Killer Bond Forms and Contract Provisions (Part 4)

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

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

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

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

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

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

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.