Originally published Summer 2023
While many surety bonds explicitly state whether they are intended to be statutory or common law bonds, a case out of a Tennessee bankruptcy court serves as an important warning that such bond provisions will not always control as anticipated by the issuing surety.1 Ultimately, commonly used bond language expressly designating it a statutory bond when state law requires the bond, and meant to substitute the state’s bond terms, was deemed ineffectual. This resulted in the bonds’ enforcement as common law bonds, providing for more generous terms and more lenient barriers than required by statute.
In the case, the surety had issued payment bonds on behalf of its bankrupt principal for two public works projects, each containing the following provision:
13. When this Bond has been furnished to comply with statutory or other legal requirement in the location where the construction was to be performed, any provision in this Bond conflicting with said statutory or legal requirement shall be deemed deleted herefrom and the statutory provisions conforming to such statutory or other legal requirement shall be deemed incorporated herein. The intent is that this Bond shall be construed as a statutory bond and not a common law bond.
(“Paragraph 13”). An adversarial proceeding was held to determine whether the bonds were common law or statutory; the answer would shape the remaining litigation between bond claimants and the surety, among others. The heart of the dispute was whether Paragraph 13 was a “savings” clause to assure the bonds’ compliance with the minimum terms required by statute, or a “deletion” clause that rendered any “greater rights” terms of the bonds ineffective, and substituting the terms of the statute.
The Tennessee bankruptcy court first concluded that the bond was properly characterized as a common law bond, using a three factor analysis as to whether the bonds (1) make explicit reference to the statute; (2) extend rights beyond those minimally required under statute; and (3) expressly contain notice or time limitations to commence an action.
First, it was undisputed that the bonds failed to specifically reference the applicable statute incorporated. Next, the court found that the bonds expanded the rights of claimants (and the scope of the surety’s liability) by extending coverage beyond the statutory minimum by ensuring that equipment was paid for in addition to labor and materials.2
The court further decided that the bonds contained notice provisions that altered the statutory notice requirements by exempting first tier claimants from the statute’s ninety day notice requirement applicable to all claimants.3 Finally, the bonds extended the limitation period for claimants to commence an action under the bond, the court said, from the statutory minimum of six months to one year. Thus, the court concluded that the bonds were common law bonds.
The court then addressed whether Paragraph 13 operated as a “deletion” clause, or only as a “savings” clause. Since there was no controlling Tennessee law on the issue, the court analyzed interpretations of provisions identical to Paragraph 13 from other jurisdictions. The surety urged the court to adopt a New Hampshire court’s interpretation, which found that if the bond is provided because of a statutory requirement, it should be interpreted as a statutory bond, accepting as determinative the surety’s statement of intent for how the bond would be construed.
The bankruptcy court disagreed, adopting instead a Michigan court’s interpretation of Paragraph 13 as a savings clause, meant only to ensure that the bonds’ terms meet the statutory minimum, operating as a “floor” for surety liability exposure, rather than a “ceiling.” Agreeing with this rationale, the bankruptcy court stated that it:
“…cannot accept the more extreme interpretation that a single clause in the contract, apparently included to assure compliance with minimum state standards, should be construed as eliminating other significant contractual provisions that expanded the rights well beyond those minimum requirements.”
Paragraph 13 was a savings clause, said the court, which would only supplant a bond term if that term failed to satisfy the statutory minimum requirements.
Although the interpretation of clauses such as Paragraph 13 varies by jurisdiction, this decision should alert sureties that its language cannot be relied upon to convert an otherwise common law bond into a statutory bond if the terms exceed the statutory minimum. Even a surety’s expressed intent may be insufficient to create the “ceiling” the surety desires.
Marina De Rosa is an Associate at Ernstrom & Dreste, LLP, in Rochester, New York. Her primary areas of practice focus on construction and surety law as well as complex commercial litigation. Her Juris Doctor degree is from Syracuse University College of Law, where she was an associate editor of the Journal of Science and Technology. She is a member of the ABA TIPS FSLC. De Rosa can be reached at mderosa@ed-llp.com or 585.242.4960.
1 In re Pinnacle Constructors, Inc., 647 B.R. 352 (Bankr. M.D. Tenn. 2022).
2 In this case, equipment also included utilities such as gas, water, power, light, and other costs.
3 Those claimants in direct privity with the contractor-principal are considered “first tier.”