Surety Bonds: Direct Claims v Derivative Claims – Who Knew?

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) –

The debtor made claims against a surety that issued a performance bond in connection with a construction contract.  The surety contended that it was not liable for the consequential damage 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.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
This entry was posted in Real Estate and tagged . Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s