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Construction Law - November 2009

Surety Company Bound to Honor Contractor’s Warranty

By John S. Mrowiec

Contract completion may not end surety liability under an extended warranty. A performance bond with no time limit can have a long tail.

Owners often require that contractors procure performance bonds to guarantee the contractor’s faithful performance of the contract. Statutes require performance bonds on public construction projects.

The performance bond surety’s liability to the owner for the contractor’s failure to complete the contract is not controversial. Absent defenses, the surety must either complete the contract or pay the penal sum of the bond.

John S. Mrowiec
John S. Mrowiec

But what if the contractor apparently completes the contract successfully, the standard contractual warranty passes without discovery of any defect and one is discovered during the longer period of an extended contractor’s warranty required by the contract and given as a contractual condition to final payment?

Is the surety liable for the contractor’s post-completion obligations under that extended warranty? That was the question in Milwaukee Board of School Directors v. Bitec, Inc., 2009 Wisc. App. LEXIS 707 (Dist. One, Sept. 9, 2009).

The Milwaukee Board of School Directors submitted bids for a roof replacement at an elementary school. The bid documents included the form of contract and form of required performance bond.

Specialty Associates, Inc. was the successful contractor bidder. Atlantic Mutual Insurance Co. was the contractor’s surety. Bitec, Inc. was the supplier of the roof system.

The contract provided that “All Work of every kind shall be delivered upon completion of the project in a perfect and undamaged condition, free of flaws or defects.” The contract further provided that, “unless modified in the detailed specifications,” the contractor would remedy any defective workmanship or materials within one year of final payment.

The contract also provided for additional extended warranties. The contractor was obligated to provide a five-year workmanship warranty and a 12-year “no dollar limit” manufacturer’s warranty covering the materials. The contract mandated specific terms the warranties must contain.

The contractor completed the work, issued the five-year workmanship warranty and delivered the supplier’s 12-year materials warranty to the owner and received final payment. More than two years after final payment, the owner noticed problems with the roof. Within five years of the project’s substantial completion, the owner filed suit against the contractor, the contractor’s insurer, the supplier and the supplier’s insurer— but not against contractor’s surety.

After learning that the contractor had received a bankruptcy discharge, the project owner added contractor’s surety as a defendant, alleging that the surety was liable for its contractor-principal’s breach of contract.

The owner alleged that the contractor had improperly installed, failed to inspect and provided insufficient adhesion, allowing water to infiltrate and damage the roof and structure.

The surety moved for summary judgment. It argued that its duties under the roofing contract had expired and it had no obligation regarding the “separate” five-year extended workmanship warranty issued by the contractor. The trial court agreed. The owner appealed.

As almost all performance bonds do, this bond provided that the surety’s obligation was void if the contractor-principal “shall well, truly and faithfully perform its duties, all the undertakings, covenants, terms, conditions, and agreements of said contract during the original term thereof, and any extension thereof . . . and if he/she shall fully indemnify and save harmless the owner from all costs and damages which it may suffer by reason of failure to do so, and shall reimburse and repay the owner all outlay and expense which the owner may pay in making good any default . . .”

Unlike some bonds, though, this performance bond did not contain any time limit to sue. That is not surprising because the required bond form was part of the owner’s bid solicitation.

The Bitec, Inc. appellate court analyzed the contract and the bond and concluded that the surety had agreed to “all the undertakings” in the contract including the five-year workmanship warranty.

Bitec, Inc. first relied on an older Wisconsin case where the contract contained a general one-year warranty and a specific two-year title warranty.

In that case, the surety was held liable for a claim of cracked and buckling tile. Bitec, Inc., 2009 Wisc. App. 707, *13- 14 quoting Milwaukee Country v. H. Neidner & Co., 263 N.W. 468 (1935), modified on other grounds, 265 N.W. 226 (1936).

Continuing, the Bitec, Inc. appellate court cited cases from other states which had found that a performance bond surety could be liable for post-completion latent defects.

The surety argued that the five-year workmanship warranty was a separate and distinct obligation from the original contract. Surety’s obligation, it argued, ended when contractor properly issued the written extended warranty and, thereafter, the surety was not guarantying that warranty.

The Bitec, Inc. court disagreed; the contract required that contractor provide the five-year warranty as one of the original contractual obligations which the surety had agreed to guaranty.

According to the court, the five-year warranty was not separate; it was not signed by the owner, its terms were not negotiated and there was no separate payment or other consideration for it. Bitec, Inc., 2009 Wisc. App. LEXIS 707, *16 – 17.

By that logic, the surety argued, the surety also would be liable for the 12-year supplier warranty because the contract required the contractor to provide it to the owner even though it was the supplier’s warranty. Perhaps, the court said, but that was not an issue for decision in the appeal.

The appellate court reversed. Absent any special surety defenses, if the contractor breached the extended warranty, the surety would be liable.

Bitec, Inc. teaches that apparently successful contract completion may not be the end of surety liability where extended warranties are required by the contract. A performance bond without a time limit might have a long tail indeed.

John S. Mrowiec is a partner with Chicago-based Conway & Mrowiec, a construction and public contracts law and litigation practice. He may be reached at (312) 658-1100. For information, go to the firm’s Web site at www.cmcontractors.com.

 

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