SURETY CLAIMS AGAINST THIRD-PARTIES
By Allen West
Hamilton Stephens Steele + Martin, LLC
I.
General
Where after contractor default and demand upon the surety is made, and the remaining
balance of contract funds are insufficient to cover the costs needed to complete the contractor’s
scope of work, the surety may look to third parties to recover some or all of the losses it is about
to incur. This section of the materials will discuss the viability of such claims, and some of the
defenses that may be asserted against them.
Underlying the surety’s claim against third parties is that their errors or omissions
impaired the surety’s rights, diminished the contract balance, or increased the surety’s risk of
loss. Most often the acts of the architect will come under scrutiny. Other potential targets
include accountants, lenders, construction managers, inspectors, engineers and other design
professionals. The most common assertions by the surety against the design professional are: (1)
failure to properly inspect work in place, (2) failure to properly supervise the contractor, (3)
failure to timely respond to RFIs or submittals, (4) premature release of retainage, and (5) failure
to properly certify contractor pay applications resulting in over payment of the contractor.
II.
Surety Negligence Claims
Without privity of contract, the surety must have standing to bring a direct negligence
claim against the third-party, and must show that there was a duty owed and proximate
causation. Historically most jurisdictions declined to recognize tort claims against design
professionals, because without contractual privity the design professional owed no duty to the
{00291069.DOCX V. W046.011993;}
1
third party or through the application of the economic loss rule their losses were deemed not
recoverable. See, e.g., McKinney Drilling Co. v. Nello Teer Co., 38 N.C. App. 472, 248 S.E.2d
444 (1978); N.C. State Ports Authority v. Lloyd A. Fry Roofing Co., 294 N.C. 73, 240 S.E.2d
345 (1978). However, in most jurisdictions, including North Carolina, the manner in which
courts analyze such claims has changed dramatically over the years, including an erosion of the
privity requirement, which may permit sureties to seek redress against parties with whom it does
not have a contract.
In North Carolina cases such as Davidson v. New Hanover1 and Shoffner Industries2
opened the door for a contractor to recover economic losses arising from architect/engineer
negligence. Read more broadly, this line of cases establishes the precedent that regardless of the
fact that the contractor, engineer, construction manager, architect, and surety are all performing
their duties pursuant to contracts, suits among and between them on a tort theory may be
recognized. “The duty to exercise due care may arise out of contractual relations. However, a
complete binding contract between the parties is not a prerequisite to a duty to use due care in
one’s actions in connection with an economic relationship, nor is it a prerequisite to suit by a
contractor against an architect.” Davidson, at 666, 255 S.E.2d at 584.
In Shoffner, as in Davidson, the Court looked at whether harm to a third party was
foreseeable in the course of carrying out contractual duties. “An act is negligent if the actor
intentionally creates a situation which he knows, or should realize, is likely to cause a third
person to act in such a manner as to create an unreasonable risk of harm to another.” Shoffner, at
55, __ S.E.2d at 265; see also Browning v. Maurice B. Levien & Co., 44 N.C. App. 701, 262
S.E.2d 355 (1980) (holding that individual limited partners of the project owner had a negligence
1
2
Davidson and Jones, Inc. v. New Hanover County, 41 N.C. App. 661, 255 S.E.2d 580 (1979).
Shoffner Industries Inc. v. W.B. Lloyd Construction Co., 42 N.C. App. 259, 257 S.E.2d 50 (1979).
{00291069.DOCX V. W046.011993;}
2
claim against the architect hired by the lender to supervise the project for over certifying
contractor pay applications); but see Energy Investors Fund, L.P. v. Metric Constructors, Inc.,
351 N.C. 331, 338, 525 S.E.2d 441, 446 (2000) (barring claim of limited partner, stating that
although a common law duty of care may arise out of contractual obligations, “our case law
clearly provides that those obligations must result from some actual working relationship
between a plaintiff and defendant.”)
Although there are no recent3 North Carolina appellate court cases which specifically
address whether a surety has the right to assert a claim against third-party professionals, the
foregoing cases suggest such economic losses may be recoverable if reasonably foreseeable.
