Successor to Bankrupt Housing Developer Must Honor Surety

By Don R. Sampen, published, Chicago Daily Law Bulletin April 23, 2019

The 2nd District Appellate Court recently held that the successor in interest to a bankrupt developer under an annexation-development agreement between the developer and the far west suburban city of Yorkville was potentially obligated to the developer’s surety upon the successor’s default under the agreement.

The case is United City of Yorkville v. Fidelity & Deposit Company of Maryland, 2019 IL App (2d) 180230 (March 20, 2019). The successor, William Ryan Homes Inc., was represented by Freeborn & Peters LLP. Schuler Roche & Crisham P.C. represented the surety, Fidelity and Deposit Company of Maryland.

The original developer that subsequently went bankrupt, Kimball Hill Inc., entered into an annexation agreement with the city in 2003. That agreement obligated Kimball Hill to build public improvements necessary to serve a residential planned development. Those obligations constituted covenants that ran with the land.

The agreement also required Kimball Hill to obtain bonds guaranteeing its performance. In February 2005, Fidelity issued four subdivision performance bonds. Each identified Fidelity as surety and Kimball Hill as principal. The bonds described the improvements that Kimball Hill agreed to undertake in two units of the subdivision.

Kimball Hill filed for voluntary reorganization under the U.S. Bankruptcy Code in 2008. The reorganization was later converted to a liquidation. As a result of the bankruptcy, William Ryan Homes and another entity, TRG Venture Two LLC, acquired lots in the development.

Subsequently, Ryan and TRG declined to complete the public improvements under the annexation agreement. Yorkville city officials then brought suit against the two entities as well as Fidelity.

The city claimed that Ryan and TRG became successors to Kimball Hill under the annexation agreement, that Fidelity became their surety and that their failure to complete the public improvements triggered Fidelity’s obligations.

As part of the litigation, Fidelity brought third-party complaints against Ryan and TRG. Fidelity’s factual allegations were consistent with those of the city’s, and, in fact, Fidelity ultimately settled with city.

As to Ryan and TRG, Fidelity alleged that they succeeded to Kimball Hill’s status as the principal obligor under the annexation agreement and surety bonds.

It further claimed that Fidelity could compel them to complete the public improvements or pay reimbursement for expenses that Fidelity incurred in completing the improvements.

The trial court dismissed both the city’s complaints and Fidelity’s third-party complaints for failure to state a claim. Those entities took this appeal. Fidelity limited its appeal to its claims against Ryan.

Analysis

In an opinion by Justice Joseph E. Birkett, the 2nd District reversed. Most of the opinion addressed the obligations under the annexation agreement as applied to Ryan and TRG.

The panel found, for example, that the agreement’s duties necessarily transferred to a successor in interest and that various exceptions for “residential occupation” did not apply to residential lots purchased for sale to third parties. He further held that the city and Fidelity properly alleged that Ryan and TRG became successor developers and that they breached the agreement by failing to finish the public improvements.

Turning to Fidelity’s claims against Ryan, Birkett drew heavily from City of Elgin v. Arch Insurance Co., et al., 2015 IL App (2d) 150013, where similar issues arose.

In that case the court explained the general obligations of a surety and noted that, even though the surety and principal obligor were liable to the party to whom the principal obligor owed performance, as between the principal obligor and the surety, it was the principal obligor who bore the primary burden to perform.

In the instant case, both the city and Fidelity alleged that Fidelity issued the performance bonds for the purpose of securing Kimball Hill’s performance as developer under the annexation agreement. According to the panel, moreover, it made no difference that successor Ryan was not a signatory to the bonds or that Fidelity was not a signatory to the agreement.

Under City of Elgin, when Ryan acquired Kimball Hill’s interests in the subdivision, a surety relationship arose by operation of law, making Ryan the principal obligor and, hence, liable to Fidelity.

Further rejecting Ryan’s argument that Fidelity lacked standing to enforce the annexation agreement due to its nonparty status, the panel said Fidelity was not directly enforcing the agreement as a party in the first place.

Rather, Fidelity was invoking its common-law right to seek relief against the principal obligor — by succession — of the duties required by the agreement.

Ryan also contended that Fidelity failed to allege a basis for indemnity against Ryan under the bonds. The panel disagreed, observing that a right to indemnity may be either express or implied. In this case, the surety bonds contained an implied promise by Kimball Hill to reimburse Fidelity for its losses. And Fidelity pleaded this implied promise as a basis for relief against Ryan.

The 2nd District, therefore, reversed the dismissal of Fidelity’s third-party claim against Ryan.

Key point

An entity that succeeds to the contract obligations owed by an obligor whose performance is guaranteed by a surety, assumes a common-law duty to indemnify the surety if the entity defaults.