Construction Surety Bond Liability for Consequential Damages

March 2006

Whether a trend or just the serendipity of American jurisprudence, it appears that the coverage of the construction performance bond goes well beyond traditional "bricks and mortar" style damages in the majority of jurisdictions that have addressed the issue.

by Marilyn Klinger
Sedgwick, Detert, Moran & Arnold LLP

There are examples of cases in such diverse states as Missouri, Indiana, Georgia, California, Texas, West Virginia, Louisiana, New Jersey, Tennessee, Wyoming, Arkansas, Alabama, Colorado, South Carolina, Arizona, Hawaii, South Dakota, and even Florida that allow recovery against a surety for consequential damages, often the same damages that the obligee could recover against the principal. Nonetheless, there are cases in Florida, Pennsylvania, and Rhode Island that have also analyzed the issue and restricted the measure of damages.

Expansive Bond Liability

This commentary sets forth those cases that have found sureties liable for consequential damages in a loose chronological order going back approximately 40 years, identifying at the beginning of the discussion of each case, the types of damages involved. As is apparent, the types of damages that bond obligees have recovered against sureties is seemingly limited only by the creativity of the obligee's attorney.

Municipal Bond Interest

In Phoenix Assurance Co. of N.Y. v. Appleton City, 296 F.2d 787 (8th Cir. 1961), the court, construing Missouri law, upheld an award against a surety for interest on the municipal bonds that the obligee issued to finance its project. The basis for the award was the principal's delay in completing the project. The contract language, upon which the court relied, provided:

• In event that the contractor shall not complete work on this project in the specified time there shall be deducted from the total payment an amount equal to the interest on all bonds issued for this project, for the time required to complete over the specified time.

The court did not evaluate whether the bond would cover such damages. Often, the court does not evaluate the bond's coverage when it assesses consequential damages against a surety. Rather, it appears simply to assume that the bond responds to such damages.

Loss of Use of Building Site

In Miracle Mile Shopping Ctr. v. National Union Indem., 299 F.2d 780, 783 (7th Cir. 1962), the court, construing Indiana law, found the surety liable for lost use. The court rejected the surety's argument that it was not liable for special or consequential damages. The bond provided that in the event of default, the surety's obligation was either to complete the building or pay the cost of completion. The surety did neither. Essentially, the court noted that it was the surety's own breach that caused the obligee's damages.

The vast majority of the cases discussed herein allow consequential damages arising from the bond principal's default—not requiring the surety's own default.

Interest on Construction Loan/Loss of Rents

In New Amsterdam Cas. v. Mitchell, 325 F.2d 474 (5th Cir. 1963), the court, in enforcing Georgia law, upheld an award of lost rents and additional interest paid on a construction loan caused by delay assuming, without discussion, that such damages were appropriately assessed against the surety.

Liquidated Damages

In Mason v. City of Albertville, 158 So. 2d 924 (1963), the Alabama Supreme Court cited with approval City of Albertville v. U. S. Fid. & Guar., 272 F.2d 594 (5th Cir. 1960), finding the surety liable for liquidated damages.

Delay Damages

In General Ins. Co. of Am. v. Hercules Constr., 385 F.2d 13 (8th Cir. 1967), by applying Missouri law, the court found the surety liable for delay damages, in the form of extra erection labor and equipment costs, premium time, and extra costs for keeping the project open. Again, there was no discussion as to whether the bond covered these types of delay damages.

Delay Damages

In Amerson v. Christman, 261 Cal. App. 2d 811, 825 (1968), the court said:

• At this juncture we note the general rule that the liability of a surety is coextensive with that of the principal. Moreover, "[i]t is a general principle of suretyship law that while a surety cannot be held beyond the express terms of his contract, the contract is to be interpreted by the same rules used in constructing other types of contracts, with a view towards effectuating the purposes for which the contract was designed." ….

• [W]e think that a fair reading of the terms of the bond indicates an intent to reimburse [the obligee] for damages consequentially caused by the contractor's breach and the ensuing construction delays. We therefore hold that [the surety] is equally liable, along with [the principal], for incidental damages proximately flowing from the breach….

Liquidated Damage

In Southern Roofing & Petroleum v. Aetna Ins., 293 F. Supp. 725, 731-732 (E.D. Tenn. 1968), the court, in applying Tennessee law, upheld an award of liquidated damage equal to 10 percent of the excess cost for the obligee to complete the subcontract and said:

• [I]ncorporation of the subcontract into the bond made the ten percent provision a part of the agreed liabilities which the bond secured.

