Tag Archives: performance bond

IS PERFORMANCE BOND LIABLE FOR DELAY DAMAGES?

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images-3There 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(11th 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.

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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.)

 

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.

DRAFTING THE BOND FORM, PARTICULARLY THE PERFORMANCE BOND FORM

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imagesOftentimes, when it comes to payment and performance bonds (in particular), the bond forms are drafted by the obligee.  For example, an owner (as the obligee) may draft the bond forms that it wants its general contractor’s surety to execute.  And, a general contractor (as the obligee) may draft the bond forms that it wants its subcontractors’ sureties to execute.   As an obligee, it is always beneficial to draft the bond form (particularly the performance bond) that you want the surety to execute.  The bond is to benefit you—the obligee—so having a hand in creating conditions to trigger the application of the bond is important, specifically when it comes to triggering a performance bond upon the bond-principal’s default.

 

What if the surety executes a bond form prepared by the obligee and there is an ambiguity in the bond?  Should the ambiguity be interpreted against the obligee as the drafter of the bond?

 

This issue was addressed by the Fourth District Court of Appeal in The School Bd. Of Broward County v. Great American Ins. Co., 807 So.2d 750 (Fla. 4th DCA 2002) where the School Board owner prepared the performance bond form.  The surety argued there was an ambiguity with the bond form and wanted the ambiguity to be interpreted against the School Board as the drafter of the bond.  The court rejected this argument explaining:

 

Florida’s policy is to construe any ambiguity in a bond in favor of granting the broadest possible coverage to those intended to be benefitted by protection of the bond [e.g., the obligee]. This policy recognizes that the purpose of a bond is to protect a party to a contract; the burden is on the surety, who is in the business, to include the appropriate language in its bonds if it seeks to narrow its obligations after default.

The School Board of Broward County, 807 So.2d at 752 (internal citations and quotations omitted).

 

 

To reiterate, it is always beneficial as the obligee to prepare the bond forms (particularly the performance bond) that you want the surety to execute since the bond is designed to benefit you. Work with counsel to ensure the bond form provides you the broadest or best coverage based on the anticipated risks.    

 

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.

 

GOVERNMENT CONTRACTS AND TERMINATION FOR DEFAULTS: SURETY TAKEOVER AGREEMENTS, TENDER AGREEMENTS, ETC.

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163On federal government construction projects, the prime contractor provides the government with a performance bond (pursuant to the Miller Act) guarantying the prime contractor’s performance under the prime contract.   Under normal course and in accordance with the Federal Acquisition Regulations (“FAR”), the performance bond is triggered when the government terminates the prime contractor for default and then looks to the performance bond surety to remedy the default by completing the defaulting prime contractor’s contractual obligations.  (See FAR 49.402-3 regarding the government’s procedure to terminate the prime contractor for default and put the contractor and surety on notice.) 

 

Subpart 49.4 of FAR deals with termination for defaults.  Prime contractors as well as sureties should familiarze themselves with this subpart especially if they received notification from the contracting officer of the possibility of a terminatin for default or the notices seem to indicate that the terminatiion for default is imminent.

 

Let’s presume the contracting officer moves forward and terminates the prime contractor for default or the termination is imminent.  Now what?   Clearly, the contracting officer will be looking to the prime contractor’s performance bond surety to remedy the default.    Below are considertaions that will be explored and are the reasons why prime contractors and sureties in this situation should absolutely ensure they are consulting with counsel.

 

A. Takeover Agreements

 

One common option under FAR  49.404 that can be implemented is a surety-takeover agreement with the government (see below).  This is when the surety takes over the contractual obligations of the prime contract.  Typically, the surety will enter into a takeover agreement with the government that outlines the obligations of the takeover and will enter into a separate contract with the completion contractor the surety engages to complete its defaulting prime contractor’s scope of work.  While FAR ideally prefers a tripartite takeover agreement with the government, surety, and defaulted prime contractor, this generally does not happen with a prime contractor that challenges the termination for default and looks to convert the termination into one for convenience. 

 

49.404  Surety-takeover agreements.

(a) The procedures in this section apply primarily, but not solely, to fixed-price construction contracts terminated for default.

(b) Since the surety is liable for damages resulting from the contractor’s default, the surety has certain rights and interests in the completion of the contract work and application of any undisbursed funds. Therefore, the contracting officer must consider carefully the surety’s proposals for completing the contract. The contracting officer must take action on the basis of the Government’s interest, including the possible effect upon the Government’s rights against the surety.

(c) The contracting officer should permit surety offers to complete the contract, unless the contracting officer believes that the persons or firms proposed by the surety to complete the work are not competent and qualified or the proposal is not in the best interest of the Government.

(d) There may be conflicting demands for the defaulting contractor’s assets, including unpaid prior earnings (retained percentages and unpaid progress estimates). Therefore, the surety may include a “takeover” agreement in its proposal, fixing the surety’s rights to payment from those funds. The contracting officer may (but not before the effective date of termination) enter into a written agreement with the surety. The contracting officer should consider using a tripartite agreement among the Government, the surety, and the defaulting contractor to resolve the defaulting contractor’s residual rights, including assertions to unpaid prior earnings.

(e) Any takeover agreement must require the surety to complete the contract and the Government to pay the surety’s costs and expenses up to the balance of the contract price unpaid at the time of default, subject to the following conditions:

(1) Any unpaid earnings of the defaulting contractor, including retained percentages and progress estimates for work accomplished before termination, must be subject to debts due the Government by the contractor, except to the extent that the unpaid earnings may be used to pay the completing surety its actual costs and expenses incurred in the completion of the work, but not including its payments and obligations under the payment bond given in connection with the contract.

(2) The surety is bound by contract terms governing liquidated damages for delays in completion of the work, unless the delays are excusable under the contract.

(3) If the contract proceeds have been assigned to a financing institution, the surety must not be paid from unpaid earnings, unless the assignee provides written consent.

(4) The contracting officer must not pay the surety more than the amount it expended completing the work and discharging its liabilities under the defaulting contractor’s payment bond. Payments to the surety to reimburse it for discharging its liabilities under the payment bond of the defaulting contractor must be only on authority of—

(i) Mutual agreement among the Government, the defaulting contractor, and the surety;

(ii) Determination of the Comptroller General as to payee and amount; or

(iii) Order of a court of competent jurisdiction.

 

B.  Tender Agreements

 

Another option the surety can implement is by tendering a completion contractor to the government for the government to complete the work.  Oftentimes the surety will obtain pricing to complete the defaulting prime contractor’s scope of work.  The surety will then tender a completion contractor to the government so that the government can hire this contractor directly.  The surety will also tender the difference between the balance of the defaulted prime contractor’s contract amount and the completion contractor’s contract amount to complete the work.  (For example, if the balance of the defaulted prime contract is Twenty Million but it will cost a completion contractor Twenty Five Million to complete the defaulted prime contractor’s scope of work, the surety will tender the additional Five Million.)  A tender agreement is generally entered into between the surety and the government and outlines the parameters of the tender including monetary responsibilities of the surety. 

