 Project that proposal was flatly rejected. The Sureties' argument is also thoroughly inconsistent with its position that a year and a half later, when Brasoil declared the P-19 and P-31 Consortia to be in default of their contractual obligations, the Consortia were not in fact in default. Mr. Trauner's testimony was not credible on the subject of the administration of the contracts as cost plus contracts. His credibility was further undermined by his purportedly expert testimony as to the existence of a "secret decision," an opinion that his engineering and construction expertise did not qualify him to give and which was based in part on the opening statement of the Sureties' counsel. (Id. at 2460-61, 2761.) Further, the history of the careful way in which the contracts were administered, with the negotiation of specific changes, undercuts any argument that the contracts were being administered as cost plus contracts. Finally, when it was subsequently proposed that the contracts be transferred to another company and turned into cost plus contracts, Mr. Vilarinho flatly rejected the proposal. (Id. at 959, 982, 1252, 3278.)

171. It is plain that the senior management of Petrobras discussed in December, 1995 and January, 1996 what to do about the IVI situation in view of the requests for assistance. However, the results of those discussions were the approval of the blocked accounts to assure that funds were being paid for proper purposes on the Projects, a modification of the EAP schedule to allow greater funds to be provided to the Consortia at an earlier point in time, and the request for IVI to yield the P-31 and P-32 contracts. (Id. at 3254-56.) These proposals were adopted, except for the transfer of the P-31 Project, which was rejected by Mr. Tanure. Id. at 3255.

172. The actions by the Petrobras Diretoria did result in the continuation of the P-19 and P-31 Projects with their respective Consortia, but this did not mean that the Petrobras would not declare a default when there was a default to be declared. The Diretoria followed a strategy to "follow up these projects on a daily basis, and seek to adapt its decisions in accordance with what was happening." (Tr. at 214.) In response to a question by the Court at trial, Mr. Vilarinho testified credibly that in December 1995, he "could say that the prevailing idea, based on what we saw in the progress of the projects and the difficulties involved in taking the ships to other countries and loss of time, and the financial impacts of any such action, that we would work with the situation until it became unworkable. That was not so much a decision, but rather an evaluation of the situation." (Tr. at 3268.) Mr. Vilarinho also testified credibly that in January, 1996,

the default was beginning to become a concern for the board of directors of Petrobras, based on our experience with the Brazilian naval construction industry. The matter, or the subject, was talked about frequently.
In the specific case, or in the specific period of January of 1996, however, the idea did not go forward because there remained a lot of money in the contractual accounts, and the progress on the construction of the platforms, despite the difficulties that the shipyard was having with the unions, was going well, and the delays were very small.
So Petrobras could not make that decision independently on the default because there remained a lot of money in the contracts and the construction was going reasonably well.

(Tr. at 3256.)

173. The Consortia were in compliance with the P-19 and P-31 Contracts in December, 1995. (Id. at 508-09, 3532-33.) Petrobras/Brasoil had no legal basis to terminate the contracts unilaterally because the contracts were on time and there were balances owed to the Consortia under the contracts. (Id. at 3256.) David Fischel testified candidly that he would not agree that the Consortium would give up the P-31 Contract. (Id. at 1040.) If Petrobras/Brasoil had sought to terminate the P-31 contract at that point, the P-31 Consortium would have brought a lawsuit. (Id. at 191-92.) Indeed, the Sureties concede that "it is not clear that in December 1995 or January 1996, Brasoil had a clear legal right to declare a default and terminate the contracts of one or both of the Consortia." (Sureties' Proposed Findings of Fact ¶ 31(b).)

174. On or about January 9, 1996, IVI provided Brasoil with a cash flow schedule indicating that by December, 1997 the Consortia would incur a loss of approximately $61 million in connection with the P-19, P-31, and P-34 Projects. (S-157; Tr. at 3536-37.) Mr. Alceu recommended to a Petrobras director that Petrobras agree to changes to the EAPs for the three Projects in order to provide the Consortia with approximately $32 million in payments that would otherwise not be due until a later date. (S-157 ¶ 7.) The changes in the EAPs of the three contracts would recognize the additional $14.25 million spent by the Consortia for the Treasure Stawinner; provide a payment in connection with the turret order for the Vidal de Negreiros, and return a retention on the P-34 Project. (Id.)

