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Subrogation in Sureties and Guarantees

Subrogation is the substitution of one person in the place of another with reference to a lawful claim, demand, or right.  By subrogation, the substituted person succeeds to the rights of the other in relation to the debt or claim.  S/he is entitled to other person’s rights, remedies, and securities.  In finance, a surety or gurantee is a promise by one party to assume responsibility for the debt or obligation of a borrower when the borrower defaults.  The person or company that gives such promise is known as a surety or guarantor.  In the case of a principal’s failure to make payment, the surety is asked to pay the debt.  On making such a payment, the law will usually give the surety a right of subrogation.  By subrogation, a surety is allowed to step into the shoes of the principal and use the surety’s contractual rights to recover the cost of making payment.  The surety is entitled to recover the cost even in the absence of an express agreement to that effect between the surety and the principal.  When a guarantor or a surety makes good the default of his/her principal, by discharging the obligation of the principal, the surety is generally subrogated to the rights of a creditor or oblige.

Subrogation is the mode adopted by equity to compel ultimate discharge of a debt by a person, who in good conscience ought to pay the debt.  The rights of one seeking subrogation has greater equity than the rights of those who oppose him/her.  The right of a surety to subrogation exists independently of statute.  However, some statutes define the right.  They only declare the existing rules[i].  A surety is entitled to the benefit of every security for the performance of the principal obligation held by the creditor at the time of entering into the contract of suretyship.  The doctrine of subrogation is not administered by courts of equity as a legal right, but the principle is applied to achieve justice[ii].

In the case of a suretyship, the right of subrogation arises when a surety completes his/her contractual obligation.  The right is not dependent on an assignment, lien, or contract.  A subrogation right is not a security right and hence does not require conformity with the filing requirements under the Uniform Commercial Code[iii].

A surety’s right of subrogation does not exist beyond the extent necessary to reimburse itself for expenditures made in fulfilling its obligations on a surety bond.  The subrogation rights of the surety on a contractor’s performance bonds begin on the date of the execution of the bond.  To maintain a claim for equitable subrogation, a surety must take over contract of performance.  Additionally, a surety can finance the completion of the defaulted contract under the performance bond.

The right of a surety discharging the obligation of his/her principal to be subrogated depends on his/her legal status as a surety.  A compensated surety is discharged without the surety’s consent, when there has been a material modification in the creditor-debtor relationship.  The modification must substantially increase a surety’s risk.  However, no distinction in respect to subrogation can ordinarily be made between compensated and gratuitous sureties.  Even when the suretyship is one for compensation, it will not deprive the surety’s right of subrogation.  A surety who assumed a specific risk will be denied subrogation against a third party where the third party is not guilty of negligence[iv].

The doctrine of subrogation goes to the extent of giving to the surety the benefit of the rights and remedies of the creditor against all persons who were liable for the debt[v]. This is especially held to be true of the sureties of a fiduciary who are compelled to answer for his breach of trust against the fiduciary and those participating in the wrongful act[vi].  In Hall v. Windsor Sav. Bank, [vii] the court observed that “whenever the surety of a fiduciary is compelled to answer for the latter’s breach of trust, he succeeds to the rights of both the fiduciary and the cestui”.

[i] King v. Hartford Acci. & Indem. Co., 133 Cal. App. 711 (Cal. App. 1933)

[ii] Martin v. Hickenlooper, 90 Utah 150, 155 (Utah 1936)

[iii] State Bank & Trust Co. v. Insurance Co., 132 F.3d 203, 206 (5th Cir. Tex. 1997)

[iv] Meyers v. Bank of America Nat’l Trust & Sav. Asso., 11 Cal. 2d 92 (Cal. 1938)

[v] Baylies on Sureties and Guarantors, p. 358; Rooker v. Benson, 83 Ind. 250

[vi] American Bonding Co. v. National Mechanics’ Bank, 97 Md. 598, 606 (Md. 1903)

[vii] 97 Vt. 125, 134 (Vt. 1923),

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