 

C.  Government Completion (if surety does not takeover or tender)

 

FAR 49.405 gives the government authority to engage a completion contractor if the surety does not arrange for the completion of the defaulted prime contractor’s scope of work (see below).  If the government moves forward with this option, it will certainly look to the surety for all costs it incurs associated with the prime contractor’s default and any delay associated with bringing a completion contractor on board.

 

49.405  Completion by another contractor.

If the surety does not arrange for completion of the contract, the contracting officer normally will arrange for completion of the work by awarding a new contract based on the same plans and specifications. The new contract may be the result of sealed bidding or any other appropriate contracting method or procedure. The contracting officer shall exercise reasonable diligence to obtain the lowest price available for completion.

  

D. Procedures Government Can Utilize Instead of Termination for Default

 

FAR 49.402-4 identifies certain procedures that the government can utilize instead of terminating the prime contractor for default, although these procedures are generally implemented after the prime contractor and surety are on notice of an impending termination for default (see below).   The government is probably not going to move forward with these procedures unless its rights are reserved against the prime contractor and performance bond for any resultant damages (see FAR 49.406 below) associated with defaults asserted by the government against the prime contractor (e.g., liquidated damages for delays,  correction of deficient work, etc.).  If these procedures are considered and utilized, there is a good chance the procedure was suggested by the prime contractor and surety as a protocol to best mitigate potential damages asserted by the government.   (By way of example, one option a surety can present is to agree to fund the prime contractor through completion in order to keep the project moving forward with the contractor most familiar with the scope of work.)

 

49.402-4  Procedure in lieu of termination for default.

The following courses of action, among others, are available to the contracting officer in lieu of termination for default when in the Government’s interest:

(a) Permit the contractor, the surety, or the guarantor, to continue performance of the contract under a revised delivery schedule.

(b) Permit the contractor to continue performance of the contract by means of a subcontract or other business arrangement with an acceptable third party, provided the rights of the Government are adequately preserved.

(c) If the requirement for the supplies and services in the contract no longer exists, and the contractor is not liable to the Government for damages as provided in 49.402-7, execute a no-cost termination settlement agreement using the formats in 49.603-6 and 49.603-7 as a guide.

 

49.406  Liquidation of liability.

(1) The contract provides that the contractor and the surety are liable to the Government for resultant damages. The contracting officer shall use all retained percentages of progress payments previously made to the contractor and any progress payments due for work completed before the termination to liquidate the contractor’s and the surety’s liability to the Government. If the retained and unpaid amounts are insufficient, the contracting officer shall take steps to recover the additional sum from the contractor and the surety.

 

E. Preservation of Surety’s Rights

 

When a surety takesover the completion of the work, tenders a completion contractor, or even funds the original prime contractor through completion, the surety will do so while preserving its rights.  In other words,  a surety will want to best preserve rights to pursue potential claims against the government while contemporaneously mitigating its exposure under the performance bond through the takeover, tender, or funding of the completion work.  See, e.g., Transamerica, Ins. v. U.S.,  31 Fed.Cl. 532 (1994) (finding surety can pursue equitable subrogation claim against government for funds held by government when surety tendered and paid completion contractor); see also In re Appeal of Fireman’s Fund Ins. Co., ASBCA No. 50657, 2000 WL 246620 (2000) (“When a terminated contractor assigns such [pre-takeover / tender] claims to the surety to which assignment the contracting officer consents, or incorporates such an assignment in novation or takeover [or tender] agreement executed by the contracting officer, the surety has standing to prosecute such claims before the Board.”); In re Hackney Group, ASBCA No. 51453, 2000 WL 655950 (2000) (surety’s argument that it has standing to assert defaulted prime contractor’s pre-takeover claims against government based on surety’s indemnity agreement with  prime contractor failed since government was not a party to indemnity agreement and never consented to prime contractor’s assignment of pre-takeover claims to surety).

 

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.

 

 

 

DON’T MESS WITH THE GENERAL AGREEMENT OF INDEMNITY

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untitledI have previously posted articles about the all mighty General Agreement of Indemnity (“Agreement of Indemnity”) that a surety requires a contractor bond-principal and designated guarantors to execute before issuing payment and performance bonds to the contractor. In cases forming the basis of the articles, the surety demands rights under the Agreement of Indemnity such as the right for collateral security to protect the surety from anticipated or pending claims and the contractor bond-principal refuses. In these cases, the surety files a lawsuit and moves for an injunction which, among other things, requires the principal to post the very collateral security it refused to post to begin with. As reflected in these cases, the surety gets the injunction granted because the Agreement of Indemnity is designed to protect the surety’s interests. In other words, don’t mess with the Agreement of Indemnity because the surety will typically get the recourse it pursues.

 

Recently, another opinion came out further supporting the rights of a surety under the Agreement of Indemnity and why it is beneficial to figure out an avenue to work with the surety instead of against it. In this case, Travelers Casualty and Surety Co. of America v. Design Build Engineers and Contractors Corp., 2014 WL 7274803 (M.D.Fla. 2014), the contractor bond-principal was working on two public projects. On one project, a dispute with a subcontractor resulted in a claim that the surety paid plus substantial attorney’s fees awarded to the subcontractor by the court. Although the contractor reimbursed its surety for the principal amount of the claim, it refused to reimburse the surety for the substantial attorneys’ fees awarded to the subcontractor. And, on the other project, the contractor was terminated resulting in pending performance bond and payment bond claims against the surety.

 

The contractor, in furtherance of trying to shield major property and assets, did some creative asset transfers forming holding companies, etc. This did not work.  The surety filed a lawsuit against the contractor and guarantors under the Agreement of Indemnity and moved for a preliminary injunction to require the contractor to post collateral security and to prevent the contractor from disposing of assets. Guess what? The surety prevailed on its motion for an injunction and the Middle District Court ordered that the contractor post the requested collateral that included properties the contractor tried to shield and prevented the contractor and certain holding companies it formed from disposing or encumbering of assets (inclusive of the real property is was ordered to post as collateral).

 

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.

 

ARE YOU FAMILIAR WITH SUBCONTRACTOR DEFAULT INSURANCE (SUBGUARD)?

