COMPLY WITH THE CONDITIONS OF THE PERFORMANCE BOND

Posted on April 19, 2020April 19, 2020 by Edward Garber

If you are bargaining for a contracting party to obtain a performance bond, it is imperative that you honor the conditions precedent to the bond in the event you need to trigger the bond’s obligations. If you do not, then you will breach the terms of the performance bond and lose the benefit of the bond. This is definitely NOT what you want because if you are looking to the performance bond than you are dealing with the default of its bond-principal and an incurred or anticipated loss. This is particularly true if dealing with an AIA performance bond form where the surety can rely on good case law that failing to comply with the conditions of the bond discharges the obligations under the bond.

To exemplify, in a recent opinion out of the District of Columbia Circuit, Western Surety Co. v. U.S. Engineering Construction, LLC, 2020 WL 1684040, (D.C. Cir. 2020), a performance bond surety filed a lawsuit seeking declaratory relief that it had no liability under the bond because the obligee failed to comply with a condition precedent to trigger the bond’s obligations.

In this case, a subcontractor hired a sheet metal subcontractor. The sheet metal subcontractor (principal of bond) obtained an AIA A312 performance bond for the subcontractor (obligee of bond). During construction, the prime contractor notified its subcontractor that it was causing delays. The delays were caused by the sheet metal subcontractor. The subcontractor, in turn, notified its sheet metal subcontractor that it had 72 hours to cure. The sheet metal subcontractor did not cure and the subcontractor formally terminated its sheet metal subcontractor. Prior to the termination, the subcontractor did NOT notify the surety that it was considering declaring the sheet metal subcontractor in default and terminating the subcontract. In fact, the surety was not notified of the default termination until the subcontractor sent a claim under the bond to the surety many months after the sheet metal subcontractor was terminated.

Notably, section 3.1 of the AIA performance bond required the obligee (subcontractor) to notify the principal (sheet metal subcontractor) and surety that it was considering declaring the principal in default. Section 4 excused the failure to do this except if the surety demonstrated actual prejudice by the lack of notice. Section 3.2, however, required the obligee, if ending the relationship with the principal, to declare the principal in default, terminate the contract, and notify the surety. Section 3.3 provided that the obligee must agree to provide the balance of the contract price to the surety or to a contractor selected to perform the contract. Section 5 provided that when the obligee satisfies the conditions of section 3, the surety shall promptly and at its expense take one of the actions in sections 5.1 through 5.4.

The subcontractor-obligee failed to comply with any of the obligations in the bond, which resulted in a harsh outcome to the subcontractor:

The A312 bond at issue in this case states that, in order to trigger Western Surety’s [surety] obligations under the bond, U.S. Engineering [subcontractor-obligee] must declare a United Sheet Metal [sheet metal subcontractor-principal] default, terminate the subcontract, and notify Western Surety. Similar to the A311 [AIA performance] bond, the A312 [performance] bond provides four alternative methods by which the surety can respond to the default [per Section 5 of the bond]. By unilaterally completing United Sheet Metal’s remaining contract obligations before notifying Western Surety [per Section 3.2 of the performance bond], U.S. Engineering deprived Western Surety of its contractually agreed-upon opportunity to participate in remedying United Sheet Metal’s default [per Section 5 of the bond].

In other words, despite the bond’s lack of an explicit timely notice requirement [as to when the surety must be notified of the default and termination], the performance bond is properly read as requiring U.S. Engineering to notify Western Surety of the default before engaging in self-help remedies. Otherwise, “the explicit grant to the surety of a right to remedy the default itself would be operative only if the obligee chose to give it notice,” thereby rendering the options in section 5 “nearly meaningless.” Accordingly, because the bond expressly provides the surety with the opportunity to participate incurring the subcontractor’s default, we hold that it is a condition precedent to the surety’s obligations under the bond that the owner must provide timely notice to the surety of any default and termination before it elects to remedy that default on its own terms. In light of U.S. Engineering’s failure to provide such timely notice, Western Surety was not obligated to perform under the bond.

Western Surety Co., 2020 WL at *4.

The morale is that if you are bargaining for a performance bond, do not neglect to comply with the very bond conditions you need if defaulting and terminating the principal of the bond. Otherwise, you may wind up with a similar harsh result, as the subcontractor did in this case by looking to the surety many months after it default terminated the bond-principal, and started remediating the default.

