As noted in the first
surety bond article in this series, public
and private obligees, including property owners and general contractors, are
rewriting bond forms and contract provisions for contractors or subcontractors.
Detert, Moran & Arnold LLP
The following are more examples. This expert commentary is the third in the
In no event, however, shall Surety be required to pay more than a sum equal
to  the original contract price as amended from time to time together
with  any additional sums accruing as the result of amendments to the
original contract prior to default and  sums necessary to remedy any
damage or depreciation suffered by the project, with the exception that
in additional hereto, Surety shall be required to pay  all costs and
attorney's fees the Obligee incurred in enforcing the Bond.
By using the words "in no event, however, shall Surety be required," this
provision appears to be worded in a way to make it seem as if there is some
limitation as to the surety's liability on the bond. However, the four categories
of damages for which the surety is liable essentially encompass the entirety
of what a surety could possibly be liable for under a performance bond. There
essentially is no penal sum or limit of liability for the surety. It includes
penal sum increases as a result of change orders by virtue of the second clause,
i.e., any additional sums accruing as the results of amendments to the original
contract. It includes consequential damages with the broad term "any damage…suffered
by the project." And, it includes costs and attorney fees regardless of how
Surety shall not have the right, if Obligee completes, to object on the
grounds that Obligee's successor contractor is not the lowest and best bidder
or that the successor contract price is excessive unless the objection is
based on demonstrated amendments to the plans and specifications made after
the declared default and constituting new work.
Surety shall be liable to Obligee for all consequential damages resulting
from Surety's breach of this performance bond.
This approach on the part of obligees is one of the main reasons that sureties
often opt to take over a project rather than allow the obligee to complete the
project. Often, when an obligee completes, it will either have the work performed
on a time and material or cost-plus basis, thereby running the risk of completion
costs far in excess of the original contract price. Even if the obligee does
not perform the project on a time and material basis, it might select a favored
contractor or subcontractor to do the work and negotiate a contact price that
is, again, significantly greater than the cost of a competitively bid project.
Even if a surety does not decide to take over a project, a surety typically
has the argument that the obligee has included betterments or upgrades in its
completion work for which the surety is not obligated to reimburse to the obligee.
The above clause seemingly removes that argument. Admittedly, the argument is
not a very effective one for a surety in the first place—it is typically an
uphill battle. Essentially, the surety argues that the obligee has performed
work that is outside the scope of the plans and specifications of the underlying
bonded contract. However, there are subtleties in the quality of materials incorporated
into a project and it is those upgrades that would be the subject of a surety's
objection if the above clause were not included in the bond.
By the same token, upon reading the above provision in detail, in actuality,
it is saying the same thing that sureties contend, i.e., that they are not liable
for any work performed outside of the scope of the plans and specifications
of the contract. Only if there are "amendments to the plans and specifications,"
that is, work performed outside the scope of the original plans and specifications,
can the surety object to the obligee's expenditures in the sense of not being
liable for same. Thus, although the language is unusual, the provision arguably
is not significantly different from what a surety can and cannot object to when
responding to an obligee's demand for reimbursement.
As to the amount of the bid or lump sum contract price for a completion contract,
as long as the work being performed is within the scope of the plans and specifications
and as long as there was no collusion between the obligee and the completion
contract, a surety's argument that the obligee did not mitigate its damages
by selecting the least expensive responsible or qualified prospective completion
contractor is also an uphill battle. It is more than likely that the obligee
will have sufficient grounds for selecting its completion contractor such that
the surety will lose on its failure-to-mitigate argument.
If Principal breaches the Contract (as determined in Obligee's sole discretion),
Surety will, within 7 days after written notice of breach, commence to complete
the Contract. If, at its option, Obligee elects to complete, using contractors,
subcontractors, or materials that Obligee, in its sole discretion, deems
necessary, Surety will immediately pay Obligee's invoices without contest,
waiving all defenses that either Surety or Principal may have under the
Bond or the Contract.
By this provision, the surety must complete if the obligee requires it to
complete but cannot insist upon completing if the obligee elects to complete—the
worst of both possible scenarios from a surety's perspective. Further, if the
obligee completes, the surety waives all defenses, including arguably that it
is exonerated by virtue of the default of the obligee. The waiver language does
not apply if the surety completes. Accordingly, the surety could arguably complete
under a reservation of rights and then pursue its excess costs against the obligee
if it determines that the obligee was in default.
Of course, it would be impossible for the surety to commence completion in
7 days of notice of the breach. This provision implies that the surety industry
has a group of contractors in every possible type of construction standing by
to mobilize within a week and commence completion. It just does not happen that
way. It is likely that the surety will obtain an extension to that 7-day requirement.
It is also likely that an obligee would be satisfied if within that 7 days or
some other very short time frame, the surety advised the obligee that it would
complete and explained what needed to be done to proceed forward in that fashion
and a time estimate as to when completion would actually commence.
In the event of the failure of Developer to complete the work covered by
the performance bond and Obligee completes construction of the improvements,
Developer and Surety under the performance bond shall be jointly and severally
liable to Obligee for such costs of completion, including but not limited
to, management and administrative costs, and engineering, legal and other
costs incurred relating to the completion. Obligee shall bill Developer
and Surety for such costs, which bill shall be paid within thirty (30) days
after its date. Interest shall accrue on any late payment at the legal rate
Arguably, each of the elements of damages described in the above provision
would be included within a subdivision bond, i.e., costs of completion, and
management, administrative, engineering, legal, and other costs incurred in
completing the improvements. The payment for such costs in 30 days is unusual
but arguably not onerous when compared to the 40 days in which a surety is to
reject or deny a claim under California's Fair Claims Settlement Practices Regulations.
Moreover, assuming the obligee has put the surety on notice of its intent to
complete the improvements, the surety arguably had the opportunity to inspect
what the obligee was doing so that it could pre-evaluate the obligee's costs
before it received its bill for reimbursement. Of course, this provision is
silent as to whether the surety has the option to complete instead of the obligee.
Arguably, even though silent, the surety would have the right to complete, rendering
the payment aspect of this clause inapplicable.
Principal and Surety agree that if Obligee is required to engage the services
of an attorney in connection with enforcement of this Bond, each shall pay
Obligee's costs and reasonable attorney's fees incurred, with or without
suit, in addition to the above penal sum.
The law generally provides that a surety's liability is capped at the penal
sum, including attorney's fees incurred in enforcing the bond. These provisions
to the contrary, making a surety (and in this case, the bond principal) liable
for attorney's fees in enforcing the bond in excess of the bond penalty is becoming
quite prevalent. The theory is that the bond penalty corresponds with the contract
price, which, in turn, theoretically corresponds to the cost to complete. If
the attorney's fees that an obligee must expend to recover against a surety
can eat away at the penal sum, there is less money available for the obligee
to complete the project or reimburse itself for the costs of completion.
* Thanks should go to Pierre Le Compte
of The Hartford for identifying the subject matter for this series.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author's employer or IRMI. Expert Commentary articles
and other IRMI Online content do not purport to provide legal, accounting, or other
professional advice or opinion. If such advice is needed, consult with your attorney,
accountant, or other qualified adviser.
Please use the print button on the IRMI toolbar to print/preview this page.
© 2000-2013 International Risk Management Institute, Inc. (IRMI). All rights reserved.