Unlike insurance policies which protect insureds from fortuitous events or accidents that arise during performance of the work, performance bonds are contracts of suretyship. They guarantee to the named obligee, usually the project owner, that the project will be constructed in accordance with the plans and specifications for the contract price within the contract time. A general contractor may require a performance bond from a subcontractor, depending on the value of the subcontract. The bond form determines conditions precedent to the surety’s obligations. At a minimum, the bond requires notice of default of the principal under the bonded contract (prime contract or subcontract as the case may be). Notice of default should be “made in terms sufficiently clear, direct, and unequivocal to inform the surety that the principal has defaulted on its obligations and the surety must immediately commence performing under the terms of its bond.” Some bond forms, however, require termination by the obligee before the surety is obligated to perform under the bond. Regardless of termination, bond forms may require one or more conferences with the obligee, surety, and principal to discuss potential curing of the default.
Generally, the obligee is required to tender to the surety the balance of funds due the principal under the bonded contract which the surety will use to complete, or correct deficiencies in, the work. The obligee may, but not necessarily, have superior claims to the contract balance. If the surety decides to engage a new contractor to complete the project, it may obtain bids from other contractors. Any new contractor will likely be required by the surety to provide its own performance and payment bonds which name the surety or owner as obligee/co-obligees. If the completion contractor is defaulted, and the original surety pays under its bonds, the original surety will be able to assert a claim under the completion contractor’s performance bond. Obtaining bids to complete a project will support a surety’s subsequent indemnity action against the principal since the surety will be able to show that it mitigated its losses.
As a general rule, a surety’s liability on a bond is determined strictly from the terms and conditions of the bond. The language in the performance bond, construed together with the purpose of the bond, governs a surety’s obligations under the bond. Thus, for example, where a bond does not expressly allow for recovery of delay damages, the surety will not be liable for such damages. Failure to adhere to a performance bond’s notification requirement is a material breach of the bond, resulting in the loss of an obligee’s rights under the bond. Depending on the language of the bonded contract and the remedies it affords the obligee for the principal’s default, such notice may not be necessary for the obligee to recover against the surety, though the prudent course is notify the surety of an intention to declare the bond principal in default and to terminate the bonded contract if the default is not timely cured. The bond’s express notice and other requirements should be read in tandem with the underlying bonded contract (incorporated into the bond) to determine whether they can be reconciled. Where they directly conflict regarding the events triggering the surety’s obligations, the bond’s requirements may control.
Under Florida law, a surety’s obligations are co-extensive with those of its principal. Thus, where the principal is not liable under its contract with the obligee, generally neither is the surety under the bond. In other words, the surety has the right to raise any contract or other defenses available to the principal. There are, however, exceptions to this general rule. Nevertheless, liability on the part of the principal does not always result in liability of the surety. The surety may have independent defenses such as the fraud or illegal conduct of the bond principal with the knowledge of the obligee which induces the discharge of the surety. This is not to say that every departure by the obligee from the underlying construction contract will relieve the surety, and performance bonds routinely provide that a surety waives notice of any changes under the contract and compliance or noncompliance with contractual formalities. The surety must demonstrate prejudice. But a significant enough change may discharge the surety’s liability.
Another important aspect of suretyship (unlike with liability insurance coverage), is that a compensated surety may recover its losses—even anticipated losses—under a bond from the bond principal or other third parties, and typically has several available common law remedies such as its right to exoneration, quia timet, subrogation, contribution, and common law indemnity. In addition, sureties are protected by a written indemnity agreement (sometimes called a general agreement of indemnity) executed by the principal in favor of the surety. These agreements are extremely onerous and provide broad remedies to the surety against the principal and others signing the agreement (known as the indemnitors) to protect the surety from losses or potential losses arising from its issuance of a bond. The principal and indemnitors are customarily made “jointly and severally” liable under these agreements meaning that each indemnitor is individually responsible to pay for the entire loss of the surety regardless of whether another indemnitor is also obligated.
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To learn more about Florida construction performance bonds, contact Florida construction mediator and lawyer Gary Brown at (954) 370-9970.