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

PERFORMANCE BOND SURETY’S EQUITABLE SUBROGATION CLAIM AGAINST OWNER

Posted on February 29, 2020February 29, 2020 by Edward Garber

There are circumstances where a performance bond surety will pursue a claim against an owner – such as a government owner—and assert an equitable subrogation claim. A performance bond surety may assert an equitable subrogation claim to recover contract funds that are still in the government’s control after the contract is completed or to recover from the government when the government improperly disburses progress payments to the defaulted contractor (principal of the performance bond). Capitol Indemnity Corp. v. U.S., 2020 WL 877687, n.7 (Fed.Cl. 2020). As to the improper disbursement of progress payments, a performance bond surety is asserting a claim against the owner in this fashion when it has had to pay under the bond and believes certain rights of it were prejudiced based on improper payments by the owner — it would have had to pay less based on the contractors’ default had the owner not impermissibly paid the defaulted contractor.

[A]n equitable subrogation claim is based on the theory “that the triggering of a surety’s bond obligation gives rise to an implied assignment of rights by operation of law whereby the surety ‘is subrogated to the [principal obligor’s] property rights in the contract balance.’ ” “[A] legally enforceableduty can arise between the government and a surety if the surety notifies the government that its principal is in default of the bond agreement.” Thecourt in a case affirmed by the Federal Circuit has also recognized that notice to the government that the contractor “is in danger of defaulting under the bond” from other sources besides the surety may be adequate to trigger the assignment of rights to the surety. Finally, a surety’s equitable subrogation rights can be triggered where the government “had knowledge of the default … and so informed the surety.”

Capitol Indemnity Corp., supra, at *7 (internal citations omitted).

An example of a performance bond surety asserting an equitable subrogation claim against the government can be found in Capitol Indemnity Corp. Here, a contractor was hired to renovate a building and complete the renovation by September 30, 2015. After numerous letters to the contractor including cure notices relating to non-conforming work, on December 30, 2015, the government notified the contractor’s performance bond surety that the contractor’s work was not complete and the surety should be receiving payment bond claims from unpaid subcontractors. A few days later, the government suspended the contract and copied the surety. The surety claims that after this date, the government impermissibly made payment to the contractor even though the surety requested any such payment to the contractor be in the form of joint checks to the contractor and corresponding subcontractor. A couple of months later, in March 2016, the government declared the contractor in default. The surety entered into a takeover agreement with the government to complete the defaulted contractor’s work, which reserved certain rights of the surety to pursue claims against the government.

Around the time the takeover work was complete, the surety sued the government. One of the arguments the surety raised was equitable subrogation as to impermissible payments the government made to the contractor. Stated differently, the surety claimed that the government abused its discretion (and prejudiced the surety) in making payment to the contractor when it knew the contractor was in default. The government moved to dismiss the surety’s equitable subrogation claim.

Initially, as to a jurisdictional argument, the US Court of Federal Claims held that the surety can sue the government in equitable subrogation without having to first raise this issue to the contracting officer through submitting a claim under the Contract Disputes Act.

Next, the US Court of Federal Claims found that the alleged facts raised by the surety as to payment to the contractor shortly before the contractor was defaulted was enough to trigger a surety’s equitable subrogation claim against the government. The surety raised facts to support that its equitable subrogation rights were triggered on December 30, 2015 when (i) the government notified the surety that the contractor’s work was not complete and the surety should expect to receive payment bond claims, (ii) the government then suspended the contractor’s performance a few days later, (iii) the surety requested that the government issue joint checks to the contractor and unpaid subcontractors, and (iv) the government refused to issue joint checks and paid the contractor directly only to default the contractor a couple of months later. The direct payment to the contractor was an impermissible payment, and through equitable subrogation, the government may owe the surety the amount of that payment irrespective of the fact that the government already paid that amount to the defaulted contractor.

PERFORMANCE BOND SURETY TAKEOVER – USING TERMINATED CONTRACTOR TO COMPLETE THE WORK

Posted on October 5, 2019October 5, 2019 by Edward Garber

When a contractor is defaulted under a performance bond, can its surety hire the same defaulted contractor to complete the work? Stated differently, can the performance bond surety engage its defaulted bond-principal in taking over and completing the same work the contractor was defaulted under? The answer is “yes” if you are dealing with a standard form AIA A312 performance bond (and other bond forms that contain analogous language), as demonstrated by the recent decision in Seawatch at Marathon Condominium Association, Inc. v. The Guarantee Company of North America, 2019 WL 4850194 (Fla. 3d DCA 2019).