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UnknownAre you familiar with subguard?  If not, subguard is an insurance product also known as subcontractor default insurance.  It is an insurance product obtained by the general contractor and subcontractors are enrolled by the contractor into the subguard program; the general contractor does the prequalification based on the subcontractors and suppliers it wants to utilize.  The general contractor can recover its losses (direct and indirect) from defaulting subcontractors (including consequential losses, losses from defective work, losses from a defaulting subcontractor’s non-payment to others, etc.).  Subguard is typically more cost effective than requiring subcontractors to obtain performance bonds and allows the general contractor to recover losses (above a deductible) much quicker than if there was a subcontractor performance bond.  (Subguard is not the only subcontractor default insurance product on the market, but it is perhaps the most recognized product.  For purposes of this article, subguard will refer to all subcontractor default insurance products.)

 

Large general contractors on large-scale projects prefer subguard versus requiring subcontractors to obtain performance bonds considering general contractors are in a position to prequalify subcontractors and remedy a potential subcontractor default (without having to jump through the required performance bond hoops that could result in further financial loss to the contractor while the claim is being investigated by the surety).    Unlike a performance bond where there is the principal, the surety, and the obligee, with subguard, there is only the general contractor–the insured that obtains the subguard–and the insurance company.  Subcontractors, while enrolled in the program, are not parties to the policy; the general contractor is the only party that can submit a claim on the subguard policy.

 

Subguard is a first party insurance policy but it works different than a typical first party insurance policy.  The general contractor obtains a subguard policy with a policy limit and (large) per claim deductibles / self-insured retentions.  The policy is written for a set period of time (in numerous instances the 10 year statute of repose period).  When there is a claim, after the general contractor pays its deductible, there is a co-pay requirement where the general contractor and subguard insurer share in the losses until the general contractor pays a retention aggregate amount which is the capped amount the general contractor will have to pay relating to a claim.  Once the cap has been paid, the subguard insurer pays the balance of the claim up to the policy limit.  The sentiment is with a large deductible and co-pay requirement until an aggregate amount is paid, the general contractor has more incentive to prequalify subcontractors, manage the work, and eliminate subcontractor default since the contractor has a vested financial interest to prevent the default from occurring.  For example, a subguard policy can have a large deductible of $500,000, a retention aggregate of $1,000,000, and require the contractor to pay 20% of the loss after the $500,000 deductible.  So, if a subcontractor default costs the contractor $2,500,000, the contractor will pay the first $500,000 and then 20% of the remaining $2,000,000 up to its retention aggregate.  In this example, the contractor would have to pay another $400,000 (20% of the $2,000,000), which would be a total of $900,000 and below its retention aggregate of $1,000,000.  The subguard insurer would be responsible for the remaining portion of the claim.

 

Additionally, a contractor that is well equipped at managing subcontractor defaults may procure a subguard policy with a retrospective premium agreement. This is advantageous to the experienced contractor because deposit premium (sometimes referred as the experience portion of the premium) can be returned to the contractor based on no subcontractor defaults or minimal claims on the policy that the deposit portion of the premium would be applied to.

 

From an owner’s perspective, subguard is not a substitute for requiring the general contractor to obtain a performance and payment bond.  A major reason being that the owner is not an insured under the policy.  With that said, subguard is a valuable alternate to requiring subcontractors to obtain performance and payment bonds and is a product on large projects by large contractors that an owner should consider since most of the work will be performed by subcontractors (and, as mentioned above, it is typically more cost effective than requiring subcontractors to be bonded).  With subguard, the general contractor is bearing the risk (with no excuses) for subcontractor default since it obtained an insurance product to specifically cover this risk (and the direct and indirect losses associated with this risk) and, thus, is incentivized to best manage the trades and eliminate default.

 

Check out this presentation for more information on subcontractor default insurance as an alternative to subcontractor performance bonds.

 

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.

 

 

SURETY BONDING – THE NUTS & BOLTS

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images-2Surety bonding is necessary in construction, particularly on federal and Florida public projects where the contractor is required to furnish a payment and performance bond.  Even certain owners of large-scale private projects want their contractor to obtain a payment and performance bond.  Understanding the nuts and bolts of surety bonding is valuable for the contractor that wants to increase job opportunities and/or increase their bonding capacity.

 

 

There are three main parties to the surety bond:

 

1. The surety– the entity (typically, a division of an insurance company) that issues the payment or performance bond for the contract price; the surety guarantees obligations on behalf of its principal, whether it is the performance of the contract (performance bond) or the payment to those entities working under the contractor providing labor, services, or materials (payment bond)

 

2. The principal – the entity (contractor) that procured the bond from the surety and who the surety is issuing the bond on behalf of; the principal along with personal and corporate guarantors will execute a General Agreement of Indemnity before the bond is issued outlining the rights and remedies of the principal/guarantors and the surety

 

3. The obligee – the entity (or entities) that can make a claim against the bond and who the bond is ultimately designed to benefit

 

Not every contactor can get a payment and performance bond.  This means that not every contractor can perform public work that requires a bid bond to be furnished with the bid/proposal and then a payment and performance bond upon the award of the contract.  This is because sureties undertake rigorous underwriting to best assess their risk before issuing bonds. And, many contractors, even if bonds are issued, will have a bonding capacity meaning the surety will not issue an unlimited dollar amount for the bond(s) issued or will not issue an unlimited number of project bonds at the same time. Rather, it will issue a bond or bonds totaling the bonding capacity of the contractor.

 

To obtain a bond, a contractor will go to a surety bond agent/broker, commonly referred to as the producer.  The producer represents select sureties.  Certain sureties cater to certain market niches or contractors and the producer tries to fit the contractor with the surety that best fits the needs, strengths, and qualifications of the contractor. The producer will work with the contractor to fill out required forms and review and collect the material and information that will be needed by the surety in the underwriting process. As a contractor, it is important to develop a strong relationship with a producer that understands your construction business and capabilities and can assist you with obtaining bonding capacity.

 

images-3In the underwriting process, the surety will want to determine the financial strength, creditworthiness, and condition of the contractor by analyzing extensive financial documentation along with the contractor’s operational ability to perform a contract based on the contractor’s history, equipment, personnel, etc.  Underwriting needs to obtain and assess financial and operational material to best assess the surety’s risk (based on the surety’s appetite or market) because if the surety has to pay out a claim on the bond it will absolutely be looking to recoup the costs it incurs from the bond principal as well as the guarantors that executed the General Agreement of Indemnity.  Among other things, the surety will run a credit check for the principal and likely the owners/guarantors; will analyze balance sheets, income statements, and other financial information to understand the contractor’s cash flow, working capital, net worth, and profitability history and forecasts; will want to know of judgments and lawsuits; will likely contact references; and will want to specifically understand past projects completed and current projects underway, including the project in which the bond is being requested, from an estimating and accounting standpoint, personnel and management standpoint, insurance standpoint, and possibly a scheduling standpoint.  The surety will do its homework because the very last thing a surety wants to do is pay a claim or expose itself to massive liability with a bond claim from a contractor that failed to pay its subcontractors or abandoned a job without any true recourse to recoup money expended.  The surety will consider the personal and corporate guarantors it requires from a contractual indemnity standpoint per the General Agreement of Indemnity and may require cash collateral or property collateral to be pledged for underwriting approval.   Again, developing the relationship with the producer that understands your business is crucial as the producer will understand the underwriting process and facilitate the transmission of information and material between the contractor and the surety.

