Killer Bond Forms and Contract Provisions (Part 4)
August 2009
As noted in the
first article in this series, public
and private obligees, including property owners and general contractors, are
rewriting bond forms and contract provisions for contractors and
subcontractors.
by Marilyn
Klinger*
Sedgwick,
Detert, Moran & Arnold LLP
This article provides more examples of these new bond provisions and
commentary as to the meaning and impact of those provisions on the liability
of the surety industry.
Built-in Ambiguity
The performance and payment bonds
shall also contain all other requirements prescribed by law.
Generally, if the bond is a statutory bond, those provisions of the
statute that require the bond are read into the bond, even if the bond is
silent as to those provisions.1 To the extent
that the obligee intends the above bond provision to achieve the same thing,
it is a relatively innocuous clause. However, if the obligee intended
something else, it is difficult to determine what requirements it means. All
it says is "requirements prescribed by law," but it does not further
elaborate as to what law. Arguably, the provision is so ambiguous as to be
unenforceable.
Scope of Subcontractor's Bond
In addition to the language of any bond,
the protection and coverage of Subcontractor's bonds shall extend to the
entities protected and the type of claims covered by Contractor's bonds with
respect to the Subcontract work so that any claim that can be made against
Contractor's bond shall be also valid and recoverable against
Subcontractor's bond.
By
virtue of this provision, the surety would need to review not only the
subcontract for which it plans to provide a bond, but the general contract
and the general contractor's bond. While the general contract is often
incorporated by reference into the subcontract,2 the
above provision by which all of the entities protected and the types of
claims included in the general contractor's bond apply to the
subcontractor's bond is unusual. It requires the surety to underwrite both
the subcontractor's bond and the general contractor's bond.
Punch List and
Latent Defects
The condition of this obligation is such that, if
Contractor shall fully, promptly, and faithfully perform the contract and
all obligations thereunder, including punch list, then this obligation shall
be null and void; otherwise, it shall remain in full force and effect. The
Bond shall remain in full force and effect and cover latent defects after
the certificate of substantial completion and after Obligee acceptance of
the construction.
There is a general misconception about the
coverage of a performance bond. Many people believe that once the warranty
period is expired, the surety has no further obligations on the performance
bond. That belief is incorrect. A surety is liable for the damages that an obligee suffers for defective construction on the part of the bonded
principal for the same period of time that the principal is liable.
In
California, for example, the principal can be liable for patent defects up
to 4 years after the project is substantial completed.3
The rule is 10 years if the defect is latent.4
Generally, the warranty covers defective and nonconforming construction for
that 1-year period, obliges the obligee to contact the contractor about any
warranty issues, and obliges the contractor to repair the problem. What is
covered under the warranty, however, does not limit the contractor's
contractual obligations to the obligee.
Defective construction is a breach
of contract, as all contractors are obliged by law and almost always by
contract, to perform the work in a good and workmanlike manner. If it does
not, both the contractor and its surety are liable to repair or correct the
defect or, more exactly, the cost to do so. Arguably, after the warranty
period is over, the owner no longer has an obligation to allow the
contractor to correct and the contractor no longer has an obligation to come
to the project to do so. Essentially, in most jurisdictions, the last
sentence of the above provision is merely stating the law.
Surety Liability
for Extended Warranties
If Principal shall well and truly perform all
the undertakings, covenants, terms, conditions, and agreements of the
Contract within the time provided therein and any extension thereof that the Obligee may grant, and during the life of any guaranty or warranty required
under said Contract….
Again, this provision essentially
restates the law. Some guaranties and warranties can span many years, more
than a surety is typically inclined to extend its bond liability.
Accordingly, this provision could be problematic and will require sureties
who see this provision to double check all guaranties and warranties
required of their bond principals, even if the manufacturers provide the
warranties or guaranties directly to the obligee. Of course, if the surety
were obliged to respond to a long-term warranty or guaranty of a
manufacturer, it would have an indemnity claim against not only its bond
principal but also the manufacturer, assuming the manufacturer is still in
business.
Binding Effect on Surety I
Surety shall be bound by
any judgment, arbitration award, settlement agreement,
or other decision rendered against Contractor with respect to Contractor's
obligations under this Contract.
In some jurisdictions, this
provision may not be enforceable because it has the effect of waiving the
surety's right to a jury trial. In California, unless the parties have
expressly agreed to arbitration, which has the effect of waiving the right
to a jury trial, a party cannot waive its right to a jury trial in a
contract pre-dispute.5
In other states where this
provision might be enforceable, if the surety agrees to issue the bond with
this provision in it, the surety must be very diligent and monitor the
construction and any disputes or litigation extremely closely. As soon as it
gets wind of any issue that could rise to the level of litigation,
arbitration, or even settlement, it must interject itself in the process
and, if necessary, intervene in any litigation or arbitration.
Binding
Effect on Surety II
Surety shall be bound by any decision or ruling
issued in any legal proceedings relating to the Contract involving Obligee
and Principal concerning obligations under the Contract.
This provision is similar but not as far-reaching as the previous one.
Because it only applies to legal proceedings, it should allow the surety
ample opportunity to interject itself. Even if the underlying contract or
the bond does not provide for the inclusion of the surety in, for example,
an arbitration, in light of the binding effect and the constitutional due
process protections, it is difficult to imagine a court that would not allow
the intervention of the surety into the legal proceeding. It might even be
an abuse of discretion for a court not to do so.
Binding Effect on Surety
III
In the event of any claim by or against Contractor or in the event
of any dispute arising under said Contract, any finding, ruling,
determination, or decision made in accordance with said Contract shall be
final and binding on Surety to the same extent that such is final and
binding on Contractor even though Surety is not a party to such a finding,
ruling, determination, or decision.
The difference in this
provision is that it expressly contemplates that the surety would
not be a party to the legal proceeding. Again, it would be
essential for the surety to interject itself in the process as soon as
possible, assuming it were enforceable at the outset.
1See, e.g.,
Powers Regulator Co. v Seaboard Sur. Co., 204
Cal. App. 2d 338 (1962).
2See, e.g.,
Pacific Employers Ins. Co. v. City of Berkeley,
158 Cal. App. 3d 145 (1984); Boys Club of San
Fernando Valley, Inc. v Fidelity and Dep. Co., 6 Cal. App. 4th 1266
(1992).
3Cal. Code of Civ. Proc. § 337.1
4Code of Civ. Proc. § 337.15.
5See, e.g.,
Grafton Partners v. Superior Ct., 36 Cal. 4th
944 (2005).
* Thanks should go to Pierre Le Compte
of The Hartford for identifying the subject matter for this series.
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