In this case, a condominium association hired a contractor in a multi-million dollar contract to renovate condominium buildings. The contractor provided the association, as the obligee, a performance bond written on an AIA A312 performance bond form. During construction, the association declared the contractor in default and terminated the contractor. In doing so, the association demanded that the performance bond surety make an election under paragraph 4 of the AIA A312 bond form that gave the surety the following options:

4.1 Arrange for the CONTRACTOR, with consent of the OWNER, to perform and complete the Contract; or

4.2 Undertake to perform and complete the Contract itself, through its agents or through independent contractors; or

4.3 Obtain bids or negotiated proposals from qualified contractors acceptable to the OWNER for a contract for performance and completion of the Contract, arrange for a contract to be prepared for execution by the OWNER and the contractor selected with the OWNER’S concurrence, to be secured with performance and payment bonds executed by a qualified surety equivalent to the Bonds Issued on the Contract, and pay to the OWNER the amount of damages as described in paragraph 6 in excess of the Balance of the Contract Price incurred by the OWNER resulting from the CONTRACTOR Default; or

4.4 Waive its right to perform and complete, arrange for completion, or obtain a new contractor and with reasonable promptness under the circumstances;

4.4.1 After investigation, determine the amount for which it may be liable to the OWNER and, as soon as practicable after the amount is determined, tender payment therefore to the OWNER; or

4.4.2 Deny liability in whole or in part and notify the OWNER citing reasons therefore.

Seawatch at Marathon Condo. Ass’n, 2019 WL at *1-2.

The surety elected the option under section 4.2, underlined and bolded above. The surety wanted to complete the construction contract and provided the association with a surety takeover agreement, i.e., an agreement where the surety takes over the completion of the defaulted / terminated contractor’s contract. The takeover agreement was predicated on the terminated contractor continuing to serve as the contractor to finish the contract.

The association rejected the takeover agreement largely because it was adamant that the terminated contractor cannot serve as the completion contractor under the takeover agreement. The association also argued that the surety could not properly elect section 4.2 because it was not a licensed contractor and needed to be a licensed contractor in order to undertake the completion of the defaulted contract. Because an agreement could not be reached, the association filed a lawsuit for declaratory relief on these issues seeking judicial intervention as to its rights under the performance bond.

A. The Performance Bond Surety Can Use the Defaulted Contractor to Complete the Work

The trial court, as affirmed on appeal, held that the surety was well within its rights under section 4.2 of the bond to complete the contract with the defaulted contractor (bond-principal). Section 4.2 places NO restrictions on the surety in using the defaulted contractor or any other contractor, for that matter. As noted by the appellate court:

Finally, “[i]t is common practice for a surety undertaking to complete the project itself to hire the original contractor, as [Guarantee] elected to do here.” “By completing the project itself, the surety obtains greater control than it would have had if it elected to require the obligee to complete, because the surety can select the completing contractor or consultants to finish the project as well as control the costs of completion.”

Seawatch at Marathon Condo. Ass’n, 2019 WL at *4 (internal quotations omitted).

B. The Performance Bond Surety Does Not Need to be a Licensed Contractor to Enter into Takeover Agreement

The appellate court summarily rejected the argument by the association that the surety needed to be a licensed contractor to enter into a takeover agreement and undertake the completion of the defaulted contract. Since the surety is not actually performing the completion, the court rejected this outright which would prohibit the surety from ever exercising rights under section 4.2 unless it was a licensed contractor.

One thing to consider after reading the outcome of the case is that there is nothing to prevent the obligee of a bond from modifying a standard form bond form, or my preference, creating its own manuscript performance bond form. Creating your own performance bond form gives you more flexibility regarding rights to trigger a surety’s obligations under the bond and the recourse under the bond.

QUICK NOTE: CONTRACTOR’S STATUTORY BASIS TO RECOVER ATTORNEY’S FEES AGAINST PERFORMANCE BOND

Posted on May 24, 2019April 24, 2020 by Edward Garber

On October 1, 2019, a modification to existing law (Florida Statute s. 627.756) will take place that allows general contractors to have a statutory basis to recover attorney’s fees against its subcontractor’s performance bond. (Obviously, the subcontractor will need to be properly defaulted pursuant to the terms of the performance bond and incorporated subcontract.) Now, while some manuscript subcontractor performance bonds already give the general contractor a contractual right to recover attorney’s fees against the performance bond, this right will also exist by statute for performance bonds issued on or after October 1, 2019. This modification is good news for contractors that require certain subcontractors to obtain a performance and payment bond (as opposed to enrolling the subcontractor in a subcontractor default insurance program). Irrespective of this modification, it is still good practice for a contractor requiring a subcontractor to provide a performance and payment bond to also ensure a contractual right exists to recover attorney’s fees under a bond claim. However, with this modification, a contractor defaulting a bonded subcontractor will also seek to recoup its attorney’s fees against the performance bond under this statute. Good news for contractors. Perhaps, not so good news for sureties and subcontractors required to indemnify their sureties.

INDEMNIFICATION PROVISIONS DO NOT CREATE RECIPROCAL ATTORNEY’S FEES PROVISIONS

Posted on November 3, 2018April 24, 2020 by Edward Garber

In a good, recent decision, the Eleventh Circuit in International Fidelity Insurance Co. v. Americabe-Moriarity, JV, 2018 WL 5306683 (11^th Cir. 2018), held that Florida Statute s. 57.105(7) cannot be used to shift attorney’s fees in a contractual indemnification clause in a dispute between a general contractor and subcontractor’s performance bond surety, when the dispute does not involve an actual indemnification claim stemming from a third-party.