 

 

The surety charges a premium for the issuance of the bond.  Payment and performance bonds are often single premium bonds.  Depending on the producer you ask, the premiums typically range from 1-3% of the bond amount.   Naturally, there are contractors that will have to pay in excess of 3% of the bond amount based on the associated credit risk with issuing the bond.

 

Once underwriting runs its course and the contractor is approved for the requested bonds, the producer typically signs the bonds on behalf of the surety.  The producer is given a power-of-attorney to sign bonds as an attorney-in-fact on behalf of the surety.

 

 

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.

THE ALL MIGHTY GENERAL AGREEMENT OF INDEMNITY WITH THE SURETY

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images-2Sureties do not issue bonds (e.g., payment or performance bonds) unless the principal and the principal’s personal guarantors execute a General Agreement of Indemnity (“Indemnity Agreement”).  The Indemnity Agreement routinely requires that the principal / guarantors: (1) defend and indemnify the surety for all losses, liability, claims, attorney’s fees, and expenses that the surety may incur and (2) post collateral security into a reserve account set up by the surety to cover any claim on the bond; the surety may seek an injunction to compel such collateral if the principal / guarantors refuse.  Yes, these are powerful provisions in favor of the surety if a claim is asserted against the principal’s bond (especially a performance bond claim) or if the surety, to offset liability or exposure, pays a claimant on behalf of the principal.  The leverage lies with the surety with respect to the provisions in the Indemnity Agreement and the worst thing a bond principal can do when a claim is asserted against the bond is to outright refuse to work with and cooperate with the surety (based on the powerful provisions in the Indemnity Agreement).

 

 

The opinion in Developers Surety and Indemnity Co. v. Hansel Innovations, Inc., 2014 WL 2968138 (M.D.Fla. 2014), exemplifies what can happen if a bond principal refuses to cooperate with a surety even if the principal has potentially meritorious arguments.  In this case, a surety issued a performance bond to a fire protection subcontractor.  During the course of construction (and, arguably due to the general contractor’s nonpayment), the subcontractor experienced cash flow problems.  The general contractor expressed concerns as to the subcontractor’s financial wherewithal to complete the contract work and made demand on the surety.  The subcontractor requested financial assistance from its performance bond surety and the surety agreed to pay the subcontractor and its vendors in excess of $100,000 provided the subcontractor execute a separate financing and collateral agreement (as the surety expected to recoup its “loan”).  Subsequently, the general contractor advised the surety and subcontractor of performance issues with the subcontractor’s work.  The subcontractor, however, refused to complete its work and address the performance issues unless the surety continued to fund the subcontractor’s work, released the guarantors from personal liability, and pursued claims against the general contractor.  Based on the subcontractor’s stance, the surety retained another subcontractor to complete the work and incurred additional costs.  The surety filed a lawsuit to, among other rights afforded under the Indemnity Agreement, require the subcontractor and guarantors to post $200,000 in collateral security into a reserve account.  The subcontractor and guarantor failed to post collateral upon demand.

 

 

The surety, as it customarily will do, moved for a preliminary injunction in accordance with the Indemnity Agreement for the court to order the subcontractor and guarantors to post collateral.   One of the requirements for a court to order a preliminary injunction is for the surety to establish that it is substantially likely to succeed on the merits.  This is not a challenging hurdle for a surety given the powerful provisions in the Indemnity Agreement. (Please see the following articles for more information on a surety’s right to demand collateral security and the requirements for a preliminary injunction in federal court: https://floridaconstru.wpengine.com/a-suretys-right-to-demand-collateral-security/ and https://floridaconstru.wpengine.com/a-suretys-right-to-demand-collateral-security/.)

 

 

The subcontractor argued that bad faith or unclean hands, evidenced by an improper motive, extinguished the surety’s substantial likelihood that it would succeed on its claim.  The subcontractor argued this because it did not want to post collateral.  In support of bad faith, the subcontractor contended that when the general contractor raised performance issues the subcontractor was 99% done with its work with the remaining work simply commissioning the fire sprinkler system and completing as-built drawings.  It further argued that the general contractor placed it in a dire financial position because the general contractor did not pay it for over one year and did not pay it for change order work that was performed at the general contractor’s direction.  (Not an uncommon subcontractor argument!)  The subcontractor also stated that it only signed the financing and collateral agreement because the surety assured it that the surety would assist the subcontractor in collection efforts against the general contractor if the subcontractor signed the agreement and continued with the work.  Then, the surety discontinued funding the subcontractor at the eleventh hour to help the subcontractor complete the work while contemporaneously failing to assist the subcontractor in collecting any money from the general contractor.  The Magistrate, though, was not persuaded by the subcontractor’s bad faith argument taking the position that it cannot be bad faith for the subcontractor to be induced into completing its work on a project it was hired to complete.

 

 

The subcontractor may have very strong arguments that it was truly placed in a cash flow crunch because the general contractor refused to pay for contract work plus additional work.  Thus, the subcontractor was forced to finance a job that it was never in a financial position to finance.  Then, when it agreed to complete its work with the surety’s assistance, it did so with the understanding that the surety would assist the subcontractor in recovering monies that the subcontractor should have been paid all along for contract and change order work that would also be used to reimburse the surety.  But, as shown in this case, truly establishing bad faith is very, very difficult and should not be sugarcoated with the sentiment that the provisions in the Indemnity Agreement do not have any teeth, because they do!

 

 

Keep in mind that a performance bond guarantees performance under a contract.  Once a bond is furnished, it is rarely advisable to abandon a job or refuse to perform because it puts the surety in a compromising position where it will likely need to complete the subcontractor’s performance in order to mitigate its exposure and liability.  Here, the subcontractor’s surety was willing to finance the subcontractor’s work until the subcontractor was virtually complete.  All the subcontractor had to do was complete its work when it was 99% complete and work with and cooperate with the surety since the best course of action in the long run may have been for these entities to work together to recover monies that the general contractor owed the subcontractor and/or figure out how the subcontractor would reimburse the surety.  However, based on what the surety may have construed as an obstinate position by the subcontractor, the surety incurred additional expenses and elected to pursue its options against the subcontractor and guarantors under the all mighty Indemnity Agreement.

