Recently, two courts in different states heard identical cases regarding the obligations of a surety and came to different conclusions. We’ve seen that lien and bond laws vary state-by-state, but these disputes took that theme to the next level. The cases involved the same GC, the same surety, and the same contract language.
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Obligations of a Surety
On public projects, surety bonds are pivotal since mechanics liens are not available. You can bond private projects too, but that’s not necessarily common (we discuss that more in depth in this post – Payment Bonds on Private Construction Projects). Because this protection comes via contract, rather than statute, the terms of these bonds are crucial. Protection will only be afforded subject to the bond, and the same surety bond contract may be treated differently state-by-state.
For more on bonds, check out our post – What is a Surety Bond Claim?
Carothers (the GC) hired subs on separate projects in South Carolina and Kansas. Importantly, both subcontracts required that disputes go to arbitration. The projects were federal, so the Miller Act required that the GC provide surety bonds. As part of the subcontract agreements, the GC required that the subs provide bonds, too. The subs bonded with the same surety company and used the same contract form. Their contracts stated that the agreements between the GC and each sub “is incorporated by reference…” into their (separate) bonding agreements.
Both subs failed their obligations. The GC did not make claims against the surety, though. Instead, the GC argued, the surety was required to arbitrate the claims (just as the subs were required to under their contracts). The surety disagreed, and the parties took to the courts. And that’s the fun part: identical circumstances were heard by different courts. Here’s the surety and GC’s disagreement in a nutshell:
The surety argued that it was not required to arbitrate the claims because it did not assume all of the subcontractors’ rights and obligations under the contract. Rather, the subcontract agreements were “incorporated by reference.” In other words, the surety argued that it did not step into the shoes of the subs upon default. Of course, the GC argued that the surety did agree to arbitration by incorporating the subcontracts.
The U.S. District Court for the District of South Carolina sided with the GC. However, its reasoning was based in South Carolina law, not federal law. In South Carolina, the obligations of the surety and the principal (the party who hired the surety) run together when a contract is incorporated, even if by reference. Thus, the court found:
“When the Court construes the bonds and the subcontract together as a whole, it is clear the parties intended to submit disputes to binding arbitration. If DSI did not want to be bound by that term of the subcontract, then DSI should not have guaranteed the performance of the subcontract by issuing bonds incorporating that term.”
Check out our South Carolina Construction Payment Resources.
Unbound by South Carolina law, the U.S. District Court for the District of Kansas disagreed. The court found that the Kansas sub’s obligations and the surety’s obligations should not be taken together as a whole. It found that the surety, while it incorporated the terms of the subcontract, did not step into the shoes of the subcontractor upon default.
Because the surety did not consent to the arbitration, and because incorporating the terms of the subcontract by reference did not mean the surety stepped into the shoes of the sub, the court found that the surety was not required to arbitrate the claims.
We’ve got Kansas resources, too!
In this tale of two bonds, Kansas and South Carolina came to vastly different conclusions on what were essentially identical facts. Thus, the takeaway is: lien and bond laws vary greatly from state to state. Understanding the applicable lien and bond statutes could not be more important to preserving your right to payment. Call us biased, but we think the best way to do that is to give our Construction Payment Resources a go. If you can’t find answers there, it may be time to call a construction attorney.