In this case, a prime contractor terminated a subcontractor and looked to the subcontractor’s performance bond surety to pay for the completion work. The subcontractor had a standard AIA A312 performance bond that requires the prime contractor to comply with the terms of the bond, as well as the incorporated subcontract, in order to trigger the surety’s obligations under the bond. The surety filed an action for declaratory relief against the prime contractor arguing that the prime contractor breached the terms of the performance bond through non-compliance thereby discharging the surety’s obligations. The trial court agreed and the surety moved for attorney’s fees.

The surety’s argument for attorney’s fees was threefold: (1) the indemnification provision requiring the subcontractor to indemnify the prime contractor required the subcontractor to indemnify the prime contractor for, among other things, attorney’s fees; (2) Florida Statute s. 57.105(7) provides that one-sided contractual attorney’s fees provisions must apply to both parties (and treated reciprocally), hence the inclusion of attorney’s fees in the indemnification provision means that the surety should be entitled to attorney’s fees; and (3) since the subcontract was incorporated into the performance bond, the surety should be entitled to attorney’s fees since it steps in the shoes of the subcontractor under principles of surety law.

Surprisingly, the trial court agreed with the surety. However, thankfully, the Eleventh Circuit held that the indemnity provision in the subcontract was an indemnity clause that applies only to third-party claims and not suits between the general contractor and subcontractor. Thus, the requirement of reciprocity for attorney’s fees provisions pursuant to Florida Statute s. 57.105 does not apply. The Eleventh Circuit, however, did not enter a ruling as to whether even if s. 57.105 did apply such that attorney’s fees must be reciprocal in an indemnification clause, whether such rationale would allow the performance bond surety to recover attorney’s fees under principles of surety law.

This decision is useful for a few reasons:

(1) If a contractor, subcontractor, etc. is trying to create an argument for attorney’s fees based on an indemnification clause, this decision is helpful to put that issue to bed since the indemnification provision applies in the context of third-party claims, and is not related to independent claims between the contracting parties;

(2) A party looking to take advantage of a performance bond must, and I mean, must, make sure to properly comply with the terms of the bond. Certain sureties will raise any argument to avoid obligations under a performance bond hoping that the beneficiary of the bond undertakes an act that allows the surety to discharge its obligations; and

(3) General (prime) contractors should explore subcontractor default insurance, which is a first-party insurance policy, as an alternative to performance bonds to avoid the issues associated with delays and other arguments a surety may raise in furtherance of avoiding obligations under the bond.

FIVE-YEAR STATUTE OF LIMITATIONS ON PERFORMANCE-TYPE SURETY BONDS

Posted on November 30, 2017November 30, 2017 by Edward Garber

The statute of limitations on a claim against a performance-type bond is 5 years from the breach of the bond, i.e., the bond-principal’s default (based on the same statute of limitations that governs written contracts / obligations). See Fla. Stat. s. 95.11(2)(b). This 5-year statute of limitations is NOT extended and does NOT commence when the surety denies the claim. It commences upon the default of the bond-principal, which would be the act constituting the breach of the bond. This does not mean that the statute of limitations starts when a latent defect is discovered. This is not the case. In dealing with a completed project, the five-year statute of limitations would run when the obligee (beneficiary of the bond) accepted the work. See Federal Insurance Co. v. Southwest Florida Retirement Center, Inc., 707 So.2d 1119, 1121-22 (Fla. 1998).

This 5-year statute of limitations on performance-type surety bonds has recently been explained by the Second District in Lexicon Ins. Co. v. City of Cape Coral, Florida, 42 Fla. L. Weekly D2521a (Fla. 2d DCA 2017), a case where a developer planned on developing a single-family subdivision.

In 2005, the developer commenced the subdivision improvements. Pursuant to a City ordinance governing commercial and residential development of 446.09 acres, the developer was required to provide a surety bond to the City “in an amount of the estimated cost to complete all required site improvements, as determined by the City.” The developer provided the City two surety bonds totaling $7.7 Million representing the estimated cost to complete the remaining subdivision work. The surety bonds stated:

NOW, THEREFORE, THE CONDITION OF THIS OBLIGATION IS SUCH, that if the said Principal [DEVELOPER] shall construct, or have constructed, the improvements herein described, and shall save the Obligee [CITY] harmless from any loss, cost or damage by reason of its failure to complete said work, then this obligation shall be null and void, otherwise to remain in full force and effect, and the Surety, upon receipt of a resolution of the Obligee indicating that the improvements have not been installed or completed, will complete the improvements or pay to the Obligee such amount up to the Principal amount of this bond which will allow the Obligee to complete the improvements.

