By: Richard E. Guttentag, Esq., Stearns, Roberts & Guttentag, LLC

In Allegheny Casualty Co. v. Archer-Western/Demaria Joint Venture III, 2014 WL 4162787, the court ruled that a surety’s liability under a performance bond is generally limited to the penal sum of the bond, particularly where a surety limits its liability in the contract under which it agrees to complete the defaulting contractors’ work.

The Allegheny Casualty Co. case arose out of a large construction project. The General Contractor entered into a subcontract with a drywall subcontractor (“Subcontractor”). Pursuant to the terms of the subcontract, the Subcontractor obtained a Performance Bond from the Surety, naming the General Contractor as obligee (i.e. the person in whose favor the bond is written), and which secured the performance of the drywall work in the event of the Subcontractor’s default.

Under the terms of the Performance Bond, if the Subcontractor defaulted, the Surety had the following options: 1) directly complete the subcontract; 2) arrange for the General Contractor to enter into an agreement with a new subcontractor and pay the difference in price; or 3) tender the penal sum to the General Contractor. The Performance Bond provided that the Surety’s liability could not exceed a penal sum of $1,665,000.00, the same amount of the Subcontract.

The Subcontractor was unable to complete its work, and the General Contractor declared the Subcontractor in default. The General Contractor and the Surety entered into a Takeover Agreement, under which the Surety agreed to complete the subcontract. The Takeover Agreement provided that the Surety’s liability under the agreement and the bond was limited to the bond’s penal sum, and that nothing in the agreement constituted an increase in the Surety’s liability. After several months on the project, the Surety informed the General Contractor that its expenses on the project had exceeded the penal sum, and stopped working on the project.

The General Contractor filed a claim against the Surety, arguing that the Surety breached the terms of the Performance Bond and the Takeover Agreement by performing poor quality work, failing to complete the Subcontractor’s obligations, and charging improper costs against the bond’s penal sum. In opposition, the Surety argued, in part, that it was not liable to the General Contractor because it had already expended funds in excess of the Performance Bond’s penal sum, which was the limit of its liability.

The Court held that a surety’s liability, absent breach of the surety’s duties under the bond, was limited to the amount of the penal sum in the bond, and the surety’s liability should not be extended by implication beyond the terms of a contract. The Court explained that even if it was found that a performing surety’s liability could exceed the penal sum in the bond, a surety could limit its liability by expressly disclaiming such exposure in its takeover agreement with the obligee.

In this case, the Takeover Agreement clearly provided that the Surety’s liability was limited to and should not exceed the penal sum of the bond. Thus, the Court found that the Surety’s liability was capped at the penal sum of the bond. Accordingly, the Court granted the Surety’s motion for summary judgment against the General Contractor to the extent that the Surety’s liability was limited to the performance bond’s penal sum.

This case demonstrates that a surety’s liability under a performance bond under which it agrees to complete the defaulted contractor’s work is generally limited to the penal sum of the bond, particularly where the takeover agreement provides that the surety’s liability is limited to bond’s penal sum.

About the Authors: Richard E. Guttentag is a partner with Stearns, Roberts & Guttentag, LLC, and is Board Certified in Construction Law by the Florida Bar. Mr. Guttentag exclusively in construction law including construction lien claims and defense, payment and performance bond claims and defense, bid protests, construction contract preparation and negotiation, and construction and design defect claims and defense. He can be reached for consultation at [email protected].