New Jersey Courts Provide Broader Protection for Surety Bondholders

Paul T. Fader, Esq.
Jason Isom, Esq.

As many public contractors are aware, a surety bond ensures contract completion in the event of default by a contractor. For public agencies, which often must rely on the promises of the lowest responsible bidder, the importance of surety bonds cannot be understated. Surety bonds provide financial security and project assurance by guaranteeing that contractors will perform work outlined in the project proposal. General contractors also rely heavily on surety bonds in order to provide some measure of financial assurance when dealing with multiple subcontractors.

Traditionally, surety relationships involve three parties: 1) an obligee, who is owed a debt or duty; 2) a principal, who is responsible for payment of the debt or performance of the duty; and 3) a surety, who agrees to answer for principal’s debt or duty.

Recently, in Allied Building Products Corp. v. Strober & Sons, LLC, et al. New Jersey’s Appellate Division issued an opinion on whether a surety, which issues a bond to an unintended obligee is still bound to the intended obligee due to the performance bond’s incorporation of the contract between the intended obligee and the principal. 

The obligee in this case was the general contractor for a renovation project at a local New Jersey college. The general contractor subcontracted out the roofing renovation to the principal. The roofing subcontract between the obligee and the principal required the principal to obtain payment and performance bonds in the form annexed to the subcontract. The principal paid for the performance bond from the surety, however, when the performance bond was issued, it named the college as the obligee, rather than the general contractor. Notwithstanding that fact, the performance bond incorporated the subcontract by reference.

Traditionally, New Jersey courts have found “that a surety is chargeable only according to the strict terms of its undertaking and its obligation cannot and should not be extended either by implication or by construction beyond the confines of its contract.” Monmouth Lumber Co. v. Indem. Ins. Co. of N. A.. In other words, the courts cannot not look beyond the “four corners” of the bond when interpreting the duties and obligations of the surety. The trial court relied primarily on Monmouth in granting the surety summary judgment in Allied

New Jersey’s Appellate Division distinguished Monmouth from Allied by finding that because the performance bond incorporated the subcontract by reference, the performance bond and the subcontract were one integrated contract and thus the Court could look to the subcontract to ascertain the meaning of the parties. In conducting this analysis, the Court found that the general contractor was the intended obligee and that the surety was required to cover for the principal’s non-performance under the doctrine of reformation based on mutual mistake.

Reformation is a type of equitable remedy where by a contract is rewritten in a way that better expresses the intentions of the parties. In Allied the Court identified a number of factual circumstances which indicated that the general contractor was the intended obligee, namely 1) the performance bond issued references an agreement for roofing work dated November 11, 2008 (the same date as the commencement of the subcontract); and 2) the surety could point to no other contract to which that reference could apply. In light of the foregoing factors, the Court in Allied “rewrote” the contract to reflect that the general contractor was the intended obligee.

As a practical matter, the Court’s decision in Allied means that legal counsel for principals, both public agencies and general contractors, should actively seek to incorporate by reference their contracts with the obligee. This will provide broader protection from sureties seeking to avoid their financial obligations based on legal technicalities. 

To view Paul T. Fader's professional biography click here.

To view Jason Isom's professional biography click here.

For more information on FPSF's Construction & Public Contracting Law Practice Group click here.

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