A recent Illinois Supreme Court decision has called into question the extent to which a subdivision bond surety is bound beyond the terms of its bond when the subdivision development qualifies as a public work under Illinois law. Throughout the United States, local and state governments frequently rely on specific statutory framework for enhanced community planning, coordinating the standards for public roads, right of ways, infrastructure, utilities and other similar improvements. The sources for the developer’s project-specific obligations are subdivision development agreements, local ordinances and regulations, and state law.
Subdivision bonds have long been utilized to secure the performance of the developer’s statutory obligations with respect to the required improvements. In most instances, the subdivision bond is akin to a performance bond and does not provide security for the developer’s payment obligations to subcontractors and suppliers. Of course, there are fundamental distinctions between subdivision bonds and performance bonds with the most noteworthy being the typically broader scope of coverage for performance bonds. But the two bonds share similarities in the security provided to the obligee for the developer’s faithful performance of the required improvements.
Suretyship is a contractual relationship, and the majority rule throughout the country is that interpretation of the subdivision bond is subject to the canons of contractual interpretation. As such, subdivision bonds are subject to enforcement according to their terms, applying an ordinary and plain meaning to those terms. However, if the bond is required by statute, the bond will be subject to the minimum levels of coverage and security required in the applicable statute. It is precisely this interplay between bond terms and applicable statute which led to the Illinois Supreme Court’s expansive ruling concerning a subdivision bond in Lake County Grading Co., LLC v. Village of Antioch.
Much like the majority of other states and the federal government, Illinois has enacted a Public Construction Bond Act (“Illinois Bond Act”) to govern the bonding requirements for public works projects. Specifically, the Illinois Bond Act mandates that all public entities contracting for public construction work over $50,000 require the general contractor to obtain “a bond” to secure the contractor’s performance and payment obligations on the project. See 30 ILCS 550/1 (2014).
Regardless of the language expressed in the bond (or even the intentions of the parties), the Illinois Supreme Court recently held that a bond obtained pursuant to the Illinois Bond Act is deemed as a matter of law to contain both performance and payment provisions. This interpretation of the statutory language arguably imposes a sweeping and broadening effect on a surety’s liability on bonds issued for public works projects in Illinois. Because of the potentially broadening effect on the surety’s obligations and the rights of contractors, sureties should be aware of this recent opinion and its potential ramifications.
The 2014 Lake County Grading Decision
In Lake County Grading Co., LLC v. Village of Antioch, 19 N.E.3d 615 (Ill. 2014), a subdivision developer, Neumann Homes, Inc. (“Neumann”) entered into two infrastructure agreements (“Agreements”) to make certain public improvements on two separate subdivisions located in the Village of Antioch, Illinois (“Village”). Although the court did not elaborate on the nature of the improvements, it stated that they were for the Village’s benefit. The court did not address how or by whom the development was funded.
Pursuant to the Agreements, Neumann was required to obtain surety bonds in the amount of the total cost of the public improvements. Neumann, as principal, obtained the required surety bonds for the benefit of the Village, as obligee. Each bond provided in relevant part:
[The P]rincipal [Neumann] shall perform and complete * * * improvement(s) to * * * development in accordance with either the plan(s)/specification(s)/agreement * * * then this obligation shall be void * * *. This bond will terminate upon written acceptance of the improvements by the obligee [Village] to the principal [Neumann] and/or surety [Fidelity & Deposit Company of Maryland].
(Emphasis added). Throughout the litigation, it was undisputed that the bonds did not contain any specific “payment bond” language which guaranteed payment to the subcontractors who performed labor or provided materials.
Neumann entered into an agreement with Lake County Grading Company, LLC (“Lake County Grading”), to perform certain grading work required under the Agreements. Lake County Grading completed its work but was not paid in full. Subsequently, Neumann defaulted on the Agreements with the Village and declared bankruptcy. Lake County Grading served Neumann and the Village with notices of a lien claim against public funds pursuant to 770 ILCS 60/23 and notices of a bond claim pursuant to 30 ILCS 550/1, 2.
