Illinois Construction Law Blog : Illinois Construction Lawyer & Attorney : Foran Glennon Palandech Ponzi & Rudloff Law Firm : Chicago IL

In November 2008, Illinois’ Second Appellate Court rendered its landmark decision in JP Morgan Chase Bank, N.A., v. Earth Foods, 386 Ill.App.3d 316 (2nd Dist. 2008). The decision departed dramatically from the strict definitions ascribed to “surety” and “guarantor.” As the appellate court’s decision relied in part on interpretations from sister jurisdictions, the decision had potential national implications. We offered a comprehensive analysis of that decision, specifically that it effectively dissolved the distinction between guarantors and sureties in Illinois.

Because of the importance of the precedent, on January 28, 2009, the Illinois Supreme Court accepted an appeal by JP Morgan. Last month the Illinois Supreme Court, in JP Morgan Chase Bank, N.A., v. Earth Foods, Illinois Supreme Court Docket No. 107682, October 21, 2010, affirmed in part and reversed in part the decision of the Second District and remanded the case back to the trial court.

The facts of the case are detailed here. The trial court rejected co-owner and defendant DeFranco’s argument that the notification to JP Morgan of Earth Foods’ near-insolvency discharged his obligation as a guarantor under Section 1 of the Sureties Act and summary judgment was entered in favor of JP Morgan.

On appeal, DeFranco argued that the even though the contract identified him as a “guarantor,” rather than a “surety,” the trial court erred when it rejected the application of the Sureties Act and entered summary judgment in favor of JP Morgan. The crux of DeFranco’s argument was that the term “surety” should be judicially construed to include guarantors. JP Morgan countered that the plain text of the Sureties Act made clear that its provisions were unavailable to DeFranco, as guarantor.

In holding that guarantors were included in the term “surety,” the appellate court, relying on Illinois jurisprudence, sister states’ jurisprudence, and several secondary sources, including the Restatement (Third) of Suretyship and Guaranty, undertook an analysis of the “popularly understood” meaning of the terms “suretyship” and “guaranty.”

The court found that the terms “guarantor” and “surety” are “unusually intertwined in legal parlance and that the distinctions between them are arcane and often ignored” and held that the statute applied with equal force to guarantors as it did to sureties.  Accordingly, the court found that the trial court erred in granting JP Morgan’s motion for summary judgment on the basis that DeFranco could not invoke a defense provided by the Sureties Act.

The Illinois Supreme Court reversed, holding that the Sureties Act applies to and protects only sureties, not guarantors. In its opinion, the Court found that, in spite of current usage, it was required to recognize the distinction between guarantor and surety. The Court noted that the Act is descended from a statute passed in 1819, with different language, but the same effect, and that the policy and purpose never changed.

According to the Court, at common law, the surety had no right to require the creditor to take action against the principal. So the surety was not discharged, even if the creditor neglected or failed to take action. As a result, many states, including Illinois, passed statutes like the Act to give the surety protections unavailable at common law.

Whether the parties intended to create a surety or a guarantor, and considering not only the language of the written agreement (which referred to a “guarantee”), is to be determined from all facts and circumstances, and thus summary judgment was inappropriate. The Court remanded for further proceedings to provide DeFranco an opportunity to establish whether he was a surety or a guarantor. The Court even suggested parol evidence may be necessary to that end. It appears that the Sureties Act is alive and well!

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We are pleased to present as a guest author, Danielle Rodabaugh, an authority on surety bonds.  Ms. Rodabaugh is a principal for Surety Bonds.com and can be reached through the Surety Bonds.com website:

Financing a construction project motivates a proprietor to consider effective ways to protect the investment. Surety bonds provide legal protection for those backing a construction project in Illinois, especially if the project requires considerable funding for a high-end remodel or an entirely new structure. When working on such projects, utilizing construction bonds ensures stabilization for a project's contract from beginning to end, which is why the terms "construction bond" and "contract bond" are used interchangeably.

Legal bonding requirements for construction in Illinois

United States law requires each state to set bonding regulations for its many industries. The regulations vary depending on how the particular law outlines bonding requirements for the industry. In construction, the Miller Act requires contract surety bonds to be utilized for all federal projects involving the construction, alteration, or repair of any building or public work project in an amount exceeding $100,000. This law also requires a contractor working on such a project to post two bonds: a performance bond and a labor and material payment bond.

