By David A. Harris, Manier & Herod
THE DOCTRINE OF incorporation by reference is a general rule of contract law that applies when a contract expressly describes another document which is incorporated and interpreted as part of the new contract. The doctrine allows contracting parties to add or supplement their agreement by referencing a separate document and without having to add the entire text of that document to their contract.
There are no particular “magic words” to incorporate a document by reference. The incorporating agreement must make clear reference to the document and sufficiently describe the incorporated document such that its identity may be determined beyond doubt. Additionally, to be effective, the parties must have assented to and be aware of the incorporation.
There is risk to a party incorporating by reference in one agreement a document that hasn’t been reviewed. The incorporated document doesn’t need to be reviewed by the incorporating parties, so long as it’s identified and readily available for inspection. The incorporating parties may incorporate an entire separate agreement, or parts of it, and they may be parties to the separate agreement, which is incorporated, but that’s not necessary.
The practice exists to assist contracting parties in ensuring harmony between a new agreement and a prior document. And thus, it’s a common practice, especially within surety bonds. Nearly all contract bonds incorporate by reference the bonded contract. The surety wasn’t originally a party to the bonded contract and may not have had the chance to review the bonded contract. The vigilant surety will obtain and review incorporated documents prior to the execution of the bond to fully understand the risk that’s being undertaken.
1 When Does a Bond Incorporate a Contract by Reference?
For an effective “incorporation” to occur, the incorporating document, such as a bond, must contain more than a mere reference to the collateral document. To determine whether an incorporation by reference has occurred, courts will look at the language of the incorporating document to ensure it reveals an intent to be bound by the terms of the collateral document.
The phrases “is hereby incorporated by reference” or “is hereby incorporated as though fully set forth herein,” along with specific information identifying a particular document, are widely used and judicially adopted. Such terms, along with the date, amount, and a brief description of the incorporated document, such as provided in common bond forms, is sufficient.
2 What Does Incorporation by Reference Mean for a Surety?
Fundamentally, what incorporation by reference means to the surety is that to determine the terms of a performance or payment bond, courts must look to the bond and the incorporated contract. The bond and the contract will be read together and construed fairly and reasonably as a whole.
Like any contract, the polestar guiding courts in the interpretation of bond language is the intent of the parties. When the language is clear and unambiguous, the bond is to be enforced as written. The terms in the incorporated contract don’t override or modify the express language in a bond. However, when provisions of a contract appear to be in conflict, they should be reconciled and harmonized to reflect the intent of the parties.
The scope of incorporation may extend beyond the contract identified by a bond. The doctrine has been furthered in the context of “chain[s] of incorporation.” Meaning, courts have held that contract terms in a prime contract were enforceable against a surety because the surety bond incorporated a subcontract which incorporated the prime contract.
The majority of these “chain of incorporation” cases relate to the enforcement of arbitration provisions, and the courts generally note the strong federal policy favoring arbitration agreements when holding the arbitration clause was enforceable. However, courts vary on whether arbitration provisions are enforceable even when there is one link (i.e., an arbitration provision within the contract identified and incorporating into a bond).
3 Application of Incorporation by Reference to Specific Clauses
Courts vary on enforcing terms from an incorporated contract against a surety. The following provides a review of courts’ treatment of specific contract clauses and demonstrates the limits of the doctrine.
i. Arbitration Provisions
The majority view is that a surety is bound to an arbitration contained in the bonded contract provision by virtue of the bond’s incorporation of the contract containing the arbitration clause. A minority view, represented by a decision of the Eighth Circuit, applying North Dakota law, holds that a surety cannot compel arbitration, or be compelled to arbitrate, pursuant to an arbitration provision contained in the bonded contract incorporated by reference in its performance bond.1
Specifically focusing on the incorporation clause, the Eighth Circuit determined that the bond’s incorporation clause didn’t clearly reflect a mutual intent to compel arbitration of all disputes between the surety and the obligee but instead had the mere obvious purpose of clarifying the extent of the surety’s liability to the obligee.
