DEFENSES OF A SURETY –
AN OVERVIEW

1. INTRODUCTION
2. DEFENSES OF SURETY WITH RESPECT TO THE PERFORMANCE BOND
   1. Defenses Peculiar To The Surety
      1. Fraud of the Principal
      2. Fraud or Misrepresentation of the Obligee
      3. Release or Discharge of the Principal or Judgment in Favor of the Principal
      4. Novation/Change in Parties
      5. Failure to Give Notice of Default to the Surety
      6. Material Alteration or Change
      7. Lack of Care of the Security by the Obligee and Other Acts Prejudicial to the Rights and Obligations of the Surety
      8. Contractual Limitations, Statutory Limitations and Statutes of Repose (Both Performance and Payment Bonds)
      9. Penal Sum
      10. Duty of Obligee to Proceed Against Principal: Place of Suit
   2. Defenses Of The Principal Which Surety May Assert
      1. illegality or invalidity of a construction contract;
      2. owner's failure to execute a formal contract;
      3. impossibility of performance;
      4. fraud or duress of the obligee (note – this is a reference to fraud or duress on the principal as distinguished from the obligee's fraud against the surety);
      5. owner's breach of conditions precedent and/or failure to provide building permit, right of way or building site;
      6. changed conditions of the building site;
      7. owner's failure to furnish materials as required;
      8. failure to make payment in accordance with the contract;
      9. substantial errors or omissions in drawings or specifications so as to render the project non-constructable in accordance therewith;
      10. delay or interference caused by agents, such as architects or engineers, of the owner;
      11. delay caused by changes in the plans and specifications;
      12. suspension of work by order or act of the owner;
      13. failure of consideration to support the construction contract;
      14. a claim by the principal that it is not in breach, the most common of all the principal's defenses which the Surety will assert;
      15. any material breach by the owner of its contract obligations; and
      16. any material breach by the owner of its contract obligations after default and after a surety has taken over the work or the surety has privity with the obligee with respect to the construction contract.
3. DEFENSES OF SURETY WITH RESPECT TO THE PAYMENT BOND
   1. failure to give timely notice of claim as required by bond or statutes;
   2. failure to sue in the proper court as required by statute or bond;
   3. defects in content of delivery of notice of claim;
   4. ineligibility of claimant;
   5. prior exhaustion of the penal sum of the payment bond;
   6. set off or affirmative counterclaim having to do with the claimant's performance;
   7. other breaches by the claimant of the subcontract or purchase order which may have resulted in back charges;
   8. disputes having to do with payment such as credits, change orders and payments from the owner; also misapplication of payments by the claimant;
   9. generally, as with respect to the performance bond, the surety may raise any defense its principal can raise to contract liability, such as, fraud, accord and satisfaction, lack of contract formation, statute of frauds and any material breach of the subcontract supporting provable damages or items of set off.

Abstract

The scope of this overview of the defenses of a surety extends to both performance and payment bonds, and to both private and governmental work state and federal. Generally speaking, the defenses available to a surety break down into two categories:

A. any defense available only to the surety arising out of the conditions or limitations contained in the bond or in statutes relating to the bond, and any common law defenses directly that of the surety arising out of the conduct of the obligee acting alone or in concert with the principal; and

B. any defense that the principal has under the construction contract.

When the performance of a contractor is bonded, the surety almost always delivers both performance and payment bonds or some combination of the two. To the surety, it is one underwriting, one appraisal of the risks. The payment bond, whether statutory or common law form, will almost always provide rights for third-party beneficiaries. Therefore, while the payment bond is also delivered for the protection of the obligee, the presence of third party beneficiary rights for claimants adds an extra burden (some would say impossible burden) for the surety seeking complete discharge from the payment bond as well as the performance bond. Accordingly, in mentioning defenses which could result in a complete or pro tanto discharge of the surety under its performance bond, there is no intent to suggest that the same defenses are available under the payment bond where rights of third party beneficiary claimants have already risen and the litigation is with such claimants.

Generally speaking, it is relatively rare that a surety has a defense available, either one peculiar to it, or a defense of the principal that would justify the surety denying liability in whole or in part and refusing to meet the obligations of a performance bond. The situation is not much different than with the dilemma of the contractor who insists that the owner is in material breach while the owner insists the contractor is the party breaching the contract. Usually, the contractor will find it wise and expedient to finish the work and sue for damages rather than abandon the work. likewise, because costs can skyrocket when construction work is abandoned, a surety, in the ordinary situation of work actually underway, will desire to be very sure of a defense before refusing to meet the obligations of the bond, as distinguished from performing under a reservation of rights. This is particularly true where the defense is that of the principal claiming prior material breach by the owner, a not uncommon contention the surety discovers in the default investigation.

Generally, with respect to the payment bond, the surety's defenses will arise from the failure to perfect the bond claim pursuant to whatever requirements exist, or the defense will simply be the merits of any claim of defense or partial defense to the debt claimed by the surety's principal. Sureties can be expected to readily assert and litigate questions involving substantial noncompliance with claim perfection requirements, be they contractual or statutory. On the other hand, sureties cautiously elect to litigate the principal's alleged defenses to payment bond claims because sureties are accustomed to seeing back charges, allegations of breach and counterclaims against the subcontractors of the troubled, if not defaulted, principal which claims may or may not be supportable so as to justify litigation.

Full Text

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