175. On January 29, 1996, the heads of Petrobras's engineering and financial departments sent an internal memorandum informing the Diretoria of the Consortia's cash flow problems and its projected deficit of $60 million by October 1997. (S-165 ¶ 6.2.) The memorandum recommended that the EAPs of the three projects be adjusted to ease the Consortia's cash flow problems and that blocked accounts be instituted to control the application of funds. (Id. ¶¶ 14.1-14.4; Tr. at 3256.)

Changes to the EAP and the Establishment of Blocked Accounts in the First Amendments

176. On February 12, 1996 Brasoil and the P-31 Consortium executed Amendment One to the P-31 Contract, which revised the P-31 EAP so that the Consortium would receive larger payments when the purchase orders were placed for the turret and turbocompressors. The payments for documentation were also increased from two to four percent of the schedule A price. In addition, Amendment One established the system of blocked accounts ("contas vinculadas") for payment of project expenses. (PB-820 at 1510-25.)

177. David Fischel testified that the first amendment to the P-31 Contract required the Consortium to perform the Contract at the original price and in accordance with the original terms. (Tr. at 1033.) P-31 Amendment One only changed the Contract by altering the EAP schedule and establishing the blocked accounts. All the other conditions of the P-19 contract remained unchanged. (PB-820 at 1515 § 9.1.)

178. On March 1, 1996, Brasoil and the P-19 Consortium entered into Amendment One to the P-19 Contract, which revised the P-19 EAP to increase the payment to the P-19 Consortium for the purchase and delivery of the existing vessel from 25% to 35% of the Contract value; reduced the amounts to be paid for construction and assembly, sea trials and start-up assistance; and established a blocked account system. (PB-71.)

179. Although it was not necessary to do so, Petrobras's P-19 project manager, David Schmidt, asked the P-19 Consortium's project manager, Mr. Pires, to send a copy of Amendment No. 1 to the P-19 Contract to the Sureties. (Tr. at 3376.) When the Consortium did not respond in a timely fashion, Mr. Schmidt asked again. (Id.) On or shortly after April 16, 1996, Mr. Schmidt received a copy of a letter indicating that the Consortium had sent the amendment to Tudor Marsh & MacLennan, the Brazilian arm of its broker Marsh & MacLennan, and asked Tudor Marsh & MacLennan to forward the amendment to the Sureties. (PB-78.)

180. The first amendment to the P-19 and P-31 Contracts made it clear that the establishment of blocked accounts for the projects did not represent a commitment by Brasoil as to the final cost of the performance of the Contracts, but only a means of monitoring the expenditure of funds earned by the Consortia. (PB-71 at 4 § 17.1.12; PB-820 at 1514 § 23.1.12.)

181. IVI had previously used blocked accounts for its naval contracts. (Tr. at 510-511.)

182. Blocked accounts with joint signatory powers are commonly used by Sureties in connection with troubled projects. (Tr. at 1387, 3797.)

183. The blocked account system that the Petrobras Defendants agreed on with the Consortia worked as follows. IVI would submit bank payment orders ("OPBs") to Petrobras for approval with supporting documentation five days prior to the time the funds were needed. Petrobras would then determine whether the costs were contract related and, if so, approve the expenditures. The Petrobras Defendants only had the right to remove items which were not within the scope of the three Contracts (the P-19, P-31 and P-34 Contracts). (PB-71 at 2-4; PB-820 at 1512-14.)

184. If there were a surplus remaining in the P-19 blocked account after the P-19 Contract was completed and the instrument of final receipt signed, the balance of the P-19 blocked account would be transferred to the P-31 blocked account. (PB-71 at 2 § 17.1.2.) At the end of the P-31 Project, any balance left in the P-31 blocked account would be released to the P-31 Consortium. (PB-820 at 1512 § 23.1.2.)

185. On April 2, 1996, the parties agreed on a "Procedure for Release of Funds from the [Blocked] Account[s]" ("the Procedure"). (PB-76.) The Procedure specified that positive balances from one blocked account could be used to pay expenses of the other two projects, but that the transfer from the original account would have to be restored as soon as there was a positive ...


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