COMPLY WITH THE CONDITIONS OF THE PERFORMANCE BOND

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 TAKEOVER – USING TERMINATED CONTRACTOR TO COMPLETE THE WORK

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.

 

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.