Surety Insurance and the Insured Event

Because surety insurance combines the characteristics of both a guarantee and insurance, it requires very special treatment in many respects.

In particular, having regard to the purpose of surety insurance, the Supreme Court has held the insurer liable for an insured event that occurred outside the policy period (Supreme Court Decision 2013Da62490, 26 November 2015). This is a highly distinctive legal principle that is found only in surety insurance.

The Supreme Court recently made a noteworthy ruling on the definition of surety insurance and on the requirements for an insured event under surety insurance.

Supreme Court Decision 2020Da248698, 25 February 2021

Facts

Company A had been awarded a construction contract. In respect of that work, Insurance Company B and Company A entered into a defect surety insurance contract with a policy period of five years, the same as the defect liability period. The issue was whether, upon expiry of the five-year policy period, a pledge securing Company B’s future right of reimbursement (recourse) against Company A was extinguished.

Summary of the Judgment

(The following is our English translation of the headnotes; it is not an official text.)

Surety insurance is a form of non-life (indemnity) insurance under which the insurer undertakes to indemnify the loss that the insured (the obligee under the principal contract) will suffer as a result of default by the policyholder (the obligor under the principal contract), who has a certain legal relationship with the insured. For the insured to exercise its right to claim insurance proceeds against the insurer, two requirements must be met: ‘the occurrence of the insured event’, namely the policyholder’s default under the principal contract, and ‘the occurrence of financial loss to the insured’ arising from that default. In other words, the insurer compensates the loss that the insured suffers because the policyholder fails to perform its obligations under the principal contract, in accordance with the policy terms and within the limit of the insured amount.

An insured event means an uncertain event that gives concrete form to the insurer’s liability to pay insurance proceeds under an insurance contract. What precisely constitutes the insured event in surety insurance must be determined by considering, as a whole, the policy terms incorporated into the contract by agreement between the parties, the insurance policy (certificate) referred to in those terms, and the specific content of the principal contract.

Where a policy period is stated in the surety insurance policy, the general rule is that the insurer is liable under the insurance contract only if the insured event occurs within that period. However, where the purpose of the surety insurance contract is to compensate loss caused by the policyholder’s failure to perform its obligation to remedy defects that arise within the defect liability period under the principal contract, and the policy period has nonetheless been set to be the same as that defect liability period, then, absent special circumstances, the surety insurance contract is properly construed as one under which the insurer agrees to be liable, as insurer, for defects arising within the policy period (that is, the defect liability period), even if the insured event occurs after the policy period has ended.

In this case, the Supreme Court held as follows. The insured event under the insurance contract means the very failure of Company A, the policyholder (the obligor under the principal contract), to perform after receiving a demand for repair or remediation of a defect that arose within the five-year policy period. It is clear from the wording of the policy terms that the policy period applies only to the occurrence of defects in the work performed by Company A, and not to Company A’s receipt of a demand for repair or remediation. Accordingly, as a rule, for a defect that arose within the policy period, Company B is also liable as insurer for that defect, within the limit of the sum insured, so long as Company A fails to perform under the principal contract, even if the demand for repair or remediation is made after the policy period has expired. While it remained undetermined in this way whether Company B would be liable as insurer, it could not be concluded that Company B’s right of reimbursement against Company A, which was the secured claim of the pledge, had been extinguished. Nevertheless, the court below concluded that the future right of reimbursement had definitively ceased to be capable of arising, and that the pledge had therefore been extinguished, merely because the defect liability period under the principal contract, which was the same as the policy period, had passed without any right being exercised. The judgment of the court below therefore contained errors, including a misapprehension of the relevant legal principles.