Preserving claims made against performance bonds on construction projects - by Andrew Richards

August 07, 2018 - Long Island
Andrew Richards, Kaufman
Dolowich & Voluck, LLP

On many construction projects, owners require general contractors to provide performance bonds which guaranty the performance of the general contractor’s work at the project in the event the general contractor abandons the project or the contract is terminated for cause. Many times the contract between the owner and general contractor has termination provisions which do not coincide with the performance bond’s termination provisions required to trigger the surety’s obligations under the performance bond. There are instances when an owner follows the termination provisions of a contract but fails to follow the termination provisions of the performance bond precluding a claim against the bond.

Virtually all owner/general contractor contracts have provisions that state that the owner may terminate the contract for cause when, for example, the contractor fails to perform its work in a good and workmanlike manner or does not provide the necessary manpower to complete its work by the substantial completion date.  These provisions require the owner to provide notice to the contractor of the default and that the contractor has a specified period of time, e.g., one week, to remedy the default or the contract will be terminated.  However, many performance bonds such as the AIA A312 bond require the owner to provide notice to the surety that the owner is considering declaring the contractor in default and seeks a conference with the contractor and its surety to be held within 15 days of their receipt of the notice. If the surety fails or refuses to meet with the owner within the 15-day period, the owner may then terminate the contract for cause no earlier than 20 days from the surety’s receipt of the aforesaid notice.  

If the owner follows only the contractual notice to remedy provision of one week and then terminates the contract for cause after the one week period, the owner will have failed to fulfill the condition precedent in the performance bond and will be precluded from bringing a claim against the bond.  If the contractor does not have sufficient assets to indemnify the owner for any costs incurred to complete the contractor’s work over and above the contract price, the owner will have to pay the excess costs without any reimbursement.  

Now, if the owner finds itself in a position where it followed only the termination for cause provisions of the contract but not the performance bond, one may ask if the owner could retract its termination and start the default and termination process again. There is little case law on this subject to provide guidance.  Arguments have been made by contractors based on treatises that if the owner repudiates a contract and the contractor (i) indicates to the owner that the contractor considers the repudiation to be final, or (ii) materially changes its position in reliance of the repudiation, the retraction of the repudiation has no effect. This is not a position that an owner wants to be in; i.e., engaging in litigation with the surety over whether the surety has any duty under the bond at all.  All the owner should have to litigate is the claim itself.  

There are many different scenarios and facts that have to be taken into account to determine whether the retraction of the repudiation will be valid.  However, it is critical for the owner’s field and home office representatives to make sure that they follow the bond requirements for termination so that the owner is not precluded from bringing a bond claim. Many times the owner’s personnel “jump the gun” and send out termination notices without reviewing the terms of the bond.  When that happens, the money spent by the owner on the bond premium becomes worthless and the owner may end up having no recourse for the contractor’s breach of contract.

Andrew Richards is a co-managing partner – Long Island office, chairman of construction practice group, at Kaufman Dolowich & Voluck, LLP, Woodbury, N.Y.

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