Lake County Grading eventually filed a five-count amended complaint against the Village seeking to recover payment. Counts I and III were lien claims for public funds and count V was a claim for unjust enrichment. These counts were ultimately dismissed and not part of the appeals. Counts II and IV, the only counts at issue, alleged third-party-beneficiary breach of contract against the Village for work Lake County Grading performed on the two subdivisions. Specifically, Lake County Grading alleged that the Village breached its contract with Neumann because the Village failed to require that surety bonds obtained by Neumann contain sufficient payment bond language for the benefit of the subcontractors as mandated under Section 1 of the Illinois Bond Act. The Village denied liability, countering that Section 1 of the Illinois Bond Act mandated that both performance and payment provisions were impliedly written into the bond as a matter of law. The Village argued that Lake County Grading’s claim was barred because Lake County Grading failed to give notice within the statutorily required period for a payment bond claim under the Act. Lake County Grading did not dispute that it made notices of claims outside the statutory time limit for payment claims but argued that such limitations are only applicable to a suit on the bond and since no payment bond was procured a suit on the bond was not available.
The trial court agreed with Lake County Grading on this issue and the appellate court affirmed. The lower courts reasoned that the language found in Section 1 of the Illinois Bond Act – deeming the bond to contain both performance and payment provisions – only applies after the public entity satisfies the predicate condition of requiring the general contractor to obtain the payment bond.
On appeal, the Illinois Supreme Court first turned its attention to the interpretation of the Illinois Bond Act. Section 1 of the Illinois Bond Act provides, in relevant part:
Except as otherwise provided by this Act, all officials, boards, commissions, or agents of this State, or of any political subdivision thereof, in making contracts for public work of any kind costing over $50,000 to be performed for the State, or of any political subdivision thereof, shall require every contractor for the work to furnish, supply and deliver a bond . . . . The amount of the bond shall be fixed by the officials, boards, commissions, commissioners or agents, and the bond, among other conditions, shall be conditioned for the completion of the contract, for the payment of material used in the work and for all labor performed in the work, whether by subcontractor or otherwise.
* * *
Each such bond is deemed to contain the following provisions whether such provisions are inserted in such bond or not:
The principal and sureties on this bond agree that all the undertakings, covenants, terms, conditions and agreements of the contract or contracts entered into between the principal and the State or any political subdivision thereof will be performed and fulfilled and to pay all persons, firms and corporations having contracts with the principal or with subcontractors, all just claims due them under the provisions of such contracts for labor performed or materials furnished in the performance of the contract on account of which this bond is given, when such claims are not satisfied out of the contract price of the contract on account of which this bond is given, after final settlement between the officer, board, commission or agent of the State or of any political subdivision thereof and the principal has been made.
30 ILCS 550/1 (Emphasis added). Section 2 then provides that there is no right of action under the Illinois Bond Act unless the claimant files a verified notice of claim within 180 days after the date of the last item of work or the furnishing of the last item of materials.
The court reasoned that the plain language of Section 1 mandated the procurement of “a bond” which was “deemed to contain” both performance and payment provisions “whether such provisions are inserted in such bond or not.” It noted that the paragraph did not require the procurement of a performance and payment bond, just “a bond.” The court also highlighted that the statute stated the amount of “the bond” is to be fixed by the public official and “the bond” is conditioned upon the completion of the contract and the payment of labor and materials. It ultimately held that:
[R]egardless of the actual language contained in a public construction bond procured in accordance with section 1, the legislature has unambiguously provided all such bonds are deemed to contain both completion and payment provisions as a matter of law. Simply put, we cannot envision a clearer indication of legislative intent concerning the question before us than the language contained in paragraph three that “[e]ach such bond is deemed to contain the following [payment and completion] provisions whether such provisions are inserted in such bond or not.”