 

 

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.

FEDERAL CONTRACTING AND COMPLIANCE WITH THE CONTRACT DISPUTES ACT

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images-1Federal Acquisition Regulation 52.233-1 (48 CFR 52.233-1) contains a dispute clause that is incorporated into prime contracts for federal construction projects.  This regulation is set forth at the bottom of this article and provides that the prime contract is subject to the Contract Disputes Act (41 U.S.C. s. 7101 en seq.).  The Contract Disputes Act is a vital part of federal contracting.

 

The Contact Disputes Act—containing similar language to FAR 52.233-1—requires prime contractors to submit claims relating to the prime contract in writing to the contracting officer for a decision within six years after the accrual of the claim.  41 USC s. 7103 (a).  Claims of more than $100,000 need to contain a certification that:

 

“(A) the claim is made in good faith;

(B) the supporting data are accurate and complete to the best of the contractor’s knowledge and belief;

(C) the amount requested accurately reflects the contract adjustment for which the contractor believes the Federal Government is liable; and

(D) the certifier is authorized to certify the claim on behalf of the contractor.”

41 USC s. 7103(b). 

 

(It is imperative that the prime contractor not misrepresent or fraudulently submit a certified claim as it could expose the contractor to liability.  41 USC s. 7103(c).)

 

The contracting officer will then render a decision for claims of $100,000 or less within “sixty days from the contracting officer’s receipt of a written request from the contractor that a decision be rendered within that period.”  41 USC s. 7103(f)(1).  With respect to claims of more than $100,000, the contracting officer “shall, within 60 days of receipt of a submitted certified claim…(A) issue a decision; or (B) notify the contractor of the time within which a decision will be issued.”  41 USC s. 7103(f)(2). If the contracting officer notifies the prime contractor that it needs more time to render a decision, which is not uncommon, he/she is simply required to issue a decision within a reasonable period of time factoring in the size and complexity of the claim with the back-up information submitted by the prime contractor.  41 USC s.7103(f)(3).  “Failure by a contracting officer to issue a decision on a claim within the required time is deemed to be a decision by the contracting officer denying the claim and authorizes an appeal or action on the claim….However, the tribunal concerned may, at its option, stay the proceedings of the appeal or action to obtain a decision by the contracting officer.” 41 USC s. 7103(f)(5).

 

Once the contracting officer renders a decision on the claim, this decision is final unless the prime contractor (i) appeals the decision to the applicable agency board within 90 days from the date of receipt of the contracting officer’s decision or (ii) initiate an action in the United States Court of Federal Claims within twelve months from the date of receipt of the contracting officer’s decision. 41 USC s. 7104.

 

 

The opinion in The Hanover Insurance Company v. U.S., 2014 WL 2192148 (Fed.Cl. 2014), illustrates the importance for prime contractors to comply with the Contract Disputes Act and corresponding Federal Acquisition Regulation 52.233-1 (governing disputes and incorporated into the prime contracts) prior to instituting litigation against the federal government.

 

imagesIn this case, the United States Army Corps of Engineers (“Corps”) engaged a prime contractor to perform work for an Everglades upgrade project.  The Corps default terminated the prime contractor due to issues pertaining to the prime contractor’s dewatering plan.   The Corps made a demand on the prime contractor’s performance bond surety to either complete the balance of the unperformed contract work or tender a new contractor to complete the contract work.  The Corps also denied claims the prime contractor submitted for additional costs relating to the dispute over the dewatering plan (that ultimately led to the default termination).  The performance bond surety tendered a completion contractor and executed a tender and release agreement with the Corps that obligated the surety to pay the Corps many millions of dollars which represented the difference between the amount to be paid to the completion contractor to complete the contract work minus the unpaid balance of the original prime contractor’s contract. The tender and release agreement provided that the prime contractor and surety could ultimately challenge the Corps’ default termination.

 

Subsequently, the prime contractor and its surety filed separate complaints against the federal government in the Court of Federal Claims challenging the default termination.  Ultimately, the prime contractor wanted the Corps’ default termination converted into a termination for convenience; this would, in turn, result in the federal government reimbursing the surety the many millions the surety tendered plus other related costs incurred by the contractor in the performance of the project.  (The prime contractor also sued the federal government to recover its costs tied to the claims it submitted to the Corps relating to the dewatering dispute that the Corps denied.)  These lawsuits were all consolidated.

 

The federal government moved to dismiss the claims for monetary damages asserted by the prime contractor and surety challenging the default termination.  The federal government’s motion was based on the prime contractor and surety’s failure to comply with the Contract Disputes Act. The Court of Federal Claims explained:

 

“The CDA [Contract Disputes Act] provides that in the event of a dispute between a contractor and the government ‘relating to a contract,’ all contractor claims are to be submitted in writing to the contracting officer for decision and all government claims are to be the subject of a contracting officer decision.  A claim [under Federal Acquisition Regulation 52.233-1(c)] is ‘a written demand or written assertion by one of the contracting parties seeking, as a matter of right, the payment of money in a sum certain, the adjustment or interpretation of contract terms, or other relief arising under or relating to [the] contract.’  Upon receipt of a claim, the contracting officer must issue a written decision containing his or her reasoning for the outcome and advising the contractor of its right to appeal.  If a contracting officer fails to issue a decision ‘within the period required’ by the statute, the failure is deemed to be a decision denying the claim.  The decision of the contracting officer is final unless the contractor makes an authorized appeal.  A valid claim, a contracting officer’s decision or deemed denial, and a proper appeal are all jurisdictional requirements under the CDA [to file a complaint in the Court of Federal Claims].”

The Hanover Insurance Company, supra, at *4 (internal citations omitted).

 

Neither the prime contractor nor its performance bond surety submitted a claim to the contracting officer due to the default termination in accordance with the Contract Disputes Act.  Based on this failure, the federal government argued that the Court of Federal Claims did not have proper jurisdiction to hear the merits of the dispute.  The Court of Federal Claims agreed and dismissed the claims for lack of jurisdiction stating:

 

“In the absence of a final contracting officer decision regarding termination for convenience costs or other money damages related to the default termination,

whether premised on a contractor claim or on a government claim, the court must dismiss the claims for money damages…. This ruling, however, does not foreclose Hanover and Lodge from pursuing these claims. To the contrary, by dismissing these claims for lack of jurisdiction, the court is removing the obstacle preventing the contracting officer from entertaining plaintiffs’ claims for default termination-related money damages.”

The Hanover Insurance Company, supra, at *7.

 

In other words, the prime contractor and surety will need to submit a written claim, await the contracting officer’s obvious denial of the claim, and then re-institute the action in the Court of Federal Claims based on the denial.