In March 2007, construction of the subdivision improvements ceased due to nonpayment by the developer.

In 2010, the City contacted the developer’s surety claiming it wants to have the outstanding subdivision work completed. The surety sent a letter to the City requesting information so that it could review the City’s claim. The City did not provide the requested information because the City was considering selling the project.

In 2012, a buyer purchased the project from the City for $6.2 Million.

In 2012, the City sued the surety bonds and assigned its claim to the new buyer. The surety argued that the five-year statute of limitations expired on the surety bonds before the City filed suit in 2012. The trial court rejected this argument and after a bench trial judgment was entered against the surety.

On appeal, Second District reversed the trial court’s judgment against the surety and remanded for the trial court to enter judgment in favor of the surety holding that the claims against the surety bond are barred as a matter of law by the 5-year statute of limitations.

The surety bond here, no different than a performance bond, required the developer (bond principal) to construct and complete the subdivision improvements. When the developer failed to do so (defaulted under the bond), the City’s rights under the bond accrued. Here, construction ceased in 2007; thus, the City’s rights against the bond accrued in 2007 when the developer stopped the development of the subdivision improvements.

The surety bonds the developer provided the City are analogous to obligations in a performance bond. These are analogous to performance-based obligations in a warranty bond. These surety bonds with performance based obligations will be governed by the five-year statute of limitations governing written contracts / obligations. The statute of limitations will accrue when the bond-principal defaults and otherwise breaches the terms of the bond.

If you are dealing with issues relating to a performance-type surety bond, it is important that you consult with counsel to make sure your rights are preserved. There are many considerations with the statute of limitations being one of those considerations.

SURETIES DO NOT ISSUE BONDS RISK-FREE TO THE BOND-PRINCIPAL

Posted on August 27, 2017August 27, 2017 by Edward Garber

If your construction company is bonded, then you have signed a General Agreement of Indemnity with your surety / bonding company. Stated another way, if a surety issued an obligee on behalf of your construction company, as the bond-principal, a payment or performance bond, then you have signed a General Agreement of Indemnity with your surety.

The General Agreement of Indemnity is NOT to be taken lightly. Without the General Agreement of Indemnity, the surety is NOT issuing the bonds you need to work on a certain project. A bond is not insurance and sureties do not issue the bonds under a risk-free premise. Oh no! If a surety has to pay-out claims under a bond, the surety will be looking to recoup that loss from the indemnitors that executed the General Agreement of Indemnity.

The General Agreement of Indemnity will generally require not only the construction company, but individuals (both husband and wife) and, potentially, other affiliated companies to indemnify the surety in the event a claim is made against a bond (the indemnitors). Thus, there will be multiple indemnitors the surety will look towards if they perceive risk under the bond. If you take the General Agreement of Indemnity lightly, then you could find yourself, for lack of a better expression, up “s#*#*t’s creek without a paddle!” This is no joke.

In a recent example, Great American Ins. Co. v. Brewer, 2017 WL 3537577 (M.D.Fla. 2017), a subcontractor furnished a general contractor with a performance bond. The subcontractor was defaulted and then terminated and a claim was made against the subcontractor’s performance bond. The surety, to mitigate its exposure, entered into a settlement agreement with the general contractor.

Before the surety entered into a settlement agreement with the general contractor, it demanded that the subcontractor (bond-principal) and other listed indemnitors post $1.5M in collateral pursuant to the General Agreement of Indemnity. The subcontractor (and the other indemnitors) refused. After the surety entered into the settlement agreement with the general contractor, it demanded that the subcontractor (and the other indemnitors) post approximately $2.8M in collateral representing amounts covered in the settlement and additional amounts constituting the surety’s exposure to the general contractor. The subcontractor (and other indemnitors) again refused.

The subcontractor’s refusal was predicated on the argument that it was improperly defaulted and terminated. And this argument is where the subcontractor’s problem lies. The subcontractor’s belief is largely irrelevant if the surety operates in good faith (and proving bad faith in this context is very, very challenging). But, in order to even argue that the surety did not act in good faith, the subcontractor (and its indemnitors) would need to post collateral per the terms of the General Agreement of Indemnity.

In Florida, a construction performance bond surety like Plaintiff is “entitled to reimbursement pursuant to an indemnity contract for any payments made by it in a good faith belief that it was required to pay, regardless of whether any liability actually existed.” Further, where—as here—an indemnity agreement gives the surety discretion to settle a claim brought under a bond, “the only defense to indemnity for [such a] settlement is bad faith on the part of the surety.”