The dissent disagreed with the majority’s interpretation of Section 1, stating that it contradicted the plain language of the statute, as well as its purpose and history. The dissent also reasoned that the majority’s opinion and interpretation is contrary to the common sense application of the statute and creates confusion with regard to the issuance of future public construction bonds.
The dissent first noted that the third paragraph of the statute begins with the clause “[e]ach such bond is deemed to contain the following provisions whether such provisions are inserted into the bond or not.” (Emphasis added). It reasoned that the phrase “[e]ach such bond” refers back to the type of bond previously described in the first paragraph; i.e., bonds conditioned for the completion of the project and the payment of labor and materials. Following that phrase is specific language that provides that the surety is obligated to guarantee completion of the project and payment to subcontractors. The dissent reasoned that in order to avoid rendering portions of the statute meaningless or redundant, the third paragraph must be interpreted as simply clarifying the obligations of the surety in cases where the wording of a bond itself may be ambiguous. The dissent stated that the clarifying language of the third paragraph cannot be interpreted as altering or changing the nature of the bond procured between the parties because this could lead to absurd and unjust results. The dissent further noted that the purpose of the Illinois Bond Act is, in part, to protect the subcontractors, and to adopt the majority’s interpretation runs contrary to that purpose. In order to further the purpose of the Illinois Bond Act, a subcontractor should be able to file suit against a public entity for failing to ensure the proper procurement of a bond that guarantees for the completion of the project and the payment of labor and materials.
Unfortunately, the court never clearly discussed how the subdivision development project in this case qualified as a public works project subject to the Illinois Bond Act. Certainly, by its own terms, the Illinois Bond Act requires that the owner enter into a “contract for public work of any kind costing over $50,000.” There is legal authority in Illinois which supports the argument that this requires not only public ownership of the land being developed, but also the use of public funds to pay for the contract improvements. For example, development of private land which is subsequently dedicated to the public for public use gives rise to private lien rights in Illinois as opposed to rights to assert a claim against public funds. However, the court in Lake County Grading did not clearly articulate the standard for determining what constitutes a “public work” subject to this Act.
The Practical Impact Of Lake County Grading On Subdivision Bonds Issued For Public Works Projects In Illinois
In Lake County Grading, the Village did not require the contractor to obtain a performance and payment bond but only a bond to secure faithful performance of the improvements. Thus, it was the intention of the parties and the understanding of the surety that the bond would only obligate the surety to complete the project if the contractor failed to do so. In Lake County Grading, there is no indication that the parties ever intended to furnish a payment bond to guarantee payment to the subcontractors. Nevertheless, the court’s ruling was that every bond subject to Section 1 of the Illinois Bond Act is deemed to contain such language regardless of the nature of the bond that has actually been obtained.
This ruling is noteworthy for sureties because it arguably could drastically expand their obligations under traditional subdivision bonds when a project is subject to the Illinois Bond Act. Despite the unambiguous language in a bond and the intent of the parties, a surety could potentially be held liable for payment obligations it never contemplated on outstanding subdivision bonds in Illinois. Of course, the court’s opinion is silent concerning the implication of payment provisions in instances where a surety furnishes both a performance and a payment bond for a project. In such a case, the court’s opinion could lead to unintended results if taken to its logical end. Moreover, the court’s opinion does not extend to privately owned projects.
In Illinois, sureties are now confronted with the possibility of having issued subdivision bonds with the expectation of liability being limited to performance guarantees in the bond only to learn later that, due to the Illinois Bond Act, the bond is subject to the broader guarantee of securing payment obligations as well. This drastic change to the surety’s expectations concerning its voluntary undertaking deserves attention at both the underwriting and claims levels to monitor and determine risk on existing and future subdivision bonds. Additionally, Lake County Grading is already inviting claims by opportunistic claimants against performance bonds with more favorable terms, leaving substantial ground for argument on a case-by-case basis over the applicability of the Bond Act and the reach of the court’s opinion. It is necessary for the court to provide much needed clarity to its sweeping generalization and ruling in Lake County Grading in order to lend predictability to the industry and avoid unjust outcomes.