There have been a couple of decisions as of late, particularly in federal court, that have gone in favor of a performance bond surety and against a general contractor’s claim against a subcontractor’s performance bond. These decisions have been so unfavorable that they may be swaying certain internal decisions to move to subcontractor default insurance with, perhaps, subcontractors that pose less risk. From the general contractor’s perspective, if they have to stop the management of the job and progress to jump through hoops to trigger the performance bond’s obligations, rightfully or wrongfully, the bond may not provide them the value they need. Performance bonds are an appropriate product in many instances, but there should be more consistency regarding the actual trigger of a subcontractor’s performance bond obligations. Project teams need to absolutely understand what efforts they need to take, and how they need to take such efforts, in order to properly trigger a performance bond’s obligations. This is a must (and I have presented many seminars on this very issue). Or, the general contractor should move away from the traditional AIA /standard performance bond form, which is the direction I always go when I am involved in the drafting of a performance bond.
To discuss the consternation with triggering subcontractor performance bond obligations, one just has to look at the recent decision in International Fidelity Ins. Co. v. Americabe-Moriarty JV, 2017 WL 766912 (11th Cir. 2017). This appellate decision dealt with the fundamental issue of whether the contractor properly triggered a subcontractor’s performance bond. The appellate court found that it did not. This meant that the general contractor breached the terms of the performance bond, discharging the bond’s obligations, and the surety was off the hook for any subcontractor default. This is clearly not what the general contractor intended when it wanted its subcontractor to be bonded.
In this case, the subcontract provided that if the subcontractor failed to cure a default after a three-day notice to cure period, the general contractor was at liberty to terminate the subcontract upon an additional three day notice to the subcontractor, which it could then take possession of materials and employ others to complete the work.
The performance bond incorporated the subcontract. (Every performance bond will incorporate the applicable contract.) The performance bond further contained the following routine language applicable to standard-form bonds:
§ 3 If there is no Owner Default under the Construction Contract, the Surety’s obligation under this Bond shall arise after
.1 the Owner first provides notice to the Contractor and the Surety that the Owner is considering declaring a Contractor Default. Such notice shall indicate whether the Owner is requesting a conference among the Owner, Contractor and Surety to discuss the Contractor’s performance….
.2 the Owner declares a Contractor Default, terminates the Construction Contract and notifies the Surety; and
.3 the Owner has agreed to pay the Balance of the Contract Price in accordance with the terms of the Construction Contract to the Surety or to a contractor selected to perform the Construction Contract.
§ 5 When the Owner has satisfied the conditions of Section 3, the Surety shall promptly and at the Surety’s expense take one of the following actions:
§ 5.1 Arrange for the Contractor, with the consent of the Owner, to perform and complete the Construction Contract;
§ 5.2 Undertake to perform and complete the Construction Contract itself, through its agents or independent contractors;
§ 5.3 Obtain bids or negotiated proposals from qualified contractors acceptable to the Owner for a contract for performance and completion of the Construction Contract …; or
§ 5.4 Waive its right to perform and complete, arrange for completion, or obtain a new contractor and with reasonable promptness under the circumstances:
.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, make payment to the Owner; or
.2 Deny liability in whole or in part and notify the Owner, citing the reasons for denial.
§ 6 If the Surety does not proceed as provided in Section 5 with reasonable promptness, the Surety shall be deemed to be in default on this Bond seven days after receipt of an additional written notice from the Owner to the Surety demanding that the Surety perform its obligations under this Bond, and the Owner shall be entitled to enforce any remedy available to the Owner.
On August 17, 2015, the general contractor issued a notice of default to the subcontractor and surety. This was sent per the subcontract and section 3 of the bond. On August 20, 2015, the surety responded that it needed more information and directed the contractor not to take any steps without the written consent of the surety. A conference call was held on September 2, 2015. Thereafter, on September 21, 2015, the contractor sent the subcontractor and surety a letter terminating the subcontractor and notifying the surety that it will pay the surety the balance of the subcontract amount consistent with section 3 of the bond. On October 1, 2015, the contractor sent the surety the additional notice required by section 6 of the bond, which started the 7-day clock.
However—and this is a HUGE however per the court—on September 16, 2015 the contractor got a cost proposal from a completion subcontractor relating to completing the defaulted subcontractor’s scope. The completion subcontractor sent a schedule reflecting a start state of September 21, 2015. By September 23, 2015, the completion subcontractor had begun certain work at the project.
Thus, after the surety got the October 1, 2015 letter, it sent the contractor a letter on October 8, 2015 advising the contractor that its actions engaging a completion subcontractor discharged its obligations on the bond. The contractor responded that the surety was in default of the bond by not acting with reasonable promptness per section 5 of the bond. This lawsuit was then initiated.
As mentioned, the Eleventh Circuit held that the contractor breached the terms of the performance bond discharging the surety’s obligations under the bond. In other words, the performance bond was never properly triggered:
Here, both the bond and subcontract required Americaribe [contractor] to provide notice to Fidelity [performance bond surety] when terminating CPM [subcontractor]. Americaribe did provide notice on September 21. However, the subcontract required the contractor give three-days notice before undertaking to complete the work. And the bond gave Fidelity time to choose among four options for undertaking the work itself, after Americaribe sent the termination notice. This undefined period of time was then followed by another requirement for Americaribe to provide seven-days notice before Fidelity would be in default. Neither the bond nor the contract allowed Americaribe to immediately hire Dillon to complete the work.
Before Americaribe sent the termination notice on September 21, Dillon [completion subcontractor] had already sent Americaribe a proposal for completing the work remaining on the subcontract, as well as a schedule with a presumed start date of September 21. Then, on September 22, Americaribe sent vendors of CPM a letter, copying Fidelity, informing them of CPM’s termination and that “[Americaribe] intends to award the subcontract to complete the remaining work … to Dillon.” As of September 23, Dillon had commenced some work required for the project. Thus, the question is whether these actions breached the notice provisions of the bond and subcontract.
Americaribe did not comply with the subcontract’s three-day notice requirement. It had already hired Dillon, which began remedying the defaulted work during that three-day period. Neither did Americaribe comply with the bond’s requirements, which expressly afforded Fidelity time to elect among options for completing the defaulted work. Americaribe’s immediate hiring of Dillon to complete the project and the costs Dillon incurred completing CPM’s work thwarted Fidelity’s ability to choose among the options it had for remedying CPM’s default under § 5 of the bond. Therefore, Fidelity is not liable on the bond.
This is a very, very harsh outcome. Although I mentioned this above, it is imperative that the project team understand the steps it needs to take to properly default a subcontractor and trigger the subcontractor’s performance bond. Not doing so will render the value of the performance bond useless to the general contractor that is relying on the security of that 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.