When a private construction project is bonded, the GC typically posts a performance bond and a payment bond to ensure the project’s completion. The payment bond is meant to benefit unpaid subs (and prevent mechanics lien filings for the owner). The performance bond helps owners to complete the project, in case the GC defaults on their contract. Exactly how this is accomplished is determined by the performance bond terms themselves. And a recent Florida Court of Appeals case demonstrated how important these terms are, as they allowed a surety to retain a terminated contractor to complete the project.
Background on performance bonds
A performance bond is a type of surety bond in construction that the general contractor typically purchases for the benefit of the property owner. If the contractor ends up defaulting on the project, the surety that issued the bond would step in and either:
- Ensure that the project is completed, or
- Reimburse the property owner for the additional cost to complete it
Although performance bonds are meant to benefit them, property owners should be careful about the language in the bond. Many standard performance bonds authorize the surety to complete the project with a contractor of their choosing – whether or not the property owner agrees.
Surety takes over after contractor default, and hires them back
The case in question is Seawatch at Marathon Condominium Association, Inc. v. The Guarantee Company of North America
Project Snapshot
- Owner: Seawatch at Marathon Condo. Assoc., Inc. (Seawatch)
- Surety: Guarantee Co. of North America (Guarantee)
- General contractor: Complete Aluminum General Contractors, Inc. (CAGC)
Seawatch hired CAGC as a general contractor under a $5.4M contract for the renovation of 3 condo buildings. CAGC posted 3 performance bonds in favor of Seawatch through Guarantee. The bonds they purchased were standard AIA A312 performance bonds.
During the course of the project, Seawatch discovered some construction defects. As a result, they declared CACG in default, and promptly terminated them. Seawatch then looked to Guarantee to elect how to proceed under the performance bond.
A contractor defaults – and bond surety rehires them
As stated above, the performance bonds were AIA standard documents. The terms of the bonds included options on how to proceed in the event of contractor default. The two relevant provisions gave the surety the power to either:
4.1 Arrange for the contractor, with the consent of the Owner, to perform and complete the Contract; or
4.2 Undertake to perform and complete the Contract itself, through its agents or through independent contractors…
Guarantee opted to go with the second option, choosing to complete the GC’s contract on their own terms. They drafted and sent a proposed “Takeover Agreement,” the terms of which included the election of retaining CAGC as the general contractor.
Seawatch rejected the agreement, refusing to allow CAGC to return as the GC. Instead, Seawatch filed a lawsuit challenging the surety’s ability to retain a contractor that they had just terminated.
Property owner challenges the hiring of the terminated GC
At trial, Seawatch argued that Guarantee was prohibited from hiring the terminated contractor. Furthermore, opting for the “takeover option” would require Guarantee to assume the role of GC; which they couldn’t because they weren’t a licensed contractor. Therefore, they did not consider it a viable option.
Guarantee & CAGC, for their parts, contended that the bond provisions imposed no such restrictions. They countered that, if Seawatch failed to accept the replacement contractor, it was a material breach of the performance bond.
The court agreed with Guarantee, stating that the terms were clear and unambiguous. Seawatch appealed.
Court: Nothing in the bond prevents hiring the terminated GC
The Court of Appeals stated that the payment bonds are similar to insurance contracts. And if a contract language is clear and unambiguous, then the contract will be interpreted by its plain meaning. According to a literal reading of the provisions, there is no requirement that the replacement is selected by “mutual assent.”
Furthermore, the court stated that it’s relatively common practice for a surety completing a project to hire the original contractor. The Court of Appeals upheld the trial court decision.
Use standard contract documents – including bonds – cautiously
Understanding the ins and outs of your construction contract is critical. This is particularly true when using standard, commercially available forms such as AIA contract documents. Even if you do decide to use these documents, there’s nothing preventing you from modifying the terms to suit your needs.
Or better yet, create your own bond form and include a provision stating that the replacement contractor must be mutually agreed to or approved by you as the owner. Simple adjustments to the terms could have prevented the time and money that all parties spent on the lawsuit.