Construction Law Insider

When an owner requires a contractor to post a payment and performance bond, the contractor, invariably, provides a bond in the form of AIA Document A312-2010. The payment portion of the bond is primarily for the benefit of the contractor’s subcontractors and allows the subcontractors to make a claim on the bond for nonpayment. The performance portion is for the benefit of the owner and allows the owner, theoretically, to make a claim on the bond if the contractor defaults. We say “theoretically” because the performance bond portion of the A312 is so full of conditions and traps for the unwary owner that it may be of little value. For this reason, we caution against the use of the A312 and recommend that a manuscript form developed by counsel for the owner and negotiated with the surety be utilized.

One would think that a surety under a performance bond simply guarantees the full performance of the contractor and acts as an insurer against losses an owner suffers as a result of the contractor’s default. While on its face, the A312 provides this coverage, it contains many pitfalls which may deny the owner the benefit of its bargain.

A step-by-step analysis of the requirements of the A312 bears this out.

1. If the contractor is in default, the owner must first provide notice to the contractor and the surety that it is considering declaring the contractor in default. Either the owner or the surety can then request a conference among the parties within ten business days of the surety’s receipt of the owner’s notice, to discuss the contractor’s performance.
2. Assuming the default is not resolved, the owner must then declare a default, terminate the contract, notify the surety, and agree to pay the balance of the contract price to the surety.
3. Once the owner satisfies the foregoing requirements, the surety must promptly and at the surety’s expense take one of the following actions: (a) arrange for the contractor to perform and complete the contract; (b) perform the contract itself or through its agents or contractors; (c) arrange for other contractors to complete the work and pay the owner any damages incurred, including costs in excess of the balance of the contract price; or (d) waive its rights to any of the foregoing and either pay the owner its damages or deny liability.
4. If the surety does not proceed “with reasonable promptness” as provided above, it will be deemed in default of the bond after seven days additional written notice by the owner to the surety demanding that it perform under the terms of the bond.
5. Only then may the owner bring suit on the bond, but no more than two years after the earlier of (a) the declaration of default by the owner; (b) the date the contractor ceased work; or (c) the date the surety refuses or fails to perform its obligations under the bond.

In our view, these multiple steps make it more difficult for an owner to seek recourse under the bond, and only if these requirements are strictly followed--as may be determined by a court--will the owner have such recourse. Bearing in mind that the purpose of the performance bond is to, in effect, guaranty the contractor’s full performance and, in our view, the bond need only state that if the contractor defaults, and the owner is not in default, the surety will pay the owner’s losses after the owner declares the contractor in default. Among other things, the owner should not be required to terminate the contract as a condition to making a claim on the bond and the bond should survive for the full six-year statute of limitations for breach of contract. This becomes particularly important where the default involves post completion defaults, such as the failure to correct defective work, or the owner has suffered delay damages because of the contractor’s default.

Another industry form of which to be wary is the ConsensusDocs 260 Performance Bond (2020). While this form does not require termination of the contract before making a claim on the bond, it allows the surety, after being notified on a contractor default, a period of time to investigate the default and make its own determination of the contractor’s default. Only if the surety determines that the contractor is in default is it required to elect one of various remedial courses, such as completing the work, arranging for the owner to complete the work by another contractor, or reimbursing the owner to complete the work. As with the A312, the 260 has an objectionable two-year statute of limitations for bringing suit on the bond.

In view of the above , we suggest that owners avoid using the A312 or 260. Instead, they should use a manuscript form of bond, which simply provides that, if the contractor is in default, the surety will correct or complete the contractor’s work at its cost. Additionally, the owner’s contract should state that where the contractor is required to post a bond it will be on a manuscript form acceptable to the owner. Of course, even with these provisions, the surety can still deny the default of the contractor and liability on the bond, but the manuscript form should allow for a prompt judicial determination of the merits of the claim and avoid the pitfalls of the A312 and 260.

For more information on the topic discussed, contact:

• Melissa T. Billig  |  billig@thsh.com  |  212-508-6730
• Kenneth M. Block  |  block@thsh.com  |  212-508-6790
• Brandon P. Reiner  |  reiner@thsh.com  |  212-508-7527
• Stuart Rosen  |  rosen@thsh.com  |  212-508-6719
• Hillel E. Sussman  |  sussman@thsh.com  |  212-508-6704