A bad faith defense is not available to indemnities like Defendants who do not post collateral in accordance with a demand under an indemnification agreement. When a bad faith defense is available, it requires proof of “an improper motive or dishonest purpose on the part of the surety.” Standing alone, evidence of a surety’s “lack of diligence,” negligence, and even “gross negligence,” is not evidence of bad faith.

Great American Ins. Co, supra, at *7 (internal citations omitted).

Importantly, disagreeing with a surety’s investigation is not evidence of bad faith by the surety. Great American Ins. Co, supra, at *8. It requires, as stated, a truly improper motive or dishonest purpose — very, very difficult to prove.

General Agreements of Indemnity tend to have the same fundamental provisions. Before you refuse a demand made by your surety, consider the ramifications.

HURDLES WITH TRIGGERING A SUBCONTRACTOR PERFORMANCE BOND

Posted on April 1, 2017April 1, 2017 by Edward Garber

There have been a couple of decisions as of late, particularly in federal court, that have gone in favor of a performance bond surety and against a general contractor’s claim against a subcontractor’s performance bond. These decisions have been so unfavorable that they may be swaying certain internal decisions to move to subcontractor default insurance with, perhaps, subcontractors that pose less risk. From the general contractor’s perspective, if they have to stop the management of the job and progress to jump through hoops to trigger the performance bond’s obligations, rightfully or wrongfully, the bond may not provide them the value they need. Performance bonds are an appropriate product in many instances, but there should be more consistency regarding the actual trigger of a subcontractor’s performance bond obligations. Project teams need to absolutely understand what efforts they need to take, and how they need to take such efforts, in order to properly trigger a performance bond’s obligations. This is a must (and I have presented many seminars on this very issue). Or, the general contractor should move away from the traditional AIA /standard performance bond form, which is the direction I always go when I am involved in the drafting of a performance bond.

To discuss the consternation with triggering subcontractor performance bond obligations, one just has to look at the recent decision in International Fidelity Ins. Co. v. Americabe-Moriarty JV, 2017 WL 766912 (11^th Cir. 2017). This appellate decision dealt with the fundamental issue of whether the contractor properly triggered a subcontractor’s performance bond. The appellate court found that it did not. This meant that the general contractor breached the terms of the performance bond, discharging the bond’s obligations, and the surety was off the hook for any subcontractor default. This is clearly not what the general contractor intended when it wanted its subcontractor to be bonded.

In this case, the subcontract provided that if the subcontractor failed to cure a default after a three-day notice to cure period, the general contractor was at liberty to terminate the subcontract upon an additional three day notice to the subcontractor, which it could then take possession of materials and employ others to complete the work.

The performance bond incorporated the subcontract. (Every performance bond will incorporate the applicable contract.) The performance bond further contained the following routine language applicable to standard-form bonds:

§ 3 If there is no Owner Default under the Construction Contract, the Surety’s obligation under this Bond shall arise after

.1 the Owner first provides notice to the Contractor and the Surety that the Owner is considering declaring a Contractor Default. Such notice shall indicate whether the Owner is requesting a conference among the Owner, Contractor and Surety to discuss the Contractor’s performance….

.2 the Owner declares a Contractor Default, terminates the Construction Contract and notifies the Surety; and

.3 the Owner has agreed to pay the Balance of the Contract Price in accordance with the terms of the Construction Contract to the Surety or to a contractor selected to perform the Construction Contract.

§ 5 When the Owner has satisfied the conditions of Section 3, the Surety shall promptly and at the Surety’s expense take one of the following actions:

§ 5.1 Arrange for the Contractor, with the consent of the Owner, to perform and complete the Construction Contract;

§ 5.2 Undertake to perform and complete the Construction Contract itself, through its agents or independent contractors;

§ 5.3 Obtain bids or negotiated proposals from qualified contractors acceptable to the Owner for a contract for performance and completion of the Construction Contract …; or

§ 5.4 Waive its right to perform and complete, arrange for completion, or obtain a new contractor and with reasonable promptness under the circumstances:

.1 After investigation, determine the amount for which it may be liable to the Owner and, as soon as practicable after the amount is determined, make payment to the Owner; or

.2 Deny liability in whole or in part and notify the Owner, citing the reasons for denial.

§ 6 If the Surety does not proceed as provided in Section 5 with reasonable promptness, the Surety shall be deemed to be in default on this Bond seven days after receipt of an additional written notice from the Owner to the Surety demanding that the Surety perform its obligations under this Bond, and the Owner shall be entitled to enforce any remedy available to the Owner.