This principle has been recognized in other jurisdictions, and the analysis applied in those cases
is consistent with how North Carolina courts apply concepts of duty and foreseeability in the
construction context. See e.g., U.S. V. Rogers & Rogers, 161 F. Supp. 132 (S.D. Cal. 1958);
Aetna Ins. Co v. Hellmuth, Obata & Kassabaum, Inc., 392 F.2d 472 (8th Cir. 1968); Peerless
Ins. Co. v. Cerny & Associates, Inc., 199 F. Supp. 951 (D. Minn. 1961); In re Designed Ventures
Inc., 132 B.R. 677 (D. R.I. 1991). “An architect is not a guarantor or an insurer but as a member
of a learned and skilled profession he is under the duty to exercise the ordinary, reasonable
technical skill, ability and competence that is required of an architect in a similar situation; and if
by reason of a failure to use due care under the circumstances, a foreseeable injury results,
liability accrues.” Aetna Ins., 392 F.2d at 476-477.
3
Recent, meaning subsequent to the decisions in Shoffner and Davidson. In 1961 the North Carolina Supreme
Court denied a surety’s claim against a “supervising engineer” for negligence. City of Durham v. Reidsville
Engineering Co., 255 N.C. 98, 120 S.E.2d 564 (1961). In that case the issue was liability for latent defects, and the
court analyzed the respective contracts finding that ultimate responsibility for construction lay with the contractor
and that the engineer’s duty to inspect and/or supervise did not relieve the contractor of that responsibility, nor
would it relieve the surety of its obligations under the performance bond.
{00291069.DOCX V. W046.011993;}
3
A.
The Significance of Owner/Architect Contract Provisions
The more expansive the role of the design professional during construction, the greater
the potential for the surety to claim that it was relying on the safeguards provided by the architect
in calculating its risk, and therefore has the right to assert a claim if the architect performed those
contractual obligations in a negligent manner. The design professional’s duties and
responsibilities on a project are to a large degree governed by the owner/architect contract,
particularly with respect to construction contract administration. Over time, as court precedents
began to steadily erode the privity requirement, revisions to standard contracts were made in an
effort to limit the architect’s exposure to claims for construction defects. For example, recent
iterations of the AIA A201 General Conditions state that the architect “will not be required to
make exhaustive or continuous on-site inspections to check the quality or quantity of the
work….[nor] have control over or charge of, nor be responsible for, the construction means,
methods, techniques, sequences or procedures…” (1997 version) The AIA form agreements
otherwise make clear that the architect has no role in the supervision of the contractor or its
subcontractors.
Certainly these changes did succeed in refining and defining the architect’s role during
construction, which in turn limits the architect’s potential liability for construction errors. If the
design professional has limited duties and responsibilities pursuant to its contract with the owner,
third parties cannot expect nor be entitled to claim a higher or expanded standard of care. This
expectation may be limited in a tort analysis; however, as the measure of a design professional’s
standard of care stems from its duties as a professional, which may be distinct from its
contractual obligations, or deemed to be non-delegable. See e.g., Associated Industry
Contractors, Inc. v. Fleming Engineering, Inc., 162 N.C. App. 405, 590 S.E.2d 866 (2005); PVC,
{00291069.DOCX V. W046.011993;}
4
Inc. v. McKim & Creed, 188 N.C. App. 632, 656 S.E.2d 16 (2008) (Unpublished disposition);
see also Hunt v. Ellisor & Tanner, Inc., 739 S.W.2d 933 (Tex. App. 1993) (holding the architect
liable for failing to discover construction defects despite limiting language in the owner/architect
agreement).
Not everyone has gotten the message. Even today, it is not unheard of to find architects
using form letter agreements and other industry contracts that are lacking carefully crafted risk
allocation provisions. Such agreements may impose an obligation to “inspect”, “approve” work
in place, for conformity with the contract documents, or even provide for some level of
“supervision” of the contractor or construction operations. Given the potential for a claim
against the architect on a troubled project (from the surety or otherwise), when representing
design professionals care should be taken at the contract stage and during construction. At the
contract stage, counsel should endeavor to ensure that the owner/architect agreement clearly
expresses and limits the architect’s responsibilities. Unless specifically bargained for and the
consequences fully appreciated by the design professional, these terms should be modified to
reflect the modern delegation of construction process responsibility. Owner/architect agreements
should make clear that the architect is not responsible for means and methods, detailed
inspections, insuring that the work is of a particular quality or meets a certain standard, and for
supervision. Limitation of liability clauses, or even exculpatory provisions, may also be helpful.
