BONDS

– What are they?

– A construction bond is a written agreement in
which one party (the surety) guarantees that a
second party (the principal) will fulfil its
obligations to a third party (the obligee)
• If the principal defaults on its obligations, the surety
must complete them or pay the completion costs to the
obligee
• the surety charges the principal a fee called a premium
and requires a variety of indemnities from the principal
or its owners as a condition of issuing a bond
– What are they not?
– A construction bond is NOT insurance
• They are very different
– Distinctions between bonds and insurance
– One
• A construction bond is a three-party agreement
between a surety, principal and obligee
• An insurance policy is a two-party agreement between
an insurer and an insured
– Two
• The bond is triggered when the principal defaults on its
obligation to the obligee
• construction insurance coverage is triggered only by
accidental events
– Three
• The bond pays for pure economic loss, meaning the cost of
completing the principal’s obligation even if nothing is
broken or destroyed
• Construction insurance excludes coverage for completing
construction contract obligations. Construction liability and
property insurance policies provide no coverage for fixing or
finishing defective or incomplete work or materials but
instead cover only resulting physical damage to other items.
– Four
• A surety that pays out on a construction bond has the right
to seek recovery from the defaulting principal – the bond
purchaser
• insurer that pays out on an insurance policy has no right to
recover against the insured – the policy purchaser
• Parties to the Bond
– Principal
• The principal is the party who requests the surety to
issue the bond and whose obligations are guaranteed.
– For example, if a general contractor asks a surety to issue a
bond to a project owner, the general contractor is the
principal on the bond. Similarly, if a subcontractor asks a
surety to issue a bond to the general contractor, the
subcontractor is the principal on that bond
– Obligee
• The obligee is the party who requires the principal to
obtain the bond and who receives the benefit of the
guarantee.
– If the bond is obtained by a general contractor for an owner,
the owner is the obligee. If the bond is obtained by a
subcontractor for a general contractor, the general contractor
is the obligee.
 – Surety
• A surety is the party who issues the bond that
guarantees the obligations of the principal
• Subrogation
– Upon payment of a claim, the surety is subrogated
to the obligees right to recover
– The surety becomes a claimant against the
holdback fund
– Indemnification
• The surety will require indemnitors or guarantors
• If the principal becomes insolvent the surety then has a
method of recovery through the indemnity agreements
• Types of bonds
• Bid Bond – If a contractor is awarded a contract in response
to a tender and then refuses to enter into the contract in
accordance with the terms of the tender, the surety will pay
the owner (obligee) the price difference between the
dishonoured bid and the next lowest bid up to the penalty
limit of the bond
• Performance Bond – guarantee that the contractor will
perform all the obligations under the contract
• Labour and material (L&M) Bond – provide for payment of
the bonded principal’s subcontractors and material suppliers
should the principal not make payments as required
• Construction Lien Bond – guarantee (normally to a court)
that payment will be made to the lien claimants for whom
the bond is posted. Owners post lien bonds so that
construction liens can be removed from the project lands
without waiting for resolution of the lien claim
• Execution and Delivery
– To be effective and enforceable a bond must be signed
(executed) by the principal and the surety, and then
delivered to the obligee. If the bond is not delivered it
then has no force
• Triggering the bond
– A construction bond is triggered when the principal
default on the obligation guaranteed by the surety
– The obligee (owner) must serve notice to the surety
that the principal is in default
– No obligations arise for the surety until the
notification has been received
– Bond usually will set out notification requirements
(generally in writing within a specified period of time
following the default)
• Suing on the bond
– An obligee may sue the principal or the surety to ensure
payment on the bond. This must be done within the
limitation period stated on the bond (usually 1 – 2 years)
– The principal and the surety are both liable and their
liability is joint and several (either the principal or surety or
both may be sued on the bond, and the entire liability may
be collected from either the principal or the surety)
• Limits of the Surety’s Liability
– Limited to the actual damages up to the face value of the
bond (the “penal sum”)
– Standard CCDC bonds contain a statement that limits the
liability of both the surety and principal to the face value
of the bond
– If this statement does not appear on the bond then the
principal may be liable for amounts above the face value of
the bond
• Assessment of a Contracting Company’s Bonding
Capacity
– Before issuing a bond a surety will assess the ability
and capacity of the contractor using the three C’s of
bonding
• Capacity – resources and ability to perform
• Cash – liquid assets of the company