On August 17, 2015, the general contractor issued a notice of default to the subcontractor and surety. This was sent per the subcontract and section 3 of the bond. On August 20, 2015, the surety responded that it needed more information and directed the contractor not to take any steps without the written consent of the surety. A conference call was held on September 2, 2015. Thereafter, on September 21, 2015, the contractor sent the subcontractor and surety a letter terminating the subcontractor and notifying the surety that it will pay the surety the balance of the subcontract amount consistent with section 3 of the bond. On October 1, 2015, the contractor sent the surety the additional notice required by section 6 of the bond, which started the 7-day clock.

However—and this is a HUGE however per the court—on September 16, 2015 the contractor got a cost proposal from a completion subcontractor relating to completing the defaulted subcontractor’s scope. The completion subcontractor sent a schedule reflecting a start state of September 21, 2015. By September 23, 2015, the completion subcontractor had begun certain work at the project.

Thus, after the surety got the October 1, 2015 letter, it sent the contractor a letter on October 8, 2015 advising the contractor that its actions engaging a completion subcontractor discharged its obligations on the bond. The contractor responded that the surety was in default of the bond by not acting with reasonable promptness per section 5 of the bond. This lawsuit was then initiated.

As mentioned, the Eleventh Circuit held that the contractor breached the terms of the performance bond discharging the surety’s obligations under the bond. In other words, the performance bond was never properly triggered:

Here, both the bond and subcontract required Americaribe [contractor] to provide notice to Fidelity [performance bond surety] when terminating CPM [subcontractor]. Americaribe did provide notice on September 21. However, the subcontract required the contractor give three-days notice before undertaking to complete the work. And the bond gave Fidelity time to choose among four options for undertaking the work itself, after Americaribe sent the termination notice. This undefined period of time was then followed by another requirement for Americaribe to provide seven-days notice before Fidelity would be in default. Neither the bond nor the contract allowed Americaribe to immediately hire Dillon to complete the work.

***

Before Americaribe sent the termination notice on September 21, Dillon [completion subcontractor] had already sent Americaribe a proposal for completing the work remaining on the subcontract, as well as a schedule with a presumed start date of September 21. Then, on September 22, Americaribe sent vendors of CPM a letter, copying Fidelity, informing them of CPM’s termination and that “[Americaribe] intends to award the subcontract to complete the remaining work … to Dillon.” As of September 23, Dillon had commenced some work required for the project. Thus, the question is whether these actions breached the notice provisions of the bond and subcontract.

***

Americaribe did not comply with the subcontract’s three-day notice requirement. It had already hired Dillon, which began remedying the defaulted work during that three-day period. Neither did Americaribe comply with the bond’s requirements, which expressly afforded Fidelity time to elect among options for completing the defaulted work. Americaribe’s immediate hiring of Dillon to complete the project and the costs Dillon incurred completing CPM’s work thwarted Fidelity’s ability to choose among the options it had for remedying CPM’s default under § 5 of the bond. Therefore, Fidelity is not liable on the bond.

This is a very, very harsh outcome. Although I mentioned this above, it is imperative that the project team understand the steps it needs to take to properly default a subcontractor and trigger the subcontractor’s performance bond. Not doing so will render the value of the performance bond useless to the general contractor that is relying on the security of that bond.

PROPERLY TRIGGER THE PERFORMANCE BOND

Posted on December 25, 2016November 8, 2024 by Edward Garber

A performance bond is a valuable tool designed to guarantee the performance of the principal of the contract made part of the bond. But, it is only a valuable tool if the obligee (entity the bond is designed to benefit) understands that it needs to properly trigger the performance bond if it is looking to the bond (surety) to remedy and pay for a contractual default. If the performance bond is not properly triggered and a suit is brought upon the bond then the obligee could be the one materially breaching the terms of the bond. This means the obligee has no recourse under the performance bond. This is a huge downside when the obligee wanted the security of the performance bond, and reimbursed the bond principal for the premium of the bond, in order to address and remediate a default under the underlying contract.

A recent example of this downside can be found in the Southern District of Florida’s decision in Arch Ins. Co. v. John Moriarty & Associates of Florida, Inc., 2016 WL 7324144 (S.D.Fla. 2016). Here, a general contractor sued a subcontractor’s performance bond surety for an approximate $1M cost overrun associated with the performance of the subcontractor’s subcontract (the contract made part of the subcontractor’s performance bond). The surety moved for summary judgment arguing that the general contractor failed to property trigger the performance bond and, therefore, materially breached the bond. The trial court granted the summary judgment in favor of the performance bond surety. Why?

