Discussion of performance bond-related court decisions
by Stephen M. Phillips
In September 2002, the Milwaukee Board of School Directors (MBSD) contracted with a roofing contractor, Specialty Associates Inc. (SAI), Milwaukee, to install a new roof system at Cooper Elementary School. SAI was to be paid $361,495 and required to furnish a performance bond. Atlantic Mutual Insurance Co., New York, was the surety on the performance bond SAI furnished. The bond did not contain any time limitation or language indicating the contractor's warranty obligations were not encompassed by the performance bond.
SAI finished installing the new roof by December 2002 and issued its five-year limited roof warranty to MBSD. The roofing contractor's warranty took effect Dec. 26, 2002. MBSD made its final payment to SAI in February 2003. During summer 2005, MBSD noticed problems with the roof. In November 2007, MBSD filed suit against SAI, BITEC Inc., who supplied the roofing materials, and other parties. After filing its initial suit, MBSD amended its complaint by adding a claim against Atlantic Mutual based on breach of the performance bond.
Atlantic Mutual moved for summary judgment on the grounds that its duties had "long ago" expired and it was not a party to the five-year limited roof warranty SAI issued to MBSD. The trial court agreed, granting Atlantic Mutual summary judgment.
MBSD appealed, arguing Atlantic Mutual was liable under the performance bond on the grounds the surety's obligation included correction of latent defects during the same time period for which its principal, the contractor, was liable. Atlantic Mutual countered, pointing out SAI's construction contract required the contractor to correct defects for one year and the five-year warranty was a separate document and obligation. With regard to the five-year roof warranty, Atlantic Mutual argued its performance bond obligation was satisfied once SAI issued the five-year warranty to MBSD. Atlantic Mutual also contended that because the problems with the roof were discovered after the one-year period stated in the contract, Atlantic Mutual had no liability for the defective roof.
The Wisconsin Court of Appeals reversed the trial court's decision and ruled Atlantic Mutual's liability under the performance bond included SAI's post-completion warranty obligation. Explaining the reason for its decision, the court reiterated the general rule that a surety's obligation is derived from its principal and the surety's liability is measured by the principal's liability. Like other performance bonds, the performance bond issued by SAI and Atlantic Mutual incorporated the terms of the contract between SAI and MBSD and also contained language stating it applied to "all the undertakings, covenants, terms, conditions, and agreements of said contract." There was no time limitation or other language limiting Atlantic Mutual's post-construction obligations in the performance bond.
Contrast the Wisconsin Court of Appeals' decision in Milwaukee Board of School Directors v. BITEC, Inc. with the 2007 decision of the U.S. District Court for the Eastern District of Pennsylvania in La Liberte, LLC. v. Keating Building Corporation and many similar cases and you readily will see the critical difference resulting from including a time limitation in the performance bond. In the MBSD case, the roofing contractor's surety was liable for warranty obligations extending five years after the roofing contractor's work was completed. In the La Liberte case, the sureties for subcontractors were able to obtain dismissals because of time limitations included in the bonds.
The La Liberte case involved the 1999-2000 construction of the Sofitel Hotel in downtown Philadelphia. Keating Building Corp., Philadelphia, was the general contractor and retained subcontractors who were required to provide performance bonds. A certificate of substantial completion was executed May 1, 2000, and the hotel was open to the public soon after. Shortly after the hotel opened, leaks in the ceilings of several bathrooms were reported. Keating arranged for repairs, but leaks continued. Eventually, it was discovered the leaks were caused by incorrect shower construction.
In April 2007, La Liberte, as the owner of the building, filed suit against Keating. Keating promptly sought to dismiss the suit based on expiration of Pennsylvania's four-year statute of limitations applicable to construction claims, running from discovery of leaks in 2000. Because Pennsylvania's four-year statute of limitations applicable to a suit for breach of a construction contract starts at the time a defect is discovered and the record in the case had not yet been developed regarding the Sofitel Hotel's leak history, the court denied Keating's motion to dismiss La Liberte's claim against Keating.
Keating then filed third-party complaints in August 2007 against several subcontractors and their performance bond sureties. Each of the performance bonds issued by the subcontractors and their sureties stated: "Any suit under this bond must be instituted before the expiration of two (2) years from the date on which final payment under the [Subcontract] falls due or before the expiration of one (1) year from the date on which the warranties required by the [Subcontract] (including the drawings and specifications incorporated therein) expire."
The sureties filed motions to have the performance bond claims dismissed based on the time limitations stated in the performance bonds. Because there was no dispute that more than two years had elapsed from when final payment had been made to the subcontractors and more than one year had elapsed from expiration of each of the subcontractors' one-year warranties, the claims against the subcontractors' sureties were dismissed. In concluding his decision, Chief U.S. District Court Judge Harvey Bartle III wrote:
"In this case, each performance bond provides two dates certain which start the clock for Keating to file suit thereunder. We cannot, therefore, read the performance bonds as allowing the commencement of the limitation periods to be delayed until Keating discovers what injury, if any, it has suffered. Such an interpretation would undercut the agreement for which the parties to the bonds bargained. We must honor the parties' right to set limitation periods through contract."
Although the subcontractors themselves still may have faced liability, claims based on the subcontractors' performance bonds were dismissed because of the time limitations stated in the bonds.
This Web exclusive information is a supplement to Watching the clock.