See Blaylock Grading Co. v. Smith, 189 N.C. App. 508, 658 S.E.2d 680 (2008).
B.
The Design Professional or Construction Manager as “Initial Decision Maker”
Architect agreements often provide for the architect to be involved in the process of
determining contractor default and contractor termination. In some cases, counsel for the design
{00291069.DOCX V. W046.011993;}
5
professional may want to consider negotiating these provisions out of the contract, and avoid
being placed in the untenable position of offending either the relationship with the owner or the
contractor. Alternatively, at the drafting stage counsel can endeavor to limit the architect’s
authority or confine its decisions to objective criteria. In any event, if the owner is intent on
declaring the contractor in default and demands the architect’s certification of default, the
involvement of counsel is appropriate to ensure that the contract procedure is followed, and that
judgments about contractor performance are limited.
If the surety seeks to base a claim against the design professional involving its
independent decision making, particularly whether to declare the contractor in default, or even in
discharging its duties otherwise, in certifying applications for payment, etc., the architect may be
able to defend such claims on the basis that its decision must be judged by a higher standard than
simple negligence. See Biemann and Rowell Co. v. Donohoe Companies, Inc., 147 N.C. App.
239, 556 S.E.2d 1 (2001). Biemann, involved a mulit-prime contract in which it was argued that
the architect’s failure to allocate fault was an implicit determination of fault. “When an architect
is vested with the authority to render judgment on a contractor’s performance, the determination
is prima facie correct, and the other parties have the burden of proving fraud or mistake.”
Quoting Heating Co. v. Board of Education, 268 N.C.85, 150 S.E.2d 623 (1966), the Court in
Elec-Trol, Inc. v. C.J. Kern Contractors, Inc., stated the following:
It is also clear that where the parties stipulate expressly or in necessary effect,
that the determination of the architect or engineer shall be final and conclusive,
both parties are bound by his determination of those matters which he is
authorized to determine, except in case of fraud or such gross mistake as would
necessarily imply bad faith or a failure to exercise an honest judgment. The reason
underlying this rule is that under such circumstances the contract makes the
architect or engineer the arbitrator, and his determination can be attacked only in
the same manner as that of any other arbitrator. On the other hand, where the
{00291069.DOCX V. W046.011993;}
6
stipulations are such that the meaning to be gathered therefrom is that the
architect’s or engineer’s certificate shall not be final, the parties are not bound by
the certificate
Elec-Trol, Inc. v. C. J. Kern Contractors, Inc., 54 N.C. App. 626, 629, 284 S.E.2d 119, 121
(1981).
Although neither Elec-Trol nor Biemann involved direct claims against the architect,
these cases suggest that an argument could be made that the architect’s decisions are entitled to
deference, and liability should be imposed only upon a finding of fraud or bad faith. Decisions
by courts in other jurisdictions vary as to whether the architect is entitled to some quasi
immunity. Successful application of this theory as a defense may depend upon whether the
architect was actively engaged in deciding a dispute or performing other duties such as certifying
pay applications.
C.
An Argument Against Expanding Tort Liability to Include Surety Claims
We start with the premise that the construction industry benefits from predictable and
quantifiable risk that is best addressed through allocation of that risk by contract. Overpayment
of the principal, and other impairment of the surety’s rights under a performance bond, is often
raised by the surety as an affirmative defense to claims by the bond obligee. “A surety on a bond
to secure the faithful performance of a building contract, which provides that payment shall be
made at specified times as the work progresses, is released from liability under a bond if the
owner, without the surety's consent, makes advances to the principal in excess of the amount due
by the terms of the contract.” Payments or Advancements to Building Contractor by Obligee as
Affecting Rights as Between Obligee and Surety on Contractor's Bond, 127 A.L.R. 10
(Originally published in 1940); see also Blackfeet Tribe of Blackfeet Indian Reservation v. Blaze
{00291069.DOCX V. W046.011993;}
7
Construction, Inc., 108 F.Supp.2d 1122 (D. Mont. 2000). This concept has been long recognized
in North Carolina. See Commercial Casualty Ins. Co. v. Durham County, 190 N.C. 58, 128 S.E.
