C. Nature and Extent of Surety's Liability

• Library: SC Construction Law Desk Book (SCBar) (2013 Ed.)

C. Nature and Extent of Surety's Liability

1. General Principles

Under South Carolina law, a surety's liability is governed by the strict terms of its bond.¹⁸ A surety's obligation is "contractual in nature [and as such, it] 'cannot extend beyond the terms of the bond and the intent of the parties thereto.'"¹⁹ When a bond refers to or incorporates by reference another document or instrument, it is generally held that "the other instrument . . . 'becomes a part of the bond, and the two should be read together and construed as a whole.'"²⁰ As with other written contracts, a bond is be construed according to the fair import of its language, and if the bond language is plain and unambiguous, it should be interpreted as any other contract to determine the intention of the parties.²¹

South Carolina courts have adopted the rule that when the "liability of a surety is dependent on the outcome of litigation in which his principal is or may be involved, a judgment against the principal is binding and conclusive on the surety, and the surety may not interpose defenses which should or might have been set up in the action . . . ."²² The "rule is applicable even though the surety had no notice of the suit or opportunity to defend."²³

2. What Can the Obligee Recover from the Surety in the Event of the Principal's Default?²⁴

The surety will only be responsible for compensating the obligee for those costs and expenses which result from the principal's default and which are within the scope of the bond obligation bonded by the surety company.²⁵ These expenses may include:

a. the reasonable cost of completing the work, including payments to subcontractors, material suppliers, labor claimants and other prime contractors;
b. rentals lost by delay in completion;
c. attorneys' fees incurred in defending suits by lien claimants, if provided for by the bond;
d. the reasonable cost of correcting workmanship or replacing defective materials;
e. lost profits;
f. liquidated damages provided for in the bond; and
g. unpaid taxes.

Performance bonds written for private projects can limit the types of damage that are potentially recoverable. In contrast, on public projects the types of damage are governed by the Federal Miller Act and South Carolina's Little Miller Acts.

3. Who Can Recover from the Surety?

In Frost v. Williams Mobile Offices, Inc., the United States Court of Appeals for the Fourth Circuit certified a question to the South Carolina Supreme Court: whether a sub-subcontractor could recover for labor and materials it had furnished on a project.²⁶ The South Carolina Supreme Court held that a sub-subcontractor was a third-party beneficiary of a surety bond that was executed by a subcontractor and was therefore entitled to sue for recovery of unpaid claims on that bond.²⁷

In Frost, Dawson Construction Company was hired as the general contractor to make renovations to Moncreif Army Hospital at Fort Jackson. Dawson subcontracted work related to providing temporary offices for hospital staff to Williams Mobile Offices ("WMO"). The subcontract required WMO to provide both a supplier's bond and a performance bond (both bonds were issued by Fireman's Fund Insurance Company). A provision in WMO's subcontract also stated that WMO "shall promptly pay for all materials purchased."²⁸

WMO subcontracted with Modular Concepts, Inc. for certain labor and materials required under its contract with Dawson, and Modular Concepts subcontracted with the Plaintiff, Tom Frost d/b/a Monroe Heating and Air Conditioning Company. After the project was completed, Dawson paid WMO, and WMO paid Modular, but Modular, who was insolvent, failed to pay the Plaintiff.

Plaintiff brought suit, and the Federal District Court found that Plaintiffs were third-party beneficiaries of the bond issued on behalf of WMO. On appeal, the Fourth Circuit Court of Appeals certified the following question to the South Carolina Supreme Court: "Are the claimants third party beneficiaries of the surety bond executed by Fireman and as such entitled to sue for the recovery of their unpaid claims under such bond? The bond as executed by Fireman?"²⁹

The Court held that claimants were third-party beneficiaries of the surety bond and were entitled to sue. The Court relied on another South Carolina case, Dominion Culvert & Metal Corp. v. U.S. Fidelity & Guaranty Co. in its reasoning.³⁰ The Dominion Culvert Court held "[a] contractor and the surety on his bond, given to secure payment for labor and materials furnished in the construction of a public improvement . . . are liable not only for labor and materials furnished to the contractor, but also for those furnished to a subcontractor."³¹

Although Dominion Culvert involved a contractor and surety, the Court in Frost indicated that the same reasoning applied to a subcontractor and its surety. Under the terms of its contract, the Court found that WMO was obligated to pay for materials furnished, including materials furnished to its subcontractor. The Court further held that the rule from Dominion Culvert was applicable even though the bond at issue in Dominion Culvert was a statutory bond.³² The Court indicated that the rule would be applied to bonds regardless of whether they were required by statute.³³ The Court reasoned that a "contrary rule would permit contractors and subcontractors to insulate themselves from liability by executing a series of subcontracts."³⁴ In order to protect themselves, the plaintiffs could have required bonds from each subcontractor. Nonetheless, despite the fact that the bond was not required by statute, claimants were considered third-party beneficiaries entitled to recovery.

