A hotel owner, Five Star Lodging, Inc., contracted with George Construction, LLC to build a hotel in Georgetown, Kentucky. The owner’s contract required George Construction to obtain a performance and payment bond. George Construction obtained the bond from the surety, Lyndon Property Insurance Company, as principal and in favor of Five Star Lodging, as obligee. The bond expressly stated that no lawsuit or other legal proceeding could be brought against the surety unless it was commenced within two years from the earlier of the date of the completion of the construction contract or the date of beneficial use or occupancy by Five Star Lodging. The bond also required written notice to the surety’s home office.

Construction commenced. On August 31, 2000, a certificate of occupancy was issued. The certificate of substantial completion was effective August 28, 2000. Guests were lodged in the hotel as early as June 2000.

Five Star was dissatisfied with the hotel construction and by June 2001 notified both George Construction and the surety of its dissatisfaction. The surety expressly notified George Construction of the two year provision in the bond to bring suit against the surety.

In May 2002, Five Star sued George Construction; the litigation was stayed for arbitration but in February 2007, a default judgment was granted Five Star against George Construction. On March 1, 2007, Five Star amended its complaint against George Construction to add the surety. The surety moved for summary judgment, arguing that Five Star’s occupancy of the hotel by at least August 2000 rendered the lawsuit time-barred as suit had to be filed against the surety, and not just the general contractor, by August 2002. The Fayette Circuit Court agreed and summary judgment was granted.

On appeal, Five Star argued that notice was timely provided to the surety and that the default judgment against George Construction, as contractor, legally barred the surety from arguing any time limit. The trial court and then on appeal, the appellate court, both agreed that the terms of the bond were unambiguous and there was no disputed material issue of fact regarding the date of completion of the hotel. Therefore as a matter of law, the lawsuit against the surety was time-barred.

Both the trial and appellate courts rejected the argument that the hotel owner was not a party to the bond agreement and therefore not bound by the time limitation. The hotel owner was a third party beneficiary of the contract and therefore bound by the terms of the bond agreement. Five Star could have objected to the two year suit limitation and required George Construction to obtain a performance and payment bond without the two year time limitation in which suit could be asserted against the surety. Once First Star accepted the bond upon execution of the construction contract with George Construction, the hotel owner was bound by its terms.

Furthermore, default judgment had no legal affect on the issue of the suit time limitation. A default judgment entered against the principal is not binding on a surety and the surety may continue to defend, asserting any argument it has to the original lawsuit. The cause of action against George Construction for breach of the construction contract and negligent construction is distinct from the claim asserted against the bond. A default judgment is not a judgment on the merits.

As a result, the claims against the surety were rejected and dismissed even though the appellate court recognized that the outcome was “harsh.”