Lost Profits

In Smart v. U.S. Fid. & Guar., 513 S.W.2d 291, 296 (Tex. App. 1974), the court upheld an award of lost profits in favor of the owner against the surety without responding to the surety's claim that lost profits "was not covered under the bonds."

Lost Profits/Loan Interest

Continental Realty v. Andrew J. Crevolin Co., 380 F. Supp. 246, 251 (S.D.W.V. 1974), the court, applying West Virginia law, found that the surety was liable for the obligee's construction loan interest, the expense of maintaining already-performed work, winterizing, employing security guards, and lost profits. The Crevolin court cited to the bond:

• Under the terms of the … bond, [the surety] was and is obligated to indemnify and save harmless [the obligee] from all cost and damage by reason of [the principal's] default or failure to faithfully perform its contract.

Delay Damages

Although the Hawaii Supreme Court in Mayer v. Alexander and Baldwin, Inc., 532 P.2d 1007, 1008-09 (1975) found that the surety was not liable for delay damages, it relied on the bond language at issue:

• NOW THEREFORE, the condition of this obligation is such that if the above named Principal, shall in all things well and truly keep, observe and perform the covenants, condition and agreements of said Contract, and at the time and in the manner and form therein specified … then this obligation shall be void; otherwise it shall be and remain in full force and effect.

• PROVIDED, ALSO, that the Surety shall not be liable … for the furnishing of any bond or obligation other than this instrument, nor for damages caused by delay in finishing such Contract. [Emphasis added.]

Delay Damages/Lost Profits

The court in Burnett & Doty Dev. v. C.S. Phillips, 84 Cal. App. 3d 384 (1978), found the residential sitework contractor's surety liable for lost profits, increased construction costs, and increased development loan interest expenses, resulting from the principal's delay. There was no discussion as to whether the surety could be liable for such damages.

Rent/Loss of Use

In Hemenway Co. v. Bartex, Inc. of Tex., 373 So. 2d 1356 (La. App. 1979), the court upheld an award of delay damages against the surety, in the form of rent and interest on interim financing without any discussion of whether the surety had exposure for these kinds of delay damages.

Liquidated Damages

In Aetna Cas. & Surety v. Butte-Meade Sanitary Water Dist., 500 F. Supp. 193, 197 (D.S.D. 1980), the court without discussion presumed that the surety was liable for liquidated damages.

Loss of Rent

In State Surety v. Lamb Constr., 625 P.2d 184 (Wyo. 1981), the court awarded lost rent damages against the surety based on the principal's delay, without any discussion as to whether the bond covered such damages.

Liquidated Damages

In Pacific Employers Ins. v. City of Berkeley, 158 Cal. App. 3d 145, 150, 152 (1984), the court read the contract with the bond to define the scope of damages recoverable against the surety. The court noted:

• We find no authority supporting the proposition that the giving of a performance bond ipso facto subjects the completing surety to liability for liquidated damages provided for in the contract between the contractor and the obligee. To determine whether the completing surety is liable in such a case, the court must look to the contract and to the bond.

The court concluded:

• We find … that the bond given by [the surety], which expressly referred to the contract between [the principal] and [the obligee], incorporated that contract by reference, and that [the surety] was therefore bound by the provisions in the contract for liquidated damages.

Liquidated Damages

In Riva Ridge Apartments v. Robert G. Fisher Co., 745 P.2d 1034, 1039 (Colo. App. 1987), the court rejected the surety's argument that the damages for delay arose exclusively under the agreement and that the surety was not a party to the agreement.

Lost Profits

In South Carolina Federal Savings Bank v. Thornton-Crosby Dev., 399 S.E.2d 8, 10 (S.C. App. 1990), the court upheld an award of lost profits against the surety without discussion on the issue of the propriety of such damages.

Lost Rental Income

In Bossier Med. Properties v. Abbott & Williams Constr. Co. of La., 557 So. 2d 1131, 1133 (La. App. 1990), the court upheld a judgment against the surety for lost rental income, rejecting the surety's argument that:

• [I]nterpreting the bond language fairly and reasonably, the surety simply promises to assume the expense of completing all defective or unfinished work left by the contractor, and that such items as lost rent are not contemplated by the bond provisions.