The extent of a surety’s rights as a non-signatory to an arbitration provision also varies depending on the jurisdiction. For example, courts within the Eleventh Circuit have extended the general incorporation by reference doctrine to hold that sureties may also have the right to compel a party to participate in arbitration.2
ii. Default Provisions
Many bonds, including the AIA A312 Performance Bond, provide that notice of the principal’s default is a condition precedent to the surety’s obligation under the bond. Specific cure requirements may also be included in the performance bond, as well as the requirement that the obligee terminate the bonded contract. These bond provisions are rarely the same as the default provisions contained in the bonded contract. The bonded contract may, for example, allow the obligee to take action and incur costs without termination of the bonded contract. Other differences may include different cure time periods within the bonded contract than the performance bond.
As to the definition of a default, courts will often look to the incorporated bonded contract to determine what constitutes a default. Once the principal’s default has been determined, any specific provisions contained in the performance bond, such as the conditions’ precedent in the AIA A312 Performance Bond, will apply. Where the performance bond doesn’t expressly require any particular process to declare a default or cure provision, the terms of the bonded contract will control.
iii. Damages
The types of damages that an obligee may recover from a surety often becomes a point of contention. Delay damages can be especially contentious, leading to costly disputes. Under basic surety law, a surety’s obligations cannot be more burdensome than those of its principal. But also, a surety’s liability for damages is limited by the terms of the performance bond. Thus, what’s recoverable under the bonded contract is the outer limit of the surety’s potential liability, but that may be restricted further by limits contained in the performance bond.
Specificity in the performance bond is key. For example, where the bond language obligates the surety to cover costs of completion and “other costs and damages,” some courts have held the surety was responsible for delay damages outlined in the incorporated contract.3
Courts vary when it comes to an award of delay damages depending upon whether bond incorporated the underlying contract. However, all cases have a common thread, which is the consideration of the true purpose and intent of the performance bond. Absent clear limiting language in the bond, a surety’s best defense to an award of additional damages outlined in the underlying contract is to specify the purpose of the bond and the intended scope of the guarantee.
4 Conclusion
The incorporation by reference clause is the primary vehicle by which the surety’s liability to the obligee becomes coextensive with that of the principal. However, incorporation by reference of the bonded contract doesn’t rewrite the performance bond. Courts have recognized the surety’s liability is limited by the purpose and terms of the performance bond; the surety’s liability shouldn’t be extended beyond that purpose.
The reading together of the explicit terms of the performance bond, and those incorporated by reference from the bonded contract, can lead to areas of dispute with the obligee. A thorough review of the bonded contract before execution of the performance bond can assist the surety with mitigating its risk related to onerous contract terms.
About the author:
David A. Harris is a shareholder at Manier & Herod (https://www.manierherod.com/), with a practice concentrated on representing sureties in Georgia, North Carolina, and South Carolina. Harris has experience in providing full-service surety representation, including claim investigations, indemnity and subrogation rights, payment and performance bond disputes, commercial and miscellaneous bonds, fidelity bonds, fraudulent transfer claims, and creditor rights in bankruptcy. Harris serves on the NASBP Attorney Advisory Council. He can be reached at dharris@manierherod.com or 770.905.8074.
This article was originally published as a NASBP Surety Bond Quarterly article, and is republished with the permission of NASBP and the author.
End Notes
- See AgGrow Oils, L.L.C. v. National Union Fire Insurance Co., 242 F.3d 777, 780-781, 782 (8th Cir. 2001).
- See Berkman Plaza 2, LLC v. Fidelity & Deposit Company of Maryland, 2009 WL 10671363, at ∗2 (N.D. Ga. July 31, 2009); Firemen’s Insurance Co. v. Edgewater Beach Owner’s Association, 1996 WL 509720, at ∗3 (N.D. Fla. June 25, 1996).
- Cates Construction, Inc. v. Talbot Partners, 980 P.2d 407, 415 (Cal. 1997); National Fire Insurance Co. v. Fortune Construction Co., 320 F.3d 1260, 1274 (11th Cir. 2003).
