Dan@commercialsurety.com
Commercial Surety Bond Agency
Contractors often believe the risks included in performance bond forms fall solely on surety companies. However, the contractor and surety share similar obligations outlined in a contract. As such, it’s essential to understand how these performance bonds work so as to protect your interests.
Knowing potential risk factors in performance bond forms is not only essential to ensuring your (the contractors’) success, but having a comprehensive understanding can help facilitate communication with owners and general contractors. Contractors should always consult their agent and surety to review such documents; however, becoming acquainted with introductory provisions can provide added protection against unexpected risks.
Here are the top three risks contractors should look for in performance bond forms:
1) Timeframe for the Surety Company to Perform
Surety companies often face the challenge of balancing their obligation to the obligee and principal when confronted with a claim. While it is understandable that an obligee may want immediate resolution, sureties must thoroughly investigate what happened to meet their obligations towards all parties involved. For this reason, surety companies will contact principals for more information regarding claims before taking action.
Often, obligees seek to expedite the timeframe of a project by including unrealistic deadlines in their bond forms, such as ten days. However, working through complex disputes between multiple parties and appraising sites can often take longer than ten days – not nearly enough time for surety companies to make informed decisions on top of analyzing consultants’ reports. Such hasty conclusions based on incomplete information leave principals vulnerable as they could end up carrying out costly indemnification agreements should anything go wrong with their project decision-making process down the line.
Therefore, ensuring that bond form language allows sufficient time for the parties involved is paramount in avoiding costly and detrimental missteps. A more standard and reasonable timeframe is 30 to 45 days to allow a surety to complete the investigation.
2) Options for the Surety to Perform
Performance bond forms often state the options sureties have in the event the principal is defaulted by the obligee. For example, the ConsensusDocs 206 includes the following:
- Complete the Work, with the consent of Owner, through Constructor;
- Enter into a takeover agreement with the Owner to undertake Contract Work completion;
- Arrange for the completion of the Work by a contractor acceptable to Owner and secured by performance and payment bonds equivalent to those for the Contract issued by a qualified surety. Surety shall make available as the Work progresses sufficient funds to pay the cost of completion of the Work less the Contract Balance up to the Bond Sum; or
- Waive its right to complete the Work and reimburse Owner the amount of its reasonable costs, not to exceed the Bond Sum, to complete the Work less the Contract Balance.
Some bond forms will specifically exclude option number one allowing the surety company to use the principal to complete the Work. This option can be extremely important for both the surety and the principal, because no other contractor will know the job better and hiring a new contractor will often cost much more given the many unknowns they are walking into.
Any limitations of these options create additional risk for the surety and principal.
3) Automatic Increases in the Performance Bond Penalty
Change orders are a common reality of the construction industry, making it vital for obligees to ensure that enough coverage is available from performance bonds to guarantee successful project completion. To achieve this protection while accommodating changes along the way, many obligees have started including language that automatically increases bond amounts as change orders occur. However, large-scale shifts can leave all parties blindsided.
Suppose a project dramatically increases in scope or size compared with their initial plans. In that case, the contractor and surety company may find themselves having guaranteed a project much larger in size and scope than they originally intended.
In these situations, it is helpful to have language that requires the obligee to get specific written consent from the surety company to increase the performance bond amount.
The ConsensusDocs 206 includes a section where the parties can agree on a stated percentage, and in the absence of one, the surety’s written consent is required for increases exceeding 25%.
Conclusion
Every contractor wants to avoid a bad problem that could get worse, which is why using the correct performance bond form makes all the difference. The ConsensusDocs 260 offers risk-mitigating solutions and has been nationally endorsed by notable industry groups like the National Association of Surety Bond Producers and Surety & Fidelity Association of America – giving contractors protection to potentially prevent significant issues resulting in costly delays or losses down the line.
The views expressed in this article are not necessarily those of ConsensusDocs. Readers should not take or refrain from taking any action based on any information without first seeking legal advice