Can A Bond Apply Retroactively?
August 20, 2024
In this Surety Today: The Blog post we discuss the issue of retroactivity of bonds. The question is whether the surety can be liable for defaults committed by the principal prior to the date of issuance of the bond? The general rule is that “unless a bond is in express terms retroactive it binds the sureties with respect to future transactions only,” and the surety is “not liable for any default in the condition of the bond which had already occurred when the bond took effect.” Massachusetts Bonding and Insurance Company v. Bank of Aurora, 124 Colo. 485; 238 P.2d 872 (1951); City of Chicago v. Siebert, 244 Ill. App. 83, 86 (Ill. App. Ct. 1927)(“A surety on a bond given to secure the faithful performance of a contract is not liable for defaults of his principal previous to the transaction wherein the bond and contract were executed, unless the contract is retrospective in terms.”); Wenatchee Orchard Syndicate v. Fidelity & Deposit Co., 143 Wash. 632, 255 P. 943, 945 (1927). In John v. Worthen, 188 Ill. App. 406 (Ill. App. 4th 1914) after citing the general rule, the court observed that “before a bond can be construed as being retroactive it is not sufficient that the language implies a liability but the language must be such as to expressly include such liability in its terms.” The general rule is bolstered by the familiar statement of the law that the liability of the surety is one of strict contract, which cannot be extended by implication, nor enlarged beyond the limits, which its words fairly import. State v. Banks, 76 Md. 136, 24 A. 415 (1892). While the general rule is well and good, courts have found ways to get around it. When the surety is faced with a question about whether its bond covers some prior event there are a number of factors to consider.
First, consider the language of the bond. Courts will look to the wording to see if the intent of the parties is revealed to have the bond apply retroactively. As noted above in the Worthen case the court required express language indicating retroactivity. Other courts seem to put the burden on the surety to prove that retroactivity was not intended. Courts will look to express references to the effective date of the bond and references to the contract/project being covered. What is the subject of the guaranty, is it a past transaction in whole or in part, is the language taken in its natural sense or legal effect broad and all encompassing? For example, in U.S. for Use & Benefit of Westinghouse Elec. Supply Co. v. Sisson, 927 F.2d 310, 310–12 (7th Cir. 1991) the court held that a replacement bond issued mid-way through a project under the Miller Act covered a claim for work performed prior to the issuance of the bond. The court observed that the surety failed to provide any information that showed that the payment bond was not to be retroactive. The bond indicated that it covered the work under the contract that had been entered into almost a year prior and was for a slightly larger penal amount than the original bond. The court took the larger amount as evidence of intent to cover the entire contract, reasoning that if the bond was intended to only be prospective, the penal sum would have been smaller. The court also relied on the remedial purpose of the Miller Act and obligation to liberally construe the bond in favor of coverage.
Under similar circumstances in Elec. Elec. Control, Inc. v. Los Angeles Unified Sch. Dist., 126 Cal. App. 4th 601, 24 Cal. Rptr. 3d 316 (2005), the court reached the opposite conclusion. In that case the original contractor on a school project failed to pay its subcontractors and was default terminated by the School District. Although the contractor was supposed to have posted a payment bond, it had not done so, in violation of applicable law. A new contractor agreed to accept an assignment of the original contract and a bond was issued. An unpaid subcontractor under the original contract sued the School District for failure to require the bond from the defaulted contractor. In its defense, the School District contended that the new bond posted for the completion contractor covered the subcontractor’s claim. The court reviewed the language of the bond and found that it referenced to the assignment agreement, which was entered into months after the subcontractor’s work was completed, which the court concluded evidenced the intent for the bond to apply prospectively and not to prior work. The court noted that had the bond been intended to apply to prior work, it would have referred to the original contract. The court also noted that there was no language in the bond which indicated that the surety intended to bind itself to defaults that had occurred before the bond was issued. Finally, the court observed that the notice provisions of the bond indicated it was intended to be prospective not retroactive. Under the notice provisions, if the bond was intended to reach prior work, no subcontractor would have been able to comply with the notice terms.
Second, notwithstanding the bond language, if the bond was issued pursuant to a statute, the language of the statute must be considered, because the bond language will likely be controlled by the statutory language. Thus, if the law pursuant to which a bond was issued indicates that the bond is intended to also protect transactions that occurred prior to its issuance, the bond will be construed to reach those transactions. See Corby v. Gulf Ins. Co., 114 Cal. App. 4th 1371-78, 8 Cal. Rptr. 3d 663 (2004). For example, in State Sur. Co. v. Peters, 197 Neb. 472, 475–76, 249 N.W.2d 740, 742 (1977), a bond was issued pursuant to a statute to cover motor fuel taxes to the State of Nebraska. The state contended that the surety was obligated to cover the taxes incurred both before and after the bond was issued. The bond form prescribed by the statute was silent on the question of the surety’s liability for the principal’s past indebtedness. However, because the bond was a statutory bond, the liability of the surety was measured by the terms of the statute. The statute provided that a bond was required to ensure “the payment of any and all taxes, including interest and penalties due and to become due under the provisions.” The surety argued that the general law of the land has uniformly been that suretyship agreements take effect from the date of their execution. The court held that notwithstanding the general rule, the words in the statute, “due and to become due” expressed “a clear legislative intent to impose liability for all sums due when the bond is filed.” The court stated that to accept the surety’s position “would be to construe this language out of the statute. This we refuse to do.” The surety was held liable for taxes owed prior to the issuance of the bond.
Third, look at the timing of the surrounding events. What if the conduct giving rise to the claim occurred in part before the issuance of the bond, but caused damage after the issuance of the bond – does the bond cover such a claim? In Commercial Insurance Company Of Newark, New Jersey v. Watson, 261 F.2d 143 (10th Cir. 1958) the court dealt with a claim where the title to an automobile was fraudulently obtained prior to the issuance of the bond, but the car was later sold under the ill-gotten title after the bond had been issued. The court stated that although “the fraud might have been conceived prior to the issuance of the bond, it was not consummated until after the title to the automobile was hypothecated to the bank and Powell received the proceeds of the loan sometime after the effective date of the bond.” The court distinguished this case from a case where the defalcation was complete prior to the effective date of the bond. “[A] surety contract is not retrospective in operation merely because part of the transactions with which the contract is concerned have been consummated earlier when the actual defaults insured against are still prospective.” People v. Great American Ins. Co., 222 Cal. App. 2d 552, 561 (1963).
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (410-659-1321/mstover@wcslaw.com) or any member of the Surety and Fidelity Practice Group.