Surety in the 21st century: everything old is new again.

Author:Gibson, Allen

At the end of the 1980's and throughout the 1990's, there were numerous contractor bankruptcies and insolvencies, which triggered defaults under the terms of construction contracts. This led to claims by owners against the insurance companies acting as sureties of the contractors, under performance and payment bonds. Surety companies, their consultants and attorneys were kept busy for several years.

Since that time, underwriting standards have improved, and there have been less claims on bonds. In recent years, industry veterans have noted that there does not seem to be the same understanding of the ins and outs of the surety claim process.

This article provides an overview of the suretyship and how it fits into the field of construction law. We will also underline some distinctions between the interpretation of the suretyship in the United States and Canada and will address the following points:

  1. The difference between insurance and surety;

  2. The underwriting of a surety bond and the indemnity agreement;

  3. The different type of bonds: bid bonds, performance and payment bonds; and 4. Dispute resolution: must the parties go to Court?

    1. Insurance vs. Surety

    One of the first questions asked by newcomers to the surety field is: if a bond is issued by an insurance company, why isn't it always interpreted in the same manner as an insurance policy? However similar they appear, the obligations between the parties are different, and the loss under the bond is ultimately the contractor's, that is, the principal under the bond. In the case of a first party insurance policy, the insurer pays the insured the amount of the loss, which the insurer may then seek to recover from the responsible third party, if possible. Under the terms of a CGL policy, the insurer will pay a third party for the liability of the insured.

    There is a three-party relationship in a surety arrangement between the following parties: (1) the contractor/principal, (2) the owner/obligee, and (3) the insurance company/surety. The principal has a contract to perform for the obligee, and in case of default of the principal, the surety is bound to perform and fulfill all of the terms and conditions of the underlying contract. If the surety pays an amount to the obligee, it will seek recovery from the principal as well as those parties who signed an indemnity agreement in favor of the surety, as will be explained in greater detail in the section on underwriting.

    Under the terms of an insurance policy, there are only two parties to the agreement, the insurer and the insured. The insurer does not perform the insured's obligation, its obligation is to pay the insured or a third-party claimant upon the occurrence of an insured event.

    Some courts respect the historical distinctions between insurance and suretyship, like the California Supreme Court in Cates Construction Inc. v. Talbot Partners. (2) However, certain jurisdictions are not as preoccupied with the differences between suretyship and insurance because, in certain states, sureties are treated like insurers, as may be seen in Dodge v. Fidelity and Deposit Co. of Maryland. (3) And in the more recent case of Ewing Construction Co. v. Amerisure Insurance Co., (4) the Texas Supreme Court took a different approach, as it treated CGL coverage in a manner similar to an interpretation of a surety bond. (5)

    Ewing Construction had entered into a standard AIA contract with a school district to build tennis courts.

    After Ewing completed construction, the school district complained that the tennis courts were flaking, cracking and crumbling, rendering them unusable. The school district filed suit against Ewing, asserting claims for breach of contract and negligence. Ewing tendered the defense to its general liability carrier, Amerisure, which denied coverage. Ewing sued Amerisure in federal court in Texas, seeking a declaration that Amerisure had breached its duties to defend and indemnify it in the school district's suit. On cross motions for summary judgment, the district court ruled in favor of Amerisure based on the contractual liability exclusion. Ewing appealed to the Fifth Circuit, which affirmed the district court in a 2-1 opinion. On rehearing, in an unusual turn of events, the Fifth Circuit withdrew its opinion and sent the case to the Texas Supreme Court on certified questions:

  4. Does a general contractor that enters into a contract in which it agrees to perform its construction work in a good and workmanlike manner, without more specific provisions enlarging this obligation, "assume liability" for damages arising out of the contractor's defective work so as to trigger the Contractual Liability Exclusion.

  5. If the answer to question one is "Yes" and the contractual liability exclusion is triggered, do the allegations in the underlying lawsuit alleging that the contractor violated its common-law duty to perform the contract in a careful, workmanlike, and non-negligent manner fall within the exception to the contractual liability exclusion for "liability that would exist in the absence of contract."

    The answer to the first question was "no" and therefore, the court did not answer the second question. The Texas Supreme Court determined that because under every construction contract there is an implicit obligation for contractors to perform their work in a good and workmanlike manner, the existence of a construction contract does not expand a contractor's liability or cause the contractor to assume any liability beyond that which the common law imposes. In so holding, the Texas court would appear to equate a contract claim for failing to perform in a good and workmanlike manner with a tort claim allegations of negligent performance. Consequently, it rejected the application of the contractual liability exclusion and allowed the claim under a tort/negligence theory.

    Amerisure argued that the Court's interpretation of the contractual liability exclusion would turn the insurance policy into a performance bond--essentially requiring the insurance company to guarantee the contractor's performance of its contract. The court rejected this argument, noting two critical differences between an insurance policy and a performance bond: (1) the insurance policy's requirement for resulting personal injury or property damage; and (2) the existence of other common "business risk" policy exclusions which were not before the court.

    In Canada, the courts have...

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