Knowledge Corner

In Part 1, we discussed the major difference between Liability Insurance and Performance Bonds. In addition, we reviewed the steps the Surety must take if a Performance Bond Claim is made. This week, we will explore how the courts have viewed this situation.

How courts have responded to Performance Bonds vs. General Liability Insurance

A number of courts rendered opinions on the differences between Performance Bonds and General Liability (GL) Insurance with respect to cases involving defective work. The facts and court decision below serve as an example of a Contractor who had a GL Policy for the project. In addition, the Obligee required the Principal to post Surety Bonds in this case.

After a while, it became apparent there were a number of serious construction deficiencies on the project. Ultimately, the Principal defaulted and, subsequently, the Obligee terminated their contract and filed a claim under the Performance Bond. As a result of the performance claim, the Surety completed the project. The completion included destroying portions of the defective construction and reconstructing other portions. The Principal’s Surety incurred significant losses. 

The Surety then proceeded as assignee of its insured Principal against the Principal’s GL Carrier. The Carrier raised the argument that the damage to the project—caused by negligent workmanship of its insured and one of their subcontractors—was not covered. They further argued it was not covered because providing insurance coverage for the damage would transform the insurance policy into a Performance Bond.

The key differences between a Performance Bond and an Insurance Policy

The court found against this argument. Their explanation was that a Performance Bond and an Insurance Policy are completely different. The court further explained a Performance Bond does not inure to the benefit of the Contractor; it runs to the benefit of the third-party Obligee only. The Performance Bond posted by the Principal ran to the benefit of the Obligee—not to their Principal or its subcontractor.

The Surety sued the Principal pursuant to an Indemnification Clause in the Performance Bond and Indemnity Agreement for losses and expenses it incurred in completing the project. Thus, the Performance Bond did not protect the Principal from liability because it was required to indemnify and hold its Surety harmless.

In addition, the court found that any monies the Principal recovered from its Liability Carrier—for property damage in connection with the project—belonged to the Surety through its right of equitable subrogation to cover the losses and expenses it incurred. Furthermore, through its right of indemnification, the Surety would be entitled to be reimbursed for the losses it incurred even after it might have recovered the remaining contract balances and liability insurance proceeds.      

In the end, even though a Contractor carries Liability Insurance for a construction project if the project is bonded, the Principal and its indemnitors are ultimately responsible to reimburse the Surety for any losses it incurred. If you have any questions or concerns about the differences regarding Liability Insurance and Performance Bonds, contact TSIB today!

image credit: Amnaj Khetsamtip/shutterstock.com