The Illinois Public Works Act requires a bond for any person who enters into a contract in the amount of $100,000 or greater with any political subdivision. This includes contractors working with government entities such as cities, housing districts or federally-funded colleges, just to name a few. The state's Bond Act mandates that contractors must secure a labor and material payment bond in the project's full amount, listing the public body as the bond's obligee. Furthermore, the Bond Act requires its provisions to be incorporated into every bond issued in Illinois.

Functionality of Illinois surety bonds

Oftentimes even those required to be bonded by law get confused as to how an Illinois surety bond works. Essentially, a surety bond is a legal agreement between three parties to help ensure the fulfillment of a contract:

• The principal performs a service and secures a bond to guarantee his work according to the contract.
• The obligee receives the work performed by the principal and is protected by the financial security of the bond.
• The surety issues the bond as a neutral third party to ensure that all work done by the principal is completed on time and according to the contract. The surety is also responsible for overseeing obligations on the part of both the principal and the obligee.

Since bonds are legally binding documents, they encourage the principal to follow the contract's terms or else face financial retribution. The obligee can make a claim on the bond if the principal fails to fulfill some part of the contract, such as completing the project on time. Depending on the bond type and its specific language, the surety bond company can be held fully accountable for the principal's faults. This encourages surety bond specialists take great care in completing thorough financial reviews before issuing the bond.

Surety bonds in construction

Most public contracts are required by Illinois state law to incorporate bonding of some sort. Surety bond agencies generally issue various types of construction bonds for large projects that involve in-depth, provisional contracts. Nearly all construction bonds fall into one of three major subcategories:

• Bid Bonds primarily assure that the bidder will enter into a contract with the client for the price quoted in its bid. They also confirm that the bidder will secure other appropriate performance and payment bonds necessary throughout the project.
• Performance Bonds simply guarantee that the contractor will fulfill his contract, performing all duties as outlined. Should the contractor fail, the surety company becomes solely responsible for all contractual obligations.
• Labor and/or Material Payment Bonds protect those who provide labor and/or materials for public projects.

Although each of these bonds functions in a different way, they work together to produce a solid foundation for a construction project.

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The laws applying to personal guarantees have been shifted a bit by the recent case of JP Morgan Chase Bank, NA v. Earth Foods, Inc. (2^nd Dist. Doc No. 2-07-0045). In JP Morgan, a defendant who had signed a personal guarantee to a bank for loans advanced to a business wanted to avail himself of a statute that specifically referenced sureties and not guarantees. The business he guaranteed had defaulted in its principle contract with the bank and the bank sought to get the money through the guarantee since no money could be had from the now defunct business. Prior to the business getting a notice of default, the guarantor sent a letter to the bank that warned the business was depleting its inventory which was collateral for the loan and demanded that the bank take action. If the statue applied, then he would potentially have a defense to the bank’s suit against him on the note where he had arguably complied with the statute. If the statute didn’t apply, he would have no defense to the bank’s demand that he honor the guarantee. 

The dispute centered around the interpretation of the Sureties Act (740 ILCS 155):

Sec. 1. When any person is bound, in writing, as surety for another for the payment of money, or the performance of any other contract, apprehends that his principal is likely to become insolvent or to remove himself from the state, without discharging the contract, if a right of action has accrued on the contract, he may, in writing, require the creditor to sue forthwith upon the same; and unless such creditor, within a reasonable time and with due diligence, commences an action thereon, and prosecutes the same to final judgment and proceeds with the enforcement thereof, the surety shall be discharged; but such discharge shall not in any case affect the rights of the creditor against the principal debtor.

The guarantor argued that the sureties act applied to his personal guaranty and that he had an arguable defense to the bank’s attempt to collect on the guaranty because he had complied with the statute and sent the note. The trial court disagreed and denied him this defense in granting summary judgment for the bank on the grounds that the defendant was a guarantor and not a surety. The guarantor appealed and the appellate court issued its determination and after a long recitation of the possible differences between the both guarantors and sureties (an history and discussion worth reading), held that a guarantor was the same as a surety for the purposes of the act and that the defendant could assert the defense. 

While the question didn’t seem to hinge on too many specifics in the actual contracts between the two parties, the court did take time to note that any legal distinction between the two was nullified by the terms of the contract at issue which allowed that the creditor could pursue the guarantor without first pursuing the principal. (This is important given that the classical difference between a surety and a guarantor involved the surety’s obligation as joint and several and the guarantor’s obligation as derivative and actionable only when the principal cannot pay). 

