Surety’s Liability Limited to Amount of Performance Bond

January 22, 2014

The Michigan Court of Appeals recently held that a surety’s liability was limited to the amount of its performance bond. This decision is consistent with Wisconsin law, which has long held that a surety’s liability on a bond is limited to the penal sum (the penal sum is the bond amount). Accordingly, if a public or private owner wants to recover damages in excess of the contract amount (which is typically the amount of the penal sum), then the penal sum needs to be larger than the contract amount to account for the potential for cost overruns and/or liquidated damages.

Facts

The case arose from the failure of Northline Excavating, Inc. (Northline) to complete a sanitary sewer extension project in Livingston County, Michigan, and the County’s attempt to collect damages for nonperformance of a contract under the terms of a performance bond issued by Hanover on behalf of Northline. In 2007, the County entered into a contract with Northline to construct a sanitary sewer pipe and pump station along Grand River Avenue. The contract price was Northline’s bid of $251,035. The contract also included a liquidated damages provision of $1,000 a day for each day the contract remained substantially uncompleted beyond the date for completion provided in the contract. In order to comply with Michigan statute 129.201, Northline obtained a performance bond, which, like Wisconsin, requires a contractor to provide a performance bond for public-sector contracts exceeding a certain dollar amount. The amount of the performance bond was $251,035, and the bond identified Northline as the “Contractor” (i.e., the principal contractor), Hanover as the “Surety,” the County as the “Owner” (i.e., the obligee), and the contract as the “Construction Contract.”

Shortly after Northline began excavation and sewer installation, it encountered difficulties constructing the sewer extension pursuant to the terms and specifications of the construction contract. Northline agreed to submit a “plan of action” detailing how it would complete the project. However, the County ultimately rejected Northline’s initial and revised action plans, and notified Northline of its rejection by way of letter. The County similarly notified Northline in a letter it was declaring a contractor default and terminating Northline’s contract. Thereafter, the County notified Hanover of its declaration of a contractor default with regard to Northline for noncompliance with the provisions of the construction contract. Hanover acknowledged receipt of the County’s letter and notified the County it was investigating its claim. Eventually, Hanover denied liability and notified the County of its position by way of letter.

The County commenced a lawsuit against Northline and Hanover. The County sought to recover against Northline under a breach of contract theory. It sought to recover under the performance bond against Hanover. At a pretrial conference, the trial court adjourned the trial indefinitely to allow the parties to submit briefs addressing whether Hanover’s liability for damages could exceed the penal sum of the performance bond. Following a hearing, the trial court ruled from the bench that Hanover’s liability under the terms of the performance bond was limited to the penal sum of the bond.

Appeal

The County appealed. The issue on appeal was whether the plain language of the performance bond expressed an intent contrary to the generally understood principle that a surety was liable only for the amount of the bond.

The Court stated a performance bond assures completion of a project in the event of default by the general contractor. The performance bond contract is a suretyship contract, which involves a principal, an obligee, and a surety. A surety is one who undertakes to pay money or take any other action if the principal fails therein. The liability of a surety is limited by the scope of the liability of its principal and the precise terms of the surety agreement. Further, Michigan law, like Wisconsin, has long recognized a surety is only liable for the amount of the performance bond.

The County maintained the language of the performance bond plainly expressed an intent to expose Hanover to liability exceeding the amount of the bond. The County argued the language in the bond permitted an owner to enforce “any remedy available” that removed the limitation on the surety’s damages expressed on the face of the bond, and allowed the County to pursue damages beyond the amount of the performance bond.

The Court of Appeals disagreed with the County’s argument that the language permitting the owner to enforce “any remedy available” subjected the surety to liability beyond the amount of the performance bond. The Court found the County’s argument regarding the meaning unavailing because it misinterpreted the term “remedy” to encompass both causes of action and damages. “Remedy” is defined as “[t]he means of enforcing a right or preventing or redressing a wrong; legal or equitable relief.” Black’s Law Dictionary (9th ed.). In contrast, “damages” is defined as “[m]oney claimed by, or ordered to be paid to, a person as compensation for loss or injury.”  Applying these definitions to the contract, the language permitting enforcement of “any remedy available to the Owner,” merely conferred the right to pursue any cause of action that may prevent or redress a wrong resulting from a breach of the performance bond, but it did not indicate what damages may be obtained.

Bottom Line

Public and private owners should be aware of the limitations on bonds, both in terms of enforceability and the amount of the bond. Moreover, subcontractors should be aware of whether a particular project has been bonded and, if so, should take necessary steps to supply all of the required notices in a timely manner to preserve any and all rights they may have to maintain a bond claim. All parties to a construction project are urged to work with experienced construction attorneys to make sure they have the proper contracts in place at the beginning of the project, along with adequate protection from insurance, and, where appropriate, performance bonds.

Northline Excavating, Inc. v. Livingston County, 302 Mich. App. 621, 839 N.W.2d 693 (Mich. App. 2013).

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For more information about "Surety’s Liability Limited to Amount of Performance Bond," contact Saul C. Glazer at sglazer@axley.com or 608.260.2473.