 

Since the contracting officer’s decision converting a default termination into a termination for convenience seems fairly transparent, the prime contractor and surety argued, as they should, that it would be futile to comply with the Contract Disputes Act when the contracting officer is going to obviously deny the claim.  Notwithstanding this transparent fact, the Court of Federal Claims relied on case law where a prime contractor sitting in a similar default termination situation was required to submit a claim pursuant to the Contract Disputes Act challenging the default termination in order for the Court of Federal Claims to have jurisdiction.

  

48 CFR 52.233-1

(a) This contract is subject to 41 U.S.C. chapter 71, Contract Disputes.

(b) Except as provided in 41 U.S.C. chapter 71, all disputes arising under or relating to this contract shall be resolved under this clause.

(c) Claim, as used in this clause, means a written demand or written assertion by one of the contracting parties seeking, as a matter of right, the payment of money in a sum certain, the adjustment or interpretation of contract terms, or other relief arising under or relating to this contract. However, a written demand or written assertion by the Contractor seeking the payment of money exceeding $100,000 is not a claim under 41 U.S.C. chapter 71 until certified. A voucher, invoice, or other routine request for payment that is not in dispute when submitted is not a claim under 41 U.S.C. chapter 71. The submission may be converted to a claim under 41 U.S.C. chapter 71, by complying with the submission and certification requirements of this clause, if it is disputed either as to liability or amount or is not acted upon in a reasonable time.

(d)(1) A claim by the Contractor shall be made in writing and, unless otherwise stated in this contract, submitted within 6 years after accrual of the claim to the Contracting Officer for a written decision. A claim by the Government against the Contractor shall be subject to a written decision by the Contracting Officer.

(d)(2)(i) The Contractor shall provide the certification specified in paragraph (d)(2)(iii) of this clause when submitting any claim exceeding $100,000.

(ii) The certification requirement does not apply to issues in controversy that have not been submitted as all or part of a claim.

(iii) The certification shall state as follows: “I certify that the claim is made in good faith; that the supporting data are accurate and complete to the best of my knowledge and belief; that the amount requested accurately reflects the contract adjustment for which the Contractor believes the Government is liable; and that I am authorized to certify the claim on behalf of the Contractor.”

(3) The certification may be executed by any person authorized to bind the Contractor with respect to the claim.

(e) For Contractor claims of $100,000 or less, the Contracting Officer must, if requested in writing by the Contractor, render a decision within 60 days of the request. For Contractor-certified claims over $100,000, the Contracting Officer must, within 60 days, decide the claim or notify the Contractor of the date by which the decision will be made.

(f) The Contracting Officer’s decision shall be final unless the Contractor appeals or files a suit as provided in 41 U.S.C. chapter 71.

(g) If the claim by the Contractor is submitted to the Contracting Officer or a claim by the Government is presented to the Contractor, the parties, by mutual consent, may agree to use alternative dispute resolution (ADR). If the Contractor refuses an offer for ADR, the Contractor shall inform the Contracting Officer, in writing, of the Contractor’s specific reasons for rejecting the offer.

(h) The Government shall pay interest on the amount found due and unpaid from (1) the date that the Contracting Officer receives the claim (certified, if required); or (2) the date that payment otherwise would be due, if that date is later, until the date of payment. With regard to claims having defective certifications, as defined in (FAR) 48 CFR 33.201, interest shall be paid from the date that the Contracting Officer initially receives the claim. Simple interest on claims shall be paid at the rate, fixed by the Secretary of the Treasury as provided in the Act, which is applicable to the period during which the Contracting Officer receives the claim and then at the rate applicable for each 6–month period as fixed by the Treasury Secretary during the pendency of the claim.

(i) The Contractor shall proceed diligently with performance of this contract, pending final resolution of any request for relief, claim, appeal, or action arising under the contract, and comply with any decision of the Contracting Officer.

 

 

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.

 

 

 

 

MAKE SURE ADDITIONAL INSURED COVERAGE IS FOR COMPLETED OPERATIONS

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UnknownCommercial general liability (“CGL”) insurance and additional insured coverage play an integral role in construction defect disputes. Specifically, general contractors want to ensure that they are an additional insured under their subcontractors CGL policies. (Subcontractors that engage other subcontractors to perform a portion of their scope likewise want to be an additional insured under their subcontractors’ CGL policies.) However, just being an additional insured is not enough. The key is that a general contractor should be an additional insured for ongoing operations and, importantly, completed operations since construction defects typically arise out of completed operations.

 

The recent Fifth Circuit decision in Carl E. Woodward, L.L.C. v. Acceptance Indemnity Insurance Co., 2014 WL 902575 (5th Cir. 2014), discusses additional insured coverage and the importance of additional insured coverage for completed operations. This case deals with the construction of a condominium in Mississippi. The general contractor hired a concrete subcontractor that performed work from January 2006 to October 2006 with the entire project being completed in August 2007. The general contractor was an additional insured under the concrete subcontractor’s CGL policy. Subsequent to completion, a construction defect dispute arose in arbitration that involved the concrete subcontractor’s scope of work. The concrete issues appeared to be that the subcontractor failed to properly slope concrete floors including balconies preventing water to drain and that it failed to install a step in the balcony slab at the balcony exterior walls and doors damaging exterior walls of condominium units.

 

The general contractor demanded that the concrete subcontractor’s CGL carrier indemnify and defend it in the dispute since it was an additional insured under the subcontractor’s policy (and the CGL carrier was responsible for indemnifying / defending it due to the negligence of the primary insured-concrete subcontractor). The concrete subcontractor’s CGL carrier refused to defend the general contractor because the additional insured endorsement stated that additional insured coverage was “only with respect to liability arising out of your [primary insured subcontractor’s] ongoing operations performed for that insured.” The endorsement also provided a specific exclusion to additional insured coverage–the additional insured coverage did NOT apply to property damage occurring after all work to be performed by or on behalf of the additional insured has been completed. Basically, there was NO additional insured coverage for completed operations.

 

The general contractor and its insurer filed suit against the concrete subcontractor’s CGL carrier. The argument was that the CGL carrier failed to indemnify and contribute to defense costs in connection with the arbitration. After trial, the district judge entered a judgment in favor of the contractor for approximately $1 Million. The Fifth Circuit reversed this judgment because the dispute arose out of completed operations for which there was no additional insured coverage owed to the general contractor.