• Character – that of the companies principals and the
reputation within the industry
– This will help the bonding company set bonding limits
– Bid Bonds for smaller accounts there is generally a
flat fee per annum. On larger accounts it is usually
free
– Some surety companies will charge a per bond fee
of between 0.5% and 3% of contract amount
– Capacity – resources and ability to perform
• Prior experience on similar projects
• Equipment
• Personnel
• Past, current and future workload (bonded and non bonded)
• Management plan
• organization
– Cash – liquid assets of the company
• Annual and interim financial statements
• Investment strategies
• Cost control mechanisms
• Work in progress
• Cash flow
• Net worth
• Working capital
• Credit rating
– Character – reputation with
• Project owners
• Subs
• Suppliers
• lenders
• Bid Bond
– Purpose and Function
• To ensure the winning bid will be honoured
• The effect is that contractors only submit bids they intend to
comply with
• May guarantee winning bidder will provide other security specified
in the tender documents (Performance, L&M bonds)
• Generally the tender must be accepted within a specified period of
time from the closing date (30 or 60 days) – if not the three parties
must execute an extension agreement
• If bond is not extended it simply will expire and become
unenforceable
• If the winning bidder meets all the requirements and enters into a
contract the surety’s obligations under the bond are over
• Usually has a face value (penal sum) equal to 5, 10 or 20% (10
being most common) of the tender price
• Another way of offering security to the owner is, irrevocable letter
of credit or cash
– Surety Defences to Bid Bond Claims
• If the owner has no legal right to accept a particular bid
from a bonded contractor, then the surety has no
obligation to pay on the bond.
• Tender document mistakes
– If the tender document contain errors that significantly affect
a submitted bid, the owner cannot accept the bid and
therefore the surety has no obligation – no contract can arise
• Bid mistakes
– If a bid contains a significant and obvious (patent) error the
owner cannot accept the bid and then claim on the bond if
the contractor refuses to enter into contract
– However if the mistake is not obvious (latent) the contractor
cannot withdraw the bid and therefore the owner can call on
the bond (Ron Engineering)
– Difficult to determine latent and patent errors, or
fundamental and non fundamental errors.
 • Non compliant bids
– A bid may be free from errors but still be non compliant – such as
qualifying the bid or not completing the tender documents
– The privilege clause may allow the owner to accept non
compliant bids as confirmed in Tercon Contractors Ltd. V British
Columbia
– Making a bid bond claim (calling on the bond)
• Obligee (owner) must make claim in writing to the surety
• Often a formal contract must have been presented to the
bidder prior to the claim being made
• Standard CCDC bond contact
– Limitation period
• The obligee must preserve the claim by commencing an
action within six months of the date of the bid bond. If this
limitation period is not stated on bond then the limitation
period established by common law governing the place of
work will govern
 – Calculating the Bid Bond Payment
• Unless state otherwise in the bid bond the surety
liability will be the lesser of;
– The penalty stated on the face of the bond
– The difference between the dishonoured winning bid and the
next lowest bid; or
– If there are no other bids available for acceptance, the cost of
re-tendering the project, plus any difference in price between
the dishonoured bid and the new winning bid, plus any costs
arising from the consequent delay in completing the project
• Performance Bond
– Purpose and Function
• Assures the owner that the tasks assigned to the
bonded contractor will be completed per the contract
• Face value (penal sum) is usually equal to 50% of the
contract value
– Triggering the performance bond
• Default is determined by the principals failure to meet
a contractual obligation or evidence that the principal
will not be able to meet future obligations
• Examples are;
– Failure to meet financial obligations such as paying subs and
suppliers
– Insolvency
– Refusal to remedy construction deficiencies
– Failure to meet the project schedule
• The obligee must inform the surety in writing of a
default – same as bid bonds
– Making a Performance bond claim (calling on the
bond)
• Obligee (owner) must make claim in writing to the surety
• Obligee should provide the following documentation at a
minimum
– Complete copy of the contract
– Copies of all change orders
– Copies of all draws (progress billings)
– Summary of all payments (including date of payment)
– Up-to-date summary of contract accounting
– All evidence in connection with the termination of the contract or
the declaration of default confirming that it was done within the
terms of the contract
– Copies of any claims for liens or written notices of claims
– Any other supporting documents
– A specific explanation of the default
– Surety’s Performance Bond Obligations
• Has the duty to investigate the default
– Is entitled to reasonable time investigate – excessive time may
give rise to a delay claim by the owner
– The surety has a duty to both the obligee and the principal (and
the principals indemnitors).