The lesson is to know your rights and make sure you’re on top of them in sending the right messages to your creditors if you are a guarantor and in protecting yourself by trying to contract around this statute if you are a creditor. 

Additionally, the application of the Act to guarantees raises a few more questions than answers, for instance, does the case apply only to personal guarantees, or can we extend the act to multiple types of sureties from people and from corporations? What about in the construction context? Does this change the nature of surety bonds in the state? Can we apply this case to those who contract to ensure the work of another? Has the distinction between these two words been done away with? 

With all this in mind, we thought it might be worthwhile to see where some other statutes have made or obviated the distinction and if it becomes a functioning rule, where the Illinois legislature might need to clean house a little: 

Section 49 of the Illinois Credit Union Act (205 ILCS 305) lists the terms as separate and distinct when defining a “security” under the Act but does not explain that distinction:

Security. In addition to generally accepted types of security, the endorsement of a note by a surety, comaker or guarantor, or assignment of shares or wages, in a manner consistent with the laws of this State, shall be deemed security within the meaning of this Act. A credit union shall give each surety, guarantor or comaker a copy of the instrument evidencing the indebtedness. The adequacy of any security shall be determined by the Credit Committee, credit manager or loan officer, subject to this Act and the bylaws of the credit union. The surety, guarantor or comaker may, but need not, be a member of the credit union making the loan.

In defining the operations of certain insurers and companies, the Illinois Insurance Code (215 ILCS 5) notes the distinction at Section 4 Class 2 (g) and at Section 121-3(b):

(g) Fidelity and surety. Become surety or guarantor for any person, copartnership or corporation in any position or place of trust or as custodian of money or property, public or private; or, becoming a surety or guarantor for the performance of any person, copartnership or corporation of any lawful obligation, undertaking, agreement or contract of any kind, except contracts or policies of insurance; and underwriting blanket bonds. Such obligations shall be known and treated as suretyship obligations and such business shall be known as surety business.

(b) The making of or proposing to make, as guarantor or surety, any contract of guaranty or suretyship as a vocation and not merely incidental to any other legitimate business or activity of the guarantor or surety.

Article XV part 12 of the Mortgage Foreclosure Act (735 ILCS 5/15‑1204) defines a “Guarantor” in terms that include a surety agreement:

Sec. 15‑1204. Guarantor. "Guarantor" means any person who has undertaken to pay any indebtedness or perform any obligation of a mortgagor under a mortgage or of any other person who owes payment or the performance of other obligations secured by the mortgage, which undertaking is made by a guaranty or surety agreement of any kind.

The General Definitions and Principles of Interpretation Section of the Uniform Commercial Code (810 ILCS 5/1-201(39)) settles the matter within the code by defining the two congruously:

(39) "Surety" includes a guarantor or other secondary obligor.

However, it is likely that you can still waive the provisions of this act through language in your surety/guarantee. City National Bank of Murphysboro, Il. v. Reiman, 236 Ill.App.3d 1080 (5^th Dist., 1992). You’d just want to make sure you’re doing that explicitly. And if you find yourself as a surety or guarantor, you may want to take a stab at complying with the provisions of the Act when you become aware that the entity you’ve vouched for will be running into financial troubles in the immediate future. Who knows, maybe some clever attorneys with willing clients might see if the act could be extended to other types of financial backing. 

As always, having a surety or personal guaranty gets you one step closer to an actual payment, especially in a market where shell LLCs are created and dissolved for the simplest of transactions… and being aware of this new information should help you negotiate a better deal.

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    A surety issues performance bonds to a contractor.  A third-party signs an indemnification agreement with the surety, agreeing to indemnify the surety for the payments made on the bonds.  The contractor breaches its contract for construction services and the surety pays out on the bonds.  The payments were made between 1994 and 1996.  The  surety demands payment, the third-party refuses and in 2004, the surety sues for breach of contract stating that the third-party has breached the indemnity agreement.

    That’s the start of the situation in Travelers Casualty & Surety Company v. James Bowman et al. (Ill. Sup. Ct. 2008, Doc. No. 103759).  The trial court dismissed the action of the surety, Travelers, finding that section 13-214(a) which applies a four-year statute of limitations to certain construction actions applied.  Travelers appealed and the appellate court held that the section 13-206 10 year statute of limitations applied to the action.