 

 

images-1A. What does the additional insured coverage “only with respect to liability arising out of your [primary insured subcontractor’s] ongoing operations performed for that insured” mean

 

The Fifth Circuit (relying on Mississippi law) held that under the additional insured language for ongoing operations, liability simply needs to arise out of ongoing operations–liability needs to be causally connected to the the subcontractor’s ongoing operations. But, what exactly does this mean? To determine what this specifically means, the Fifth Circuit examined the case of Noble v. Wellington Assoc., 2013 WL 6067991 (Miss.Ct.App. 2013), that involved post-completion foundation cracks in a house attributable to the site subcontractor’s compaction (before the house was even constructed). In Noble, the court maintained:

 

“Noble [additional insured] was only an additional insured for liability caused by Harris’s [site subcontractor] active [ongoing] work on the site and…did not cover property damage manifesting itself after Harris stopped working on the site…. [I]f Harris’s performance caused the damage for which Noble was liable, the cause was Harris’s completed work, not its ongoing operations. ” Carl E. Woodward, supra, at *6.

 

 

The Fifth Circuit further examined the Colorado case, Weitz Co., LLC v. Mid-Century Ins., Co., 181 P.3d 309 (Colo.App. 2007), whereby an owner observed water intrusion damage five months after the subcontractor completed its work. In Weitz, the court maintained:

 

“Because the contractor’s [additional insured] liability for the water intrusion damage arose out of the subcontractor’s completed operations–the work was completed five months before the intrusion–rather than its ongoing operations, there was no coverage under the additional-insured endorsement.” Carl E. Woodward, supra, at *7.

 

Additionally, the Fifth Circuit maintained that the additional insured endorsement (factoring in the specific exclusion that excluded property damage occurring after all work has been completed) only provided coverage for the concrete subcontractor’s ongoing (active) operations. In other words, it does not matter when the claim is actually filed as long as the liability does not arise out of completed operations.

 

Typically, and even as the Fifth Circuit noted, liability for construction defects arise out of completed operations. Even if liability arose out of the concrete subcontractor’s scope of work, the liability did not arise out of the subcontractor’s active / ongoing operations, but from the completed construction (when the owner received the completed building-substantial completion). Thus, once all work is completed, the liability and damage will arise from completed operations.

 

B. CGL is not a performance bond

 

CGL insurance is not a performance bond. I repeat, CGL insurance is not a performance bond. The reason for the repetition is because oftentimes arguments are made to essentially convert CGL insurance into a performance bond. The Fifth Circuit explained the difference between these two products that insure different risks:

 

“Allowing coverage under this [additional insured] endorsement because of an allegation that the additional insured failed to follow plans and specifications, effectively converts a CGL policy into a performance bond.
***
[A] performance bond is a form of insurance that guarantees the completion of the general contractor’s work on the project. This Circuit has previously noted the significance of the difference between these two forms of insurance [CGL and performance bond]: A CGL policy generally protects the insured when his work damages someone else’s property. The ‘your work’ exclusion [in the policy] prevent a CGL policy from morphing into a performance bond covering an insured’s own work.” Carl E. Woodward, supra, at *7 (internal quotations and citations omitted).

 

C. Take-aways

 

  • Take a look at the CGL policy and additional insured endorsement. There is a good chance the additional insured endorsement only provides additional insured status for ONGOING OPERATIONS and NOT COMPLETED OPERATIONS! This is absolutely not what a GC wants. It wants additional insured status for both ongoing and completed operations so that it can seek indemnification and defense for issues that arise post-completion.

 

  • Construction defect disputes often arise after substantial completion and after the owner receives the project. It is the owner that asserts the claim against the general contractor and the general contractor seeks indemnification and defense as an additional insured under subcontractors’ policies. If the subcontractor’s CGL policy does not provide for additional insured coverage for completed operations, courts and insurers will likely apply the same logic taken by the Fifth Circuit in this case. This is why obtaining a copy of the endorsement and requiring additional insured status for completed operations is important.

 

  • Even though contracts typically require the subcontractor to include additional insured coverage for completed operations, what the contract requires and what the policy states are oftentimes two different things. So, what is the recourse if a subcontractor’s policy does not comply with this provision? Well, you could include that the subcontractor failing to provide additional insured coverage for completed operations constitutes a material breach of contract. But, even if the contractor learns the right additional insured coverage is not being provided during construction, the chances of it terminating the subcontractor (and delaying the job) and finding a new subcontractor are probably slim to none. So what other recourse is there if this is learned during construction? Perhaps, if learned during construction, the provision can state that the general contractor is entitled to keep the subcontractor’s retainage as a form of liquidated damages based on damages that are not readily ascertainable. The subcontractor probably will not agree to such a provision. And, oftentimes, like this case, the additional insured coverage is not learned until after-the-fact when it is too late. Then what? Well, the contract already has an indemnification provision that would make the subcontractor responsible. The problem is that this provision is not additional insured coverage. Therefore, obtaining copies of subcontractors’ additional insured endorsements on the front end to determine whether there is coverage for completed operations is important.

 

  • CGL insurance is not a performance bond. They are two different insurance-type products with different purposes. Both can play a role in construction defect disputes. It is important to understand and appreciate their differences.

 

  • Finally, parties oftentimes try to navigate complicated CGL issues by themselves. This is a mistake. Parties should retain the services of counsel to assist them to ensure insurance claims are maximized and, if there is a performance bond in place, rights are preserved.

 

For more on additional insured coverage, please see: https://floridaconstru.wpengine.com/understanding-your-rights-as-an-additional-insured/

 

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.

 

PRESERVING PERFORMANCE BOND CLAIMS

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rPerformance bonds can be a valuable source of protection to owners that want their general contractors to provide a performance bond and, likewise, to general contractors that want certain subcontractors to provide a performance bond. The performance bond is designed to benefit the obligee in the event the contractor that issues the bond defaults under its contractual obligations. It is absolutely crucial that parties take the proper steps under the terms of the performance bonds to preserve their rights and arguments under the bond. To do this requires an unequivocal formal default of the contractor that issued the bond and that the party will be looking solely to the surety to complete the defaulted party’s contractual obligations. Otherwise, a court will rule in favor of the surety finding that the obligee of the bond did not comply with conditions precedent to preserve the performance bond claim and/or breached the terms of the bond by not allowing the surety to investigate and complete performance. This is exactly the situation in two federal district court summary judgment opinions relying on Florida law: North American Specialty Insurance Co. v. Ames Corp., 2010 WL 1027866 (S.D.Fla. 2010) and CC-Aventura, Inc. v. Weitz Co., 2008 WL 2699577 (S.D.Fla. 2008). Both of these cases illustrate the importance of formally and unequivocally declaring the party that issued the performance bond in default irrespective of whether the issue arises pre-completion or post-completion. Both cases also pertain to a subcontractor that provided a performance bond identifying the general contractor as the obligee (or beneficiary) of the bond.