The performance bond in this case appeared to be an AIA performance bond (the AIA Document A312 Performance Bond or modified version thereof). This appears clear from the following finding by the court:

Under the bond in this case, Arch’s [performance bond surety] obligations are not triggered unless Moriarty [general contractor-obligee]: (1) first provides notice to R.C. [subcontractor-principal of bond] and Arch that it is “considering declaring a Contractor Default”; (2) “declares a Contractor Default, terminates the Construction Contract and notifies [Arch]”; and (3) “agree[s] to pay the Balance of the Contract Price … to [Arch] or to a contractor selected to perform the Construction Contract.” …Once Moriarty complies with those three conditions precedent, the bond then requires Moriarty to allow Arch to mitigate its damages by arranging for the completion of the subcontract itself. Lastly, before Moriarty may properly make a demand under the bond, it must provide seven days’ notice to Arch.”

The general contractor, as commonly done, notified the subcontractor and subcontractor’s surety that it was considering declaring the subcontractor in default, but never (i) formally declared the subcontractor in default, (ii) terminated the subcontractor, or (iii) agreed to pay the subcontract balance to the performance bond surety. Thus, the general contractor (obligee) never allowed the surety to mitigate damages by arranging completion of the subcontract upon the subcontractor’s (bond principal) default.

Remember, in order to preserve a performance bond claim it is important to properly trigger the performance bond and the surety’s role under the bond. This means dotting your i’s and crossing your t’s when it comes to declaring the bond principal in default under the specific terms of the bond. Moreover, if you are the obligee, consider preparing the performance bond form so that you can remove some of the underlying notice provisions in the bond to make the bond more favorable to you.

IS PERFORMANCE BOND LIABLE FOR DELAY DAMAGES?

Posted on October 6, 2016November 8, 2024 by Edward Garber

There is an argument that a performance bond is not liable for delay damages UNLESS the bond specifically allows for the recovery of such damages. Keep this in mind when requiring a performance bond so that the bond covers the associated risks (and damages) you contemplate when requiring the bond. This argument is supported by the Florida Supreme Court’s 1992 decision in American Home Assur. Co. v. Larkin General Hosp., Ltd., 593 So.2d 195, 198 (Fla. 1992):

The language in the performance bond, construed together with the purpose of the bond, clearly explains that the performance bond merely guaranteed the completion of the construction contract and nothing more. Upon default, the terms of the performance bond required American [performance bond surety] to step in and either complete construction or pay Larkin [obligee] the reasonable costs of completion. Because the terms of the performance bond control the liability of the surety, American’s liability will not be extended beyond the terms of the performance bond. Therefore, American cannot be held liable for delay damages.

However, the Eleventh Circuit in National Fire Ins. Co. of Hartford v. Fortune Const. Co., 320 F.3d 1260(11^th Cir. 2003), also analyzing an issue relating to the recoverability of delay-type damages against a performance bond, did not narrowly interpret the Florida Supreme Court’s decision in Larkin General Hospital. Rather, the Eleventh Circuit stated:

Larkin General Hospital could possibly be interpreted to mean that a performance bond surety cannot be held liable for…delay damages, whether liquidated or unliquidated, unless the responsibility for delay damages is specified on the face of the performance bond. However, we do not read the decision that broadly. The “purpose of the bond” must be considered, which requires reference to the contract secured by the bond. Where a provision for liquidated delay damages is clearly delineated in the underlying contract and incorporated by reference into the bond, the surety is on notice of the time element of performance and the contractual consequences of failure to timely perform in accordance with the contract.

***

While it is true that the terms of the bonds in this case do not expressly require the surety to assume responsibility for delay, “[i]t is the general rule of contract law that where a writing expressly refers to and sufficiently describes another document, the other document is to be interpreted as part of the writing.” Even after Larkin General Hospital, Florida courts have continued to utilize the well-established doctrine of incorporation by reference to impose liability on a performance bond surety. The “purpose” of the performance bonds was to insure performance in accordance with the terms of the respective subcontracts, and those terms plainly include adverse direct consequences for delay. Therefore, under the particular facts of this case, the unequivocal delay damages provisions of the subcontracts are properly considered part of the bonds issued by National Fire because of the incorporation by reference.

Fortune Const. Co., supra, at 1275-76 (internal citations omitted).

It is uncertain whether a Florida appellate court will agree with the rationale of the Eleventh Circuit in Fortune Const. Co., albeit the rationale making perfect sense. If the contract incorporated into the performance bond renders the principal of the bond liable to the obligee for delay damages, then the bond should cover delay damages. On the other hand, Larkin General Hospital is a Florida Supreme Court decision meaning there is a very strong argument that that the performance bond’s liability for delay damages will not be extended beyond the face of the bond. For this reason, and as mentioned above, it is essential that the face of the performance bond expresses that it covers the obligee’s delay damages or any other damages stemming from the default of the principal. (By way of example, the AIA A132 performance bond expresses on the face of the bond that it covers delay costs stemming from the bond-principal’s default resulting from the surety’s failure to act and contractual liquidated or actual delay damages, if no liquidated damages, caused by the bond-principal.)