Similarly, in Moore Electric Supply, Inc. v. Ward, the South Carolina Court of Appeals held that a supplier who entered into a direct contractual relationship with a subcontractor was entitled to recover under the contractor's payment bond.³⁵ In Moore, L-J, Inc. entered into a contract with the South Carolina Department of Highways and Public Transportation to build a weigh station on Interstate 26.

Pursuant to S.C. Code Ann. § 57-5-1660 (1976), L-J obtained a payment bond from St. Paul Fire and Marine Insurance Company to cover the labor and materials supplied to the project.³⁶ L-J subcontracted a portion of the work to RDC Constructors, Inc. to supply labor for the electrical portion of the contract. RDC Constructors sub-subcontracted with White Electric Company.

White Electric ordered materials from Moore Electric for the project, but RDC agreed to pay Moore Electric directly for those items. Moore Electric extended an open line of credit to RDC to finance the purchases, and although RDC made some payments to Moore, RDC failed to pay for all the material it used. Moore sued under the payment bond and was awarded judgment.

On appeal, St. Paul argued, among other things, that Moore Electric did not establish it had a direct contractual relationship with St. Paul's principal, RDC, and therefore could not recover against the bond under S.C. Code Ann. § 57-5-1660. St. Paul argued that Moore only had a direct contract with White.³⁷

The Court disagreed, finding that Moore did have a direct agreement with RDC because RDC agreed to pay Moore directly for any supplies White purchased for the project. The Court noted further that Moore supplied materials based upon a line of credit extended to RDC.

Where the definition of "claimant" under a bond is unambiguous, however, the Court will construe the bond according to the terms used by the parties. In William M. Bird & Co. v. Whitmire, the payment bond defined "claimant" as "[o]ne having a direct contract with the Principal or with a Subcontractor of the Principal for labor, material, or both, used or reasonably required for use in the performance of the Contract . . . ."³⁸ The prime contract, which was incorporated by reference into the bond, defined subcontractor as "a person or entity who has a direct contract with the Contractor to perform a portion of the [w]ork at the site."³⁹ According to those definitions, a supplier to a sub-subcontractor was not a claimant under the bond and was not entitled to make a claim.

In William M. Bird, the general contractor subcontracted with Rizzo-Mitchell Design, Inc. to provide furniture for a dormitory being constructed at the College of Charleston. Rizzo-Mitchell, in turn, subcontracted with Whitmire Cabinet Company to construct and install the furniture for the dormitory. Whitmire purchased the materials used in building the furniture from William M. Bird & Company, Inc. The general contractor paid Rizzo-Mitchell, and Rizzo-Mitchell paid Whitmire Cabinet Company, however, Whitmire did not pay Bird. Bird sued Whitmire, the general contractor and the payment bond surety seeking the amount owed for the material.

The Court indicated that Whitmire, as one who contracts directly with a subcontractor (Rizzo-Mitchell), would be covered under the payment bond, but Bird would not.⁴⁰ Bird had no direct contact with the subcontractor or with the principal under the bond. Because the definition of "claimant" under the bond was unambiguous, the Court construed it according to its express terms. The Court concluded that "the definition of 'claimant' in the bond was intended by the parties to include only those [entities] who contracted with the principal or the principal's immediate subcontractor. To hold otherwise would extend coverage under the bond well beyond that intended by the principal and surety at the time of contract."⁴¹

4. Loan Proceeds

Payment bonds have also been construed to cover loan proceeds. In First National Bank of South Carolina v. United States Fidelity & Guaranty Co., the Court held that, to the extent loan proceeds were used to pay subcontractors and workers on a contracted project, those loans could be covered by a surety bond.⁴² In First National, the bank brought an action against the surety that had issued bonds for a contractor who went into...