Surety Bond Lesson: Properly Identify the Parties

Surety bonds offer security to owners, contractors, subcontractors, and others for performance of work and payment therefor.  Both payment and performance bonds provide a sense of comfort to parties that rely on bonded parties.  But before relying on surety bonds, parties should make sure the terms of the bond match reality.

 A recent Georgia case illustrates the importance of checking the terms of surety bonds to ensure they identify and correctly name the parties, especially the bonded principal.

  • Background

 In Choate Constr. Co. v. Auto-Owners Ins. Co, a public owner hired a contractor to construct student housing on a college campus.  The contractor hired an electrical subcontractor and required it to provide performance and payment bonds.

 Unfortunately for the contractor, the bond did not properly identify the subcontractor as the principal.  While it correctly identified the project, contracts, and other details, it listed another entity with which the contractor did not have a contract.  The subcontractor defaulted and litigation ensued.

  • The Ruling

 At a motions hearing, the surety argued it had no liability because the principal identified on the bond was not the party that defaulted on the project.  In fact, the surety admitted that the bond was fraudulently procured because the subcontractor’s owner likely would not have qualified for the bond.  Instead, another person with better credit conspired with the surety’s agent and applied for the bond under a similar name as the subcontractor.  The surety issued a bond using the similar same, but not the same name of the subcontractor.

 The trial court agreed with the surety and granted summary judgment. On appeal, the contractor argued that the surety was liable because the principal was in fact the same party as the subcontractor.  In addition, it argued that any misnomer was caused by fraudulent conduct of the principal’s and surety’s agents.  The Court of Appeals reversed the trial court, holding that a jury should resolve these questions, not the court.

  • Implications

 Practically, the ruling demonstrates the problems that can occur if parties are not correctly identified in surety bonds.  Given the great trust and reliance placed in bonds, obligees and others who rely on bonds for performance security should take the short time to confirm the identity of parties — especially the principal.

 The case presents a few interesting legal issues.  Lawyers are familiar with the Statute of Frauds, which requires certain types of contracts to be in writing in order to be enforced.  One type is contracts of suretyship or surety bonds.  Normally, parol evidence (evidence outside of the contract) is not admissible to provide that a surety obligation exists.  In this case, however, the court distinguished between using parol evidence to establish a surety obligation, on one hand, and using parol evidence to resolve ambiguity about the identity of the principal, on the other.

 Another interesting legal issue discussed by the court is whether fraud of the principal will discharge a surety.  At some level, it seems unfair to hold the surety responsible for damages caused by fraud.  But as the court noted, as long as the creditor (or obligee) does not participate in the fraud, the surety remains fully liable.

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