Find out more about What Surety Bonds are here.
Below is a great synopsis of a case, New Bern Riverfront Dev., LLC v Weaver Cooke Constr., LLC (In re New Bern Riverfront Dev. LLC), 521 B.R. 718 (Bankr. E.D.N.C. 2014), by Vicki Harding of Pepper Hamilton.
In the case, she deftly goes over the claims that can be made against a surety in a bond dispute. As she rightly points out, the underlying contract is what the surety is guaranteeing and that they are not liable for damages beyond the original contract. However, the case further points out that the surety company is still liable for their own breach. Of course, this makes sense.
The real world implication is that surety claims are a bit more difficult than typical contract claims between two parties. Instead, the surety adds a layer of complexity to the entire claims process, which in turn leads to some confusion and litigation. Finally, this is one reason why the surety is generally very cautious in taking on new clients in the first place.
Our advice: work with you surety bond company. That relationship will help you in a variety of ways, including any claims.
The court characterized suretyship as “a contractual arrangement whereby one party, the surety, agrees to be answerable for the debt or performance obligation of another, the principal.” Although the bond agreement defines a surety’s liability, there is also a concept that the surety’s liability for a principal’s default is limited to the obligations of the principal under the construction contract. In other words, a surety’s derivative liability is evaluated in light of the underlying construction contract.
In this case the underlying construction contract between the contractor and the debtor included a mutual waiver of consequential damages. Consequently, to the extent that the surety’s liability was derivative of the contractor’s default under the construction contract, the debtor was not entitled to recover consequential damages in connection with its claims.
However, the court noted that the surety also had independent obligations under the bond agreement. The court drew a distinction between consequential damages caused by the contractor’s default from consequential damages caused by the surety’s default. Since the bond agreement did not include any waiver of consequential damages, the surety could be held liable for the “natural and foreseeable damages incurred by virtue of [its] own breach.”
Under the bond agreement, when the debtor declared a default pursuant to the construction contract, the surety was obligated to (1) arrange for the contractor, with the debtor’s consent, to complete the construction contract, (2) undertake to perform and complete the work itself, (3) find a new contractor to complete the work, or (4) either tender payment of the amount for which it was liable or deny liability with reasons. The bond agreement further provided that if the surety did not proceed with “reasonable promptness,” it would be deemed in default. The debtor alleged that the surety failed to promptly make an election as required.
Although the bond provided that the surety’s responsibilities under the first three options were no greater than those of the contractor under the construction contract, it also provided that the surety would be obligated for certain additional costs due to the contractor’s default “and resulting from the actions or failure to act of the Surety.” The court found that this meant that the surety had independent obligations under the bond.
The score card at the end of this inning was: consequential damages for contractor claims – NO, consequential claims for surety derivative claims – NO, and consequential claims for surety direct claims – YES.
Something to keep in mind when dealing with suretyship issues is that they often involve more than a standard straightforward contract interpretation.