Making a Claim Under a Performance Bond
Surety bonds are an essential component of any prudent construction risk management strategy. Surety bonds provide critical protection to construction purchasers and investors against the perils of contractor default.
In order to take advantage of this protection, owners should understand their obligations under the bond and the contract and ensure compliance with these obligations. One very important obligation is to have paid (in a timely and proper way) the principal for work completed as per the specific terms and conditions of the bonded contract.
Upon receipt of a claim made under the bond, the surety will commence an investigation in order to ascertain the validity of the claim. In other words the surety will attempt to determine if both the obligee and principal have met their respective obligations under both the contract and bond.
To make a claim under a standard performance bond, three conditions must be met:
- The owner (obligee) must formally (in writing) declare the bonded contractor (principal) in default under the contract’s terms and conditions.
- The contractor must actually be in default under the contract’s terms and conditions.
- The owner must have fulfilled their obligations under the contract.
If all three conditions are met, there are four options available to the surety:
The surety can take action to “fix” the situation that created the default and thereby convince the owner to rescind the declaration of default and allow the contractor to continue.
The surety can enter into a formal contract with the owner to complete the contractor’s obligations under the contract.
Arrange for Completion
The surety can arrange for a replacement contractor to complete the bonded contractor’s obligations. Under this approach, the surety would arrange for a completion contract to be executed between the owner and replacement contractor. If this method is chosen, the surety will absorb the additional cost above the original contract amount.
The surety will pay a sum of money to the owner which is the lesser of: a) the excess cost to complete or b) the amount of the bond.
The following is typical information/documentation that must be submitted to the surety when making a claim under the performance bond. As each claim is different, other and/or additional documentation may be required, depending upon the circumstances:
- A complete copy of the contract with the Principal with respect to the subject project.
- Copies of change orders issued with respect to the contract.
- Copies of all progress billings in connection with the contract.
- A summary of all payments made including the date of each payment.
- An up-to-date summary of the contract accounting between he Obligee and Principal.
- All evidence in connection with the termination of the contract or the declaration of default confirming that it was done in accordance with the terms of the contract.
- Copies of any claims for a lien or written notices of claims received.
- Any other documents which would assist in establishing the validity of the claim.
- Specific explanation as to the grounds upon which the contractor was declared to be in default.
When a Surety Will Not and Should Not Respond Under a Performance Bond
No declaration of default
When there has been no declaration of default, there is no reason or justification for a Surety to act in this situation.
When the Surety is not satisfied that the contractor is in fact in default
Often a situation arises where a contractor refuses to do certain work which they feel is not within the scope of their contract, while the Obligee believes that it is. This is a dispute which should be resolved between the parties themselves or with assistance of mediators, arbitrators or if need be, the Courts.
When the Obligee has not fulfilled their contractual obligations
The typical situation is one where the Obligee has failed to make payments contractually due.
When the Obligee has acted in a manner prejudicial to the Surety
A typical situation would be one where the three (3) conditions precedent to invoking the Bond had been fulfilled, but where an Obligee has made payments in advance of work having been completed where there is no provision in the contract for such payments.
This information is intended to serve as a general guideline to assist members and other readers in responding to the issues discussed. Nothing contained herein should be construed as legal advice and readers are cautioned to consult with legal counsel for such advice.