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 email@example.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.