    For those interested, section 13-214(a) and 13-206 read in relevant part as follows and are important to anyone contracting in the construction setting as they are the statutes of limitations usually found applicable to actions arising from disputes over construction agreements:

• 13-214(a)

“Actions based upon tort, contract or otherwise against any person for an act or omission of such person in the design, planning, supervision, observation or management of construction, or construction of an improvement to real property shall be commenced within 4 years from the time the person bringing an action, or his or her privity, knew or should reasonably have known of such act or omission. Notwithstanding any other provision of law, contract actions against a surety on a payment or performance bond shall be commenced, if at all, within the same time limitation applicable to the bond principal.”

• 13-206

“[A]ctions on bonds, promissory notes, bills of exchange, written leases, written contracts, or other evidences of indebtedness in writing … shall be commenced within 10 years next after the cause of action accrued…”

    Travelers asserted in the Supreme Court that the appellate court was right and that a 10 year statute of limitations was correct since they had brought a claim for breach of contract based on the indemnity agreement with the third-party.  The third-party claimed that either the four-year statute of limitations applied, or that an even shorter two-year statute of limitations for contribution and indemnity expressed under section 13-204 applied.

     The Supreme Court agreed with Travelers.  The court noted that it is the nature of the liability to which a person is subject and not the nature of the relief sought by a party is the test for determining the character of a cause of action.  In other words no matter what an attorney might call an action, it is the underlying nature of the action and the facts of the dispute that will determine what kind of action it is.

    Here, although construction omissions had led to the payment by Travelers on the bonds, the payment on the bonds triggered obligations under the separate indemnity agreements with the third-parties and when the third-party refused to pay under the indemnity agreements, Travelers had a cause of action against them for breach of contract.

    With regard to the second theory of a two-year statute of limitations, the Supreme Court held that the third-party was incorrect in claiming that any of its cases had ever held that a two year statute of limitations would ever apply to actions based on written indemnification agreements.  The court stated that the claims of indemnity and contribution addressed under the section 13-204 addressed “cases involving the allocation of damages in connection with an underlying tort claim for injury to person or property.”  It went on to state that such a claim based on indemnity was only for “implied indemnity” (where the law offers indemnity) not for the express indemnity (where the indemnity claim is based on an agreement providing that one party will indemnify the other). 

“In sum, section 13–204 is applicable to claims for implied indemnity involving allocation of damages in connection with an underlying tort claim for injury to person or property, regardless of whether subsection (a) or (b) is at issue. Section 13–204 is not applicable to claims for express indemnification based on a written contract. Because the claim at issue is based on a breach of express indemnification provisions in a written agreement, it is subject to the10-year limitations period in section 13–206.”  Slip. Op. at 12.

The court then held that the 10 year statute of limitation applied to the indemnity agreement.

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The concept of having to obtain a surety bond shouldn't be of any new relevance to anyone doing public work.  Knowing the full extent of the provisions in the surety instrument and having a chance to properly negotiate might not seem all that important to a contractor who plans on completing its obligations.   Negotiating those terms or being aware of the full force of any personal indemnity provisions could be the difference between large-scale financial ruin and being able to get out of trouble with your reputation and bank account in tact.  On the flip-side, knowing whom you're granting surety to, and whether or not they're worth it is equally important.

The recited facts in United Fire v. Bartlett Bituminous should allow everyone to understand that the plaintiff will likely never see its money. (The defendants didn't even bother to respond to a motion for summary judgment.)  With the amount in controversy close to exceeding six million dollars, the point well taken is actually two-fold; one, sometimes you should cut your losses and know when you're sunk and two, performing research on the assets and background of the company you're dealing with is research worth doing.  A little foresight can go a long way.

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            This is an interesting decision from the Northern District, the plaintiff, a surety company paid out on bonds to subcontractors when the bank that a general had deposited the money into took the funds the general had for payment to the subs to satisfy the general's obligations to the bank.

            The surety had three theories, conversion, a claim for a trust under the mechanic's lien act, and constructive trust.  The court found that because the surety was not suing as subrogee to the general, but rather as subrogee on the funds it paid out to the subs and because it had failed to allege that the bank had knowledge that the funds were for the subcontractors none of the counts could lie.  The Court also held that the bank was not implicated or obligated under the terms of the mechanic's lien act.

            While it initially looks like the failure of the plaintiff to properly plead the facts necessary to maintain the claim resulted in the dismissal, much of the language used implied that in order to maintain the actual claims, the surety should step in as subrogee to the general and not to the sub. 

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