469 (1925); Donlan v. Am. Bonding & Trust Co., 139 N.C. 212, 51 S.E 924 (1905); but see
Salem Realty Co. v. W.K. Batson, 256 N.C. 298, 123 S.E.2d 744 (1977) (holding that the surety
was not discharged where the owner was acting in honest (but mistaken) belief that contractor
had satisfactorily performed).
Accordingly, the rights of the surety are adequately protected in the case of over
certification of pay applications, because the acts of the architect may be imputed to the owner.
Alamo Community College Dist. v. Browning Const. Co., 131 S.W.3d 146 (Tex. App. 2004). If
the surety can prove that the errors and omissions of the design professional impaired its rights
under the performance bond, it can argue that its obligations to the obligee were discharged pro
tanto. Restatement (Third) of Suretyship & Guaranty § 37, Impairment of Suretyship Status
(1996). The analysis is similar to that which is used in contractor-owner disputes, wherein the
contractor can avoid liability if it can show that defects were caused by design, and that the
owner represented to the contractor that it was entitled to rely on the accuracy and sufficiency of
plans and specifications, a provision commonly found in construction contracts. See U.S. v.
Spearin, 248 U.S. 132 (1918).
III.
Negligent Misrepresentation Theory
A surety may also target accountants or others who provide information if it can show
that it reasonably relied on negligently prepared financial statements or other information. See
Seaboard Surety Co. v. Garrison, Webb & Stanaland, P.A., 823 F.2d 434 (11th Cir. 1987). In
Seaboard Surety, the Eleventh Circuit applied Florida law to reject the argument that the analysis
{00291069.DOCX V. W046.011993;}
8
should hinge on tort concepts such as whether it was foreseeable that the surety would rely on
the information it provided. Instead the Court used a third-party beneficiary analysis, and framed
the issue in terms of whether it was reasonable to expect that the owner would provide the
information to a third party for purposes of inducing that third party to act, in which case the
accountant’s contractual duty to perform its services ran to the benefit of that third party.
It is possible that North Carolina Courts would permit the surety to assert a negligent
misrepresentation claim against an accountant. North Carolina has recognized that a creditor
may have a claim against an accountant. Raritan River Steel Co. v. Cherry, Bekaert & Holland,
322 N.C. 200, 367 S.E.2d 609 (1988); Brinkman v. Barrett Kays & Associates, 155 N.C. App.
738, 575 S.E.2d 40 (2003). In analyzing these cases, North Carolina applies the definition of
negligent misrepresentation supplied by the Restatement of Torts:
One who, in the course of his business, profession or employment, or in any other
transaction in which he has a pecuniary interest, supplies false information for the
guidance of others in their business transactions, is subject to liability for
pecuniary loss caused to them by their justifiable reliance upon the information, if
he fails to exercise reasonable care of competence in obtaining or communicating
the information.
Restatement (Second) of Torts § 552.
Whether an architect or engineer would be liable to a surety under such a theory may
depend on how its scope of work is defined, and whether or not the information provided was the
“end and aim” of the architect’s work, or merely ancillary to it. See RLI Ins. Co. v. Indian River
School Dist., 556 F.Supp.2d 362 (D. Del. 2008). In RLI, the Court found that the architect’s and
construction manager’s certification of pay applications was “incidentally supplied as part of
construction” and therefore did not fall within the exception to the economic loss rule. A key
consideration will be the purpose of the financial statements, and whether the accountant and the
{00291069.DOCX V. W046.011993;}
9
owner intended for the surety to rely on their accuracy. The erosion of the privity and economic
loss doctrines as discussed above will also be applicable in such cases.
{00291069.DOCX V. W046.011993;}
10