Successor To Principal On Surety Bond Has Duty To Make Good To The Surety

January 6, 2016 / Writing and Speaking

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

The successor, TRG Venture Two LLC, was represented by Duane, Morris LLP. Riordan, McKee & Piper LLC represented the surety, Fidelity and Deposit Company of Maryland. The case is City of Elgin v. Arch Insurance Co., et al., 2015 IL App (2d) 150013 (Dec. 10, 2015).

The original developer that subsequently went bankrupt, Kimball Hill Inc., entered into an annexation agreement with Elgin in 2003. That agreement obligated Kimball 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 to obtain bonds guaranteeing its performance. It obtained bonds from two insurers, with six having been issued by Fidelity securing various aspects of the work, in the total amount of $1.4 million.

After making some of the improvements and selling some homes to individual buyers, Kimball declared bankruptcy in 2008. In 2010, TRG purchased Kimball’s interest in the development but refused to make the remaining improvements. The city sued TRG and the two performance bond companies, including Fidelity.

Fidelity answered and filed a counterclaim against TRG alleging that it had an obligation to repay to Fidelity any amounts that Fidelity was required to pay the city to complete the project.

Following various dispositive motions, the trial court held that Kimball was released from its obligations under the annexation agreement due to the sale of the property to TRG; that the city therefore could not proceed against the sureties under the agreement; and that the surety bonds, however, were separate contracts that were enforceable by the city.

The trial court further held that although TRG was bound by the agreement, the city’s claim against it would be dismissed because of the failure to name indispensable parties, and the court concluded that Fidelity’s counterclaim against TRG would be dismissed under 735 ILCS 5/2-615, apparently on the ground that Fidelity had no contractual relationship with TRG.

Fidelity brought this appeal from the latter holding, namely, the order dismissing its counterclaim.

Duty To Surety

In an opinion by Justice Mary Seminara Schostok, the 2nd District reversed in part. She initially described generally the obligations of a surety and observed that, while both surety and principal may be obligated to the “obligee,” here, the city, as between the surety and principal, the principal should bear the cost of performance.

TRG primarily contended that as the alleged principal on Fidelity’s counterclaim, it had no obligation to Fidelity because it had no contract with Fidelity and that, even if it was bound by the requirements of the annexation agreement, Fidelity was not a party to that agreement.

Schostok disagreed. She found that, with TRG having acquired the obligations of Kimball under the annexation agreement, the suretyship relationship with Fidelity arose by operation of law. She further noted that the Fidelity bonds conferred a direct benefit on both Elgin and TRG. Thus, the mere fact that TRG was not in direct privity with Fidelity, or that the bonds were issued subsequent to the agreement, would not defeat Fidelity’s claim.

She applied this logic to the two counts of Fidelity’s counterclaim that were dismissed for failure to state a claim. In one of the counts, Fidelity sought recovery on an indemnity-reimbursement theory. Schostok found that TRG owed Fidelity a common law duty to hold Fidelity harmless from TRG’s failure to perform its obligations under the annexation agreement.

Similarly, with respect to the second count based on unjust enrichment, she found that Fidelity adequately alleged that TRG obtained the benefit of the improvements for which Fidelity was required to pay through TRG’s wrongful conduct in refusing to perform its obligations. These two counts, therefore, should not have been dismissed.

Necessary Parties

TRG also argued that the counterclaim was properly dismissed because Fidelity did not name all the necessary parties, in particular, that it did not name as counter-defendants the individuals who had bought homes in the development. According to TRG, these homeowners, which purchased from Kimball, were also liable under the theories asserted by Fidelity and the litigation should not proceed without them.

In response, Schostok observed that Section 2-615(a) contemplates appropriate relief where, among other circumstances, necessary parties need to be added. In this instance, however, TRG did not seek the addition of necessary parties but only outright dismissal. The court, moreover, in evaluating the relief sought, was limited to the facts pleaded on the face of the complaint.

Schostok found that the necessity of homeowners as parties was not evident from the allegations of the counterclaim. In addition, the annexation agreement did not impose upon individual purchasers all of the obligations of the developer, but only the obligations for the individual parcels sold. If Kimball had fulfilled its obligations as to a particular parcel prior to sale, then the purchaser would have no further obligation.

Ultimately, Schostok said that some homeowners may be necessary parties, but that the record was insufficient to make that determination. Under these circumstances dismissal was not warranted.

The court, therefore, affirmed dismissal of certain counts of Fidelity’s counter-complaint on the ground of mootness, but reversed the dismissal of the indemnity-reimbursement and unjust enrichment counts and remanded.

Key Points

  • A contractor 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 contractor defaults.
  • A complaint should not be dismissed under Section 2-615 for failure to name a necessary party unless the face of the complaint evidences the absence of the necessary party.
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