Unemployment Insurance Taxes

In Hartford Acc. & Indem. v. Arizona Dept. of Trans., 838 P.2d 1325, 1327 (Ariz. App. 1992), a completing surety sued the state for the contract funds. The state refused to pay the surety because it offset against the contract funds the unemployment insurance taxes that the principal failed to pay. The court agreed with the state's position.

Prevailing Wage and Overtime Violation Penalties

In East Quincy Svcs. Dist. v. General Acc. Ins. Co. of Am., 88 Cal. App. 4th 239 (2001), the court did not expressly find that the surety was liable for the penalties assessed against the principal for prevailing wage and overtime violations. Rather, the court found that the completing surety's equitable subrogation rights did not have priority over those penalties. The result was the same—the penalties came out of the surety's pocket.

State and Federal Taxes

In Island Ins. v. Hawaiian Foliage & Landscape, 288 F.3d 1161, 1162, 1164 (9th Cir. 2002), the court, in applying Hawaii law, found that the government was an intended beneficiary on the bond as it related to federal and state taxes and cited to United States v. Phoenix Indem., 231 F.2d 573 (4th Cir. 1956) (sureties liable to U.S. for unemployment, withholding, and Social Security taxes), and Home Indem. v. F.H. Donovan Painting, 325 F.2d 870, 873-74 (8th Cir. 1963) (bond given to protect federal Social Security and withholding taxes and state unemployment taxes).

Lost Equity Delay Damages

In Cates Constr. v. Talbot Partners, 21 Cal. 4th 28, 39-40 (1999), the court found the surety liable for lost equity delay damages. The court stated the issue as follows:

• [W]hether [the surety] is liable under the performance bond for those so-called "delay damages." [The surety] disputes liability because the bond … did not guaranty [the principal's] prompt performance but merely assured completion….

The court then recited the general rules for bond interpretation, noting (1) that bonds are construed in a fashion similar to other contracts; (2) the court looks first to the express terms of the bond; (3) where the bond incorporates by reference the contract, the bond and the contract are read together; and (4) the contract referred to the time for performance. Then, the court concluded:

• Taken together as a whole, the bond and underlying construction contract are fairly and reasonably read as requiring [the surety] to answer for damages suffered by [the obligee] as a direct result of [the principal's] failure to promptly and faithfully perform the contract. Although the bond did not explicitly mention the subject of delay damages, [the surety] knew from the construction contract, which had been "made a part" of the bond, that time was "of the essence" of the contract and that the bond's purpose was to provide security for the "faithful" performance of the contract in the event of [the principal's] default…. And notably, the bond specifically called for [the surety] … to either complete or arrange for completion of the contract "in accordance with its terms and conditions"—without providing for any exceptions.

Overpayment

In R.J. Griffin & Co. v. Continental Ins., 497 S.E.2d 586, 587 (1998), the court held that the surety was liable for the amounts the subcontractor was obliged to repay to the general contractor as a result of the general contractor's clerical error in paying the subcontractor for the same work twice. The court stated: "[W]e conclude that the subcontractor's wrongful retention of funds is a breach of the subcontract and covered under the terms of the bond."

Loan Repayment/Indemnity Obligation to Surety

In St. Paul Fire & Marine Ins. v. Tennefos Constr., 396 F.2d 623, 627, 630 (8th Cir. 1968), two parties formed a joint venture. The joint venture provided a United Pacific bond. One of the joint tenant partners, Cox, provided a bond to indemnify the other joint venture partner, Tennefos, for damages arising out of Cox's failure to perform the joint venture agreement. St. Paul provided that bond.

Cox borrowed money from a bank to finance its construction. Cox failed to replay the bank and it sued United Pacific and prevailed. In that case, Farmers State Bank v. Ed Cox & Son, 132 N.W.2d 282, 283 (1965), the court found that money loaned to a contractor which he used to pay claims incurred in the construction is within the coverage of his bond. (But see, Farmers State Bank of Parkston v. Kuipers Constr., 190 N.W.2d 769 (1971) (denying the SBA recovery against a surety of loan proceeds).)

Tennefos paid the bank and sued on the St. Paul bond arguing that it suffered damages as a result of Cox's default under the joint venture agreement. St. Paul argued that the joint venture agreement specified in detail the obligations that Cox agreed to assumed and that the payment of money borrowed was not within the contemplation of the joint venture agreement or the bond. The court's reasoning in rejecting St. Paul's argument was that the joint venture agreement, the construction contract, the United Pacific bond, and the St. Paul bond all must be read together.

