A performance bond is a valuable tool designed to guarantee the performance of the principal of the contract made part of the bond. But, it is only a valuable tool if the obligee (entity the bond is designed to benefit) understands that it needs to properly trigger the performance bond if it is looking to the bond (surety) to remedy and pay for a contractual default. If the performance bond is not properly triggered and a suit is brought upon the bond then the obligee could be the one materially breaching the terms of the bond. This means the obligee has no recourse under the performance bond. This is a huge downside when the obligee wanted the security of the performance bond, and reimbursed the bond principal for the premium of the bond, in order to address and remediate a default under the underlying contract.
A recent example of this downside can be found in the Southern District of Florida’s decision in Arch Ins. Co. v. John Moriarty & Associates of Florida, Inc., 2016 WL 7324144 (S.D.Fla. 2016). Here, a general contractor sued a subcontractor’s performance bond surety for an approximate $1M cost overrun associated with the performance of the subcontractor’s subcontract (the contract made part of the subcontractor’s performance bond). The surety moved for summary judgment arguing that the general contractor failed to property trigger the performance bond and, therefore, materially breached the bond. The trial court granted the summary judgment in favor of the performance bond surety. Why?
The performance bond in this case appeared to be an AIA performance bond (the AIA Document A312 Performance Bond or modified version thereof). This appears clear from the following finding by the court:
Under the bond in this case, Arch’s [performance bond surety] obligations are not triggered unless Moriarty [general contractor-obligee]: (1) first provides notice to R.C. [subcontractor-principal of bond] and Arch that it is “considering declaring a Contractor Default”; (2) “declares a Contractor Default, terminates the Construction Contract and notifies [Arch]”; and (3) “agree[s] to pay the Balance of the Contract Price … to [Arch] or to a contractor selected to perform the Construction Contract.” …Once Moriarty complies with those three conditions precedent, the bond then requires Moriarty to allow Arch to mitigate its damages by arranging for the completion of the subcontract itself. Lastly, before Moriarty may properly make a demand under the bond, it must provide seven days’ notice to Arch.”
The general contractor, as commonly done, notified the subcontractor and subcontractor’s surety that it was considering declaring the subcontractor in default, but never (i) formally declared the subcontractor in default, (ii) terminated the subcontractor, or (iii) agreed to pay the subcontract balance to the performance bond surety. Thus, the general contractor (obligee) never allowed the surety to mitigate damages by arranging completion of the subcontract upon the subcontractor’s (bond principal) default.
Remember, in order to preserve a performance bond claim it is important to properly trigger the performance bond and the surety’s role under the bond. This means dotting your i’s and crossing your t’s when it comes to declaring the bond principal in default under the specific terms of the bond. Moreover, if you are the obligee, consider preparing the performance bond form so that you can remove some of the underlying notice provisions in the bond to make the bond more favorable to you.
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.