 

I. North American Specialty Ins. Co. v. Ames Corp. (Pre-Completion)

 
In this case, a general contractor hired a roofer for a federal project. The roofer provided performance bonds identifying the general contractor as the obligee. The bonds provided as follows (which is common language in performance bonds):

 

“Whenever Principal shall be, and be declared by Obligee to be in default under the subcontract, the Obligee having performed Obligee’s obligations thereunder:

(1) Surety may promptly remedy the default …;

(2) Obligee after reasonable notice to Surety may, or Surety upon demand of Obligee may arrange for the performance of Principal’s obligation under the subcontract …;

(3) … If the Surety arranges completion or remedies the default, that portion of the balance of the subcontract price as may be required to complete the subcontract or remedy the default and to reimburse the Surety for its outlays shall be paid to the Surety at the times and in the manner as said sums would have been payable to Principal had there been no default under the subcontract.”

Ames Corp., 2010 WL at *1.

 

During construction, the general contractor notified the surety that the roofer was refusing to perform and that the general contractor will look to the surety for costs incurred above the roofer’s subcontract amount. A follow-up notice advised the surety that expenses were being incurred to finish the roofer’s subcontract amount and no one from the surety visited the jobsite. The surety then commenced an investigation while advising the general contractor that the “prior letters were not accompanied by supporting documentation and/or prior notice to the principal of default and/or potential default.” Ames Corp., 2010 WL at *3. A meeting was coordinated with the owner, the general contractor, the roofer, and the roofer’s surety at which time the surety represented it would need up to 5 months to assume responsibility and take action. After this meeting, the general contractor sent another letter to the surety and the roofer explaining that the roofing subcontract was not terminated or declared in default and that the surety needed to appreciate the short time allotted for completing the roofer’s contract. The surety responded that because the general contractor had not declared the roofer in default, the surety had no obligation to act under the performance bonds.

 

Notwithstanding the general contractor never formally declaring the subcontractor in default, it supplemented the roofer’s scope of work. Both the roofer and the surety objected; the surety even advised that such efforts would be a material breach of the bonds. However, due to leaks with the roofing system (the manufacturer of the roofing system inspected the roof and found that there were installation defects), the general contractor incurred substantial costs to complete the roofer’s scope of work which exceeded the roofer’s subcontract balance. In addition, the general contractor incurred delay damages associated with completing the roofer’s scope of work.

 

The surety initiated this lawsuit based on the monetary demands from the general contractor. The surety moved for summary judgment based on the argument that a condition precedent to the bonds obligations was never triggered, that being that the general contractor never declared the roofer in default. The surety also argued that the general contractor breached the bonds by not allowing the surety the right to remedy any default and by not making available to the surety the unpaid subcontract balance in connection with the surety remedying the default.

 

Relying on Florida law, the Southern District found:

 

[A] surety’s liability on a bond is determined strictly from the terms and conditions of the bond agreement. The purpose of a performance bond is to guarantee completion of the contract upon default by the contractor.

***

A declaration of default sufficient to invoke the surety’s obligations under the bond must be made in clear, direct, and unequivocal language. The declaration must inform the surety that the principal has committed a material breach or series of material breaches of the subcontract, that the obligee regards the subcontract as terminated, and that the surety must immediately commence performing under the terms of the bond.

Ames Corp., 2010 WL at *6 (internal citations and quotations omitted).

 

Based on this law, the Southern District held that none of the letters the general contractor sent to the surety defaulted the roofer in clear, direct, and unequivocal language. While the letters urged the surety to become involved and threatened default, they did not formally and unequivocally default the roofer. Accordingly, the court granted summary judgment in favor of the surety.

 

Furthermore, the Southern District agreed with the surety that the general contractor breached the bond by completing / supplementing the subcontract without giving the surety the opportunity to remedy any default under the subcontract. As the court explained: “‘[O]nce Ames/Dawson [general contractor] engaged in the supplementation of work without allowing NAS [surety] to perform, its conduct constituted a material breach that voided the bond.” Ames Corp., 2010 WL at *9.

 

II. CC-Aventura, Inc. v. Weitz Co. (Post-Completion)

 

In this case, the general contractor was hired to construct a senior living facility. The general contractor hired a painter with a subcontract that contained an indemnification provision and a provision that required the painter to correct defective work. The painter provided a performance bond identifying the general contractor as the obligee.

 

pAfter completion of the project, the owner sued the general contractor for water intrusion and damage. The general contractor sued subcontractors including its painting subcontractor. The general contractor also asserted a claim against the painting subcontractor’s performance bond surety for breach of the bond. The surety moved for summary judgment arguing that the bond obligations were never triggered because the general contractor never formally declared the painting subcontractor in default.

 

The general contractor argued that it did provide default notices when it transmitted the owner’s expert and its expert reports regarding the paint that the painter applied. In the notices, the general contractor demanded that the surety correct the defects and that the painter’s failure to take corrective action will be a default under the subcontract.

 

The surety took the position that these types of notices were insufficient. The Southern District of Florida agreed and granted summary judgment in favor of the surety finding:

 

“Both of Weitz’s [general contractor] letters do state that Delta [subcontractor] is in ‘default’ of its Subcontract-and had Weitz maintained that position and indicated that Weitz now looked to American Casualty [surety] alone, both of its letters could reasonably be interpreted as declarations of default sufficient to trigger American Casualty’s liability on the Bond. However, in its December 30, 2005 letter Weitz also advised Delta to ‘please accept this letter as The Weitz Company’s final written demand that Delta Painting or its Surety take appropriate corrective action’….In its April 11, 2006 letter, Weitz reiterated that it had made ‘numerous demands upon both Delta and American to correct [the painting] deficiency.’ Weitz then stated its intention to perform the corrective work itself and announced that ‘Weitz will seek such costs and all other damages from Delta and American.’ If Weitz wanted to trigger American Casualty’s obligations on the Bond, it would have had to clearly and unambiguously notify American Casualty that it now looked to it to complete Subcontract obligations, in accordance with the Bond.”

CC-Aventura, 2008 WL at *4.

 

 

As illustrated above, there are certainly procedural hurdles that are required to take place in order to properly default a contractor that provided a performance bond. Not doing so can be fatal to the performance bond claim. Default is always viewed as a last resort because parties do not want to be in material breach for incorrectly defaulting or terminating a party. However, by not defaulting a party, the performance bond’s obligations are not triggered. Due to these hurdles, general contractors are now obtaining subguard (subcontractor default insurance) instead of requiring individual subcontractors to provide performance bonds. This allows the general contractor to be more involved in the process since it is the one obtaining subguard and it eliminates subcontractors from having to obtain the bond (which could be problematic for certain subcontractors).

 

For more on performance bonds, please visit: https://floridaconstru.wpengine.com/statute-of-limitations-on-performance-bond-claims/

 

 

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.