Restrictive Bond Liability

As mentioned at the outset of this article, Florida, Pennsylvania, and Rhode Island have also analyzed the issue and restricted the measure of damages. These are discussed in more detail below.

Florida

Delay Damages. In American Home Assur. v. Larkin General Hosp., 593 So. 2d 195, 196 (1992), the court found "that a surety cannot be held liable for delay damages due to the contractor's default unless the bond specifically provides coverage for delay damages." The court stated:

• The purpose of a performance bond is to guarantee the completion of the contract upon default by the contractor. Ordinarily, a performance bond only ensures the completion of the contract. The surety agrees to complete the construction or to pay the obligee the reasonable costs of completion if the contractor defaults. ¶ [F]lorida courts have long recognized that the liability of a surety should not be extended by implication beyond the terms of the contract, i.e., the performance bond.

The court in L&A Contracting v. Southern Concrete Svcs., 17 F.3d 106 (5th Cir. 1994), in dicta, followed Larkin. The court first found that the obligee had not met the bond's requirement for declaring the bond principal in default. Then, although not necessary for its decision, the court held that Larkin was controlling such that the lower court erred in awarding delay damages.

Florida courts are enforcing Larkin but only as to delay damages. In Federal Ins. v. Southwest Florida Retirement Ctr., 707 So. 2d 1119, 1121 (Fla. 1998), the court pronounced: "We decline to extend Larkin beyond claims for delay damages."

Relocation Costs. In Mycon Constr. v. Board of Regents of the State of Fla., 755 So. 2d 154, 155 (Fla. 2000), the court overturned an award of delay damages in the form of the costs to relocate students living in defectively constructed dormitories.

Liquidated Damages. At least one Florida court has challenged Larkin. In National Fire Ins. Co. of Hartford v. Fortune Constr., 320 F.3d 1260, 1274-1275 (11th Cir. 2003), the court stated:

• Even after Larkin General Hospital, Florida courts have continued to utilize the well-established doctrine of incorporation by reference to impose liability on a performance bond surety. SeeDCC Constructors, Inc. v. Randall Mech. Inc., 791 So. 2d 575, 576-77 (Fla. 5th D.C.A. 2001); Southwest Fla. Retirement Ctr. v. Fed. Ins., 682 So. 2d 1130, 1132-33 (Fla. D.C.A. 1995), aff'd 707 So. 2d 1119 (Fla. 1998). The "purpose" of the performance bonds was to insure performance in accordance with the terms of the respective subcontracts, and those terms plainly include adverse direct consequences for delay.

Pennsylvania

Delay Damages. In Downingtown Area Sch. Dist. v. International Fid. Ins., 769 A.2d 560, 565-566 (Pa. Commw. 2001), the court stated:

• [I] still think that as a matter of plain English, the [Performance Bond] does not make [the surety] liable for delay damages caused by [the principal]….

The court determined that the fact that the bond incorporated the contract by reference "only sets out the condition of [the surety's] liability rather than the scope of that liability."

Attorney Fees. In North Am. Specialty Ins. v. Chichester Sch. Dist., 158 F. Supp. 2d 468, 471-473 (E.D. Pa. 2001), relying on Downingtown, the court concluded that the obligee could not recover attorney's fees based on the attorney's fees clause in the contract. The court noted:

• [T]he Pennsylvania Commonwealth Court [referring to Downingtown] clarified that whether the surety was liable for delay damages and attorneys' fees depended, not on the underlying contract, but rather on the language of the bond itself.

Liquidated Damages. In Wise Investments, Inc. v. Bracy Contracting, Inc., 232 F. Supp. 2d 390, 402-403 (E.D. Pa. 2002), the court rejected the obligee's attempt to recover liquidated damages and attorney fees from the surety. See also, LBL Skysystems (USA) v. APG-America, 319 F. Supp. 2d 515, 526 (E.D. Pa. 2004) (acknowledging Pennsylvania law disallowing recovery of consequential damages, such as lost settlement opportunity damages, against a surety).

Rhode Island

Consequential Damages. In Marshall Contractors v. Peerless Ins., 827 F. Supp. 91, 94-96 (D.R.I. 1993), the court used traditional notions of surety liability in determining that a bond had no exposure for consequential damages. It said:

• [A] performance bond must be strictly construed. [T]he extent of the liability of the surety … is determined solely by the language of the bond. Construction by implication, which will extend the surety's liability, is not permissible in such a case.

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