Chapter 12 - § 12.5 • SUBROGATION

• Jurisdiction: Colorado

§ 12.5 • SUBROGATION

Among the oldest and perhaps the most important rights of a surety are those of subrogation. Although the scope of this chapter does not permit a complete analysis of the surety's subrogation rights (most of which are not dependent on Colorado precedent), no discussion of sureties and their rights is complete without a brief overview of this issue. Subrogation is a creature of equity, and is, in effect, an equitable assignment, under which the surety receives the right of the principal's creditor that it pays, pursuant to its bond obligations.

For a contract bond surety, the application and evolution of the right of subrogation is defined by several key U.S. Supreme Court decisions. In Prairie State National Bank v. United States,¹⁶⁸ a performance bond surety's right of equitable subrogation was recognized, and the Court found that the surety could protect itself by resorting to the same remedies that were available to the government obligee.¹⁶⁹ In Henningsen v. U.S.F.&G.,¹⁷⁰ the Court recognized that both payment and performance bond sureties had a priority to claims by an assignee bank.¹⁷¹ In United States v. Munsey Trust Co.,¹⁷² the Court recognized that a payment bond surety's subrogation rights existed, but then held that those rights were inferior to the government's rights of set-off.¹⁷³ Finally, in Perlman v. Reliance Insurance Co.,¹⁷⁴ the Court held that a payment bond surety's subrogation rights entitled it to priority in receipt of contract funds, over and above the claims of the principal's trustee in bankruptcy.¹⁷⁵

In the event of a bond default, after the surety has performed its payment and performance bond obligations, subrogation rights are paramount in preserving a surety's claim to reimbursement. The contract funds still in the hands of the owner or obligee are the primary target for these claims. Of course, such funds are often sought by entities other than the surety. In sorting out these claims and rights, a key element of the analysis is determining to what entity the surety is subrogated. The surety that pays claims under its payment bond, or to complete the project under a performance bond, is subrogated to the rights of (1) the obligee; (2) the paid claimants; and (3) the principal.

Proper application of the subrogation rights can help sort out the conflicting claims to remaining contract funds. A few of the most common scenarios are:

1) Surety versus obligee. When the obligee claims back charges against the

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