– If the surety completes any work or makes any payment where
the principal has legitimate defence to a claim in default then the
surety will have breached its duty to the principal (indemnitors
will be relieved of liability to repay surety)
• If the investigation proves there was a default by the
principal the surety has options;
– Assist the principal in remedying the default
– Complete the work itself
– Issue tenders on behalf of the obligee and pay any additional
costs up to face value of bond
– Pay the obligee the amount of damages up to the face value of
the bond
– Limitation period
• The obligee must preserve the claim by commencing an
action within two years from the date on which final
payment under the contract “falls due”. Important to note
that it is not when the last payment was made but when it
was due to be made (“falls due”)
• If this limitation period is not stated on bond then the
limitation period established by common law governing the
place of work will govern
– Surety Defences to Performance Bond Claims
• There are four common defences
– The principal is not actually in default
– The construction contract has been materially altered since the
surety issued the bond
– The obligee has acted to prejudice of the surety
– The obligee has misled the surety as to the risk of it undertaking
the bond
• No default defence
– Particular item of uncompleted work is outside the scope of
the contract and not covered by proper change
order/directive
– Owner consented to the alleged default
– Owner improperly withheld progress draws therefore the
principal was justified to stop work
– Contractor could not commence or finish its work because
necessary preceding work out of their control was not
complete (D & S, owner supplied materials, etc.)
• If the obligee does not agree with this defence then
they may sue the principal, the surety or both to secure
payment
• Material change to contract
– The contract has been materially changed when a change
order has been issued, the owner waives a delay, or adjust the
construction schedule
– Any material changes must be communicated to the surety
• Owners Actions have prejudiced surety
– Improper payments to the contractor may prejudice the surety
» Payments made contrary to the payment schedule may
discharge the surety.
» Cash advances to ease cash flow problems, or that are out of
proportion with the work completed may discharge the
surety
» Paying for deficient work may discharge the surety
– Why do you think these circumstances will prejudice the surety?
» Because the surety will have less ability to persuade the
principal (contractor) to finish the work
» However if the obligee acted upon the advice of a payment
certifier for the payment then the surety may not be
discharged
– Owners delay in notifying the surety of a default may discharge
the surety
» The owners delay in notification may hinder the surety in
resolving the default
 • Obligee (owner) elects to remedy the default
– The owner rectifying the default without consulting the surety
may discharge the surety.
» The owners actions interfere with the surety’s ability to
select the most cost effective remedy for the default
• Misrepresentation
– If the owner makes any material misrepresentation (or withholds
information that should be disclosed) that misleads the surety as
to the risk it is undertaking the surety is prejudiced as a result and
may be entitled to refuse payment
• Labour and Material Payment Bond
– Purpose and Function
• Provide security for principals subcontractors and suppliers
• Alternative to filing liens – why important to obligee?
• Subs and suppliers can still pursue payment under the bond
and liens simultaneously
• Most often required in public sector projects – why?
– Triggering the bond
• If the principal fails to pay when due the surety’s
obligations arise
• However if a pay when paid clause is in effect then the
surety’s obligations to not arise until the principal has
been paid and subsequently failed to pay monies due
– Making a claim
• Must be in writing to the surety
• Notice must be within 120 days after payment
• Legal action must commence within 1 year after the
claimants work is completed, the claimants materials
are last supplied, or the principal ceases work
• Obligee should provide the following documentation at
a minimum
– Complete copy of the contract
– Copies of all change orders
– Copies of all draws (progress billings)
– Summary of all payments (including date of payment)
– All evidence of the last date upon which the labour and /or
material was supplied to the project (delivery slips, time
sheets)
– Evidence and documentation supporting other amounts
claimed which have not been agreed to or authorized in
writing under the contract or within a change order
– Copy of any claim for lien
– WSB clearance letter
– Statutory declaration with respect to the claimants own subs /
suppliers
• The surety is only liable for the limit on the bond!
• Construction Lien Bond
– Purpose and Function
• Posted by the owner (now the principal) to the court to
vacate a lien against the property
• If the owner does not defend the lien the surety may
step in to defend