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.