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Performance Bond Surety Avoids Arbitration
Carolinas AGC Weekly Bulletin - 01/01/2004
Kenneth Lautenschlager

The Federal Court in the Eastern District of North Carolina recently held that a surety under a performance bond cannot be forced to arbitrate its "personal surety defenses" pursuant to an arbitration agreement in the general contract between the owner and general contractor. In Ocean Trail Convalescent Center, Inc. v. Travelers Casualty & Surety Company, 5: 03CV-49 (May 30, 2003, E.D.N.C.), the owner, after declaring the general contractor in default, sued the performance bond surety and moved to stay the action pending a consolidated arbitration of its claims against the surety and general contractor. The performance bond incorporated by reference the general contract, and therefore, the arbitration provision applied equally to the performance bond surety. However, the surety raised several defenses which it claimed were not subject to arbitration.

Under North Carolina law, the court must determine whether the surety had consented to arbitrate disputes with the owner. If the general contract containing the arbitration clause is incorporated by or adopted by the surety, the arbitration agreement is enforceable as to the surety. "Construction Contract-Based Defenses" which are raised by the surety would be subject to arbitration. These defenses include any of the claims which the general contractor could raise against the owner. The performance bond surety essentially asserts the general contractor's rights, and therefore, is bound to the mandatory arbitration provisions in the general contractor's contract. The performance bond surety in Ocean Trail also asserted "Personal Surety Defenses" which are not available to the general contractor. These defenses are viewed as being personal to the surety and outside the context of the construction contract. Specifically, the surety claimed that the owner: (1) made cardinal changes in the contract that increased the surety's risk, (2) made overpayments to the general contractor for work the owner now claims to be defective and (3) failed to commit the contract balance to complete the project.

The Court concluded that the arbitration clause did not compel the surety to arbitrate its "Personal Surety Defenses" as these did not arise out of or relate to the construction contract. The result may force claimants under performance bonds to simultaneously fight disputes in the civil courts and arbitration.