Delaware Federal Court Imposes Limit on Surety's Liability Under Performance Bond

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A recent decision from the United States District Court for Delaware held that a surety was not liable for consequential damages to a building owner after a default by its contractor because the surety’s liability could not be greater than its principal’s liability. See Iron Branch Associates, LP v. The Hartford Fire Insurance Company, Civil Action No 21-463, 2021 WIL 4129116 (D. Delaware September 9, 2021).

Owner Iron Branch Associates, LP (“Owner”) entered into a construction contract (the “Construction Contract”) in 2017 with contractor Petrucon Construction Inc. (“Contractor”) for the renovation of a housing development. Contractor purchased a performance bond (the “Performance Bond”) as required by the Construction Contract from Hartford Fire Insurance Company (“Surety”). The Performance Bond incorporated the Construction Contract by reference. The Performance Bond defined the scope of the Surety’s obligations and when the Performance Bond would be triggered in the event of Contractor’s default. In 2019, Contractor defaulted on its performance under the Construction Contract. As a result, Owner terminated the Construction Contract, triggering Surety’s obligations under the Performance Bond. Owner demanded that Surety hire a replacement contractor to complete the renovations and pay Owner consequential damages for lost rental income, relocation costs, consulting and legal fees, extended financing costs, and lost tax credits. Surety agreed to complete the renovations, but Owner and Surety moved for cross summary judgment with respect to Surety’s obligations for consequential damages.

After a bench trial, the Court ruled against the Owner and held that although Surety may be liable for some of the costs (e.g., extended financing costs), it would not be liable for anything categorized as consequential damages. The Court’s finding was consistent with the common law principle of “co-extensive liability.” Under that principle, the liability of a surety is no greater than that of its principal. The express terms of the Performance Bond reiterated that principle. Under the Construction Contract, Owner and Contractor had mutually waived the right to consequential damages. As the Performance Bond had incorporated the Construction Contract by reference, the two contracts needed to be read together to ascertain the intent of the parties as it related to Surety’s obligations. The Performance Bond was unambiguous in that Surety’s liability was to be co-extensive with Contractor’s, and Surety’s obligations for damages were the same as those held by Contractor.

Owner argued that Surety expanded its obligations beyond the Construction Contract because the Performance Bond included a provision obligating Surety to pay for “the responsibilities of Contractor for correction of defective work and completion of the Construction Contract, . . . and additional legal, design professional and delay costs resulting from Contractor’s default and resulting from the actions or failure to act of Surety.” The Court disagreed, and held that the waiver of consequential damages in the underlying Construction Contract was incorporated into the Performance Bond by reference and was thus essentially part of the bond itself.

This case serves as a reminder to owners, contractors, and sureties to be aware of the interrelationship between construction contracts and performance bonds. Given the principle of co-extensive liability, and the bond’s incorporation by reference of the construction contract, the construction contract serves to set limits on the liability of the surety.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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