I. INTRODUCTION

A performance bond is intended to provide assurance to the owner of a project that the project will be completed at no additional cost to the owner in the event the contractor defaults or fails to perform as required by the construction contract. In order for the owner to derive the intended benefit from the performance bond, the owner must comply with the technical notice requirements and conditions of the bond and must choose the appropriate remedy available under the bond. As its first line of defense to a claim against a performance bond, the surety will insist upon stringent compliance with the notice requirements and other conditions that must be met to call the performance bond into play. If these requirements are satisfied, the surety will usually then turn its attention to the least expensive remedy available under the bond. The owner must be prepared to satisfy all requirements of the bond, and must be knowledgeable of the remedies available to it in order to maximize the benefit of the performance bond.

This section discusses the hoops the owner must jump through to assert a claim under the bond, the remedies available to the owner, and which remedies are best suited for the owner and its project.

All performance bonds, including the A312, set forth specific notice requirements and other actions that must be taken by the owner before the surety is obligated to take any action under the bond. If the owner fails to satisfy any of the notice or other requirements, the surety may deny liability leaving the owner without the remedies intended by the performance bond. This section addresses the specific requirements of the A312 performance bond. However, the overarching lessons of this section, specific and technical compliance with the requirements of the bond, are applicable to virtually all performance bonds. Nearly every performance bond will have notice and default requirements similar to those set forth in the A312 bond.

A. Notice That Owner Is Considering Declaring A Contractor Default

The first step in asserting a claim under the A312 performance bond is written notice by the owner to both the contractor and surety that the owner is "considering" declaring a Contractor Default. A Contractor Default is defined in the bond as "failure of the contractor, which has neither been remedied nor waived, to perform or otherwise to comply with the terms of the construction contract." Based on this definition, the Owner must look to the construction contract to determine the bases for declaring a Contractor Default. A declaration of a Contractor Default must be tied to a failure to perform acts required by the construction contract.

There is no requirement that the owner describe in the notice the basis for the potential Contractor Default. However, a description of the potential Contractor Default may very well facilitate resolution of the owner's claim. Without a description of the potential Contractor Default, it is difficult to obtain any action from the surety, or for that matter, the contractor. If the Contractor Default is described in the notice, the description should, at least in general, identify each basis for the potential default. Both the surety and the contractor will attempt to limit claims under the bond to the defaults described in the notice.

In addition to providing notice to the contractor and the surety that it is considering declaring a Contract Default, the performance bond also requires the owner to request and attempt to arrange a conference with the contractor and the surety to discuss performance of the underlying contract. The owner can satisfy this requirement by including in its notice that it is considering declaring a Contractor Default, a request for a conference and potential dates for the conference. By including the request in the notice, the owner has written proof that it has complied with these requirements of the performance bond. It also places the responsibility on the surety and the contractor to respond to the request for a conference, which must be held within fifteen (15) days of the surety and contractor receiving notice that the owner is considering declaring a Contractor Default. The owner should note that it is under no requirement to resolve the potential Contractor Default in the conference with the contractor and the surety.(fn1)

The written notice is required to be mailed or delivered to the contractor and the surety at the addresses specified in the bond. The notice should be mailed or delivered in such a manner, such as by certified or registered mail, federal express or the like, that the date of delivery of the notices is verifiable from an independent source.

In summary, the first step an owner must take in asserting a claim under the A312 performance bond is written notice, mailed or delivered to both the contractor and the surety, that informs them that owner is considering declaring a contractor default and that requests a conference to discuss performance of the construction contract. If such a conference is not held within fifteen (15) days of contractor's and surety's receipt of the notice, or if the conference does not resolve the potential Contractor Default, owner can then proceed to the next step for asserting a claim against the bond.

B. Owner Declares a Contractor Default and Terminates Contractor's Right to Complete the Contract

The next step in pursuing a claim under the performance bond is a declaration by the owner of a Contractor Default and formal termination of the contractor's right to complete the construction contract. The owner may declare a Contractor Default, and terminate the contractor's right to complete the contract, twenty (20) days after providing the notice described above in section II (A). It is critical that written notice be provided to the contractor that expressly states that owner is declaring a Contractor Default and terminating the contractor's right to complete. The surety's obligations under the performance bond are not triggered until a Contractor Default has been specifically declared by the owner and the contractor formally terminated from completing the construction contract.

Courts that have reviewed this requirement have held that the owner must specifically state that it is declaring a contractor default and is terminating the contractor's right to proceed in order to assert a claim against the bond. Close does not count in complying with this requirement. For instance, in L&A Contracting Company v. Southern Concrete Services, Inc., 17 F.3d 106 (5^th Cir. 1994), the Court denied the owner's claim against the performance bond because in its "notices of default," the owner did not specifically use the word "default." In reaching its conclusion, the court held "a declaration of default sufficient to invoke the surety's obligations under the bond must be made in clear, direct, and unequivocal language." See also Siegfried Construction, Inc. v. Gulf Insurance Company, 203 F.3d 822 (4^th Cir. 2000). In short, the notice declaring a contractor default must track the language set forth in the performance bond to be effective.

Further, in declaring a Contractor Default, and terminating the contractor's right to complete the construction contract, the owner must also be sure to comply with the default provisions of the underlying construction contract. A typical defense asserted against a claim made on a performance bond is that there has been no default of the underlying construction contract and that the declaration of a Contractor Default is improper. Most construction contracts will have their own notice requirements, and typically a cure period, which must also be complied with before the owner can declare a Contractor Default as defined under the performance bond.

The importance of complying with the specific requirements for declaring a Contractor Default, under both the performance bond and the construction contract, cannot be emphasized enough. The primary defenses typically asserted against a claim on a performance bond relate to a failure to specifically declare a Contractor Default and to terminate the contractor, or an improper declaration of default based upon the provisions of the underlying construction contract.

C. Notification to Surety That A Contractor Default Has Been Declared By Owner

Once the owner has declared a Contractor Default and formally terminates the contractor's right to complete, the finally step in asserting a claim against the bond is notice to the surety that such a default and termination has been declared and demand on surety to fulfill its obligations under the bond. The notice should be in writing to the surety, should forward the notice provided by the owner to the contractor declaring the contractor default and formally terminating the right to complete, and should also state that the owner agrees to pay the balance of the contract price to the surety in accordance with the terms of the construction contract. Once this notice is provided to the surety, the surety is required "with reasonable promptness," to either deny liability or to offer one of the several remedies provided for in the bond, which will be discussed below.

D. Failure of Surety to Act Under the Bond

After a Contractor Default has been declared and notice of demand made upon the surety under the performance bond, as discussed in section II (B), the surety is required to act promptly to provide one of the remedies described in the bond, or to deny liability. If the surety fails to act with reasonable promptness, owner must give the surety fifteen (15) days written notice demanding performance by the surety before the owner can pursue a claim against the surety under the bond. If the surety fails to perform its obligations under the bond within fifteen (15) days of the written notice, the owner is then free to pursue all claims against the surety. There is one exception to this notice requirement; if a cash settlement is offered by the surety and rejected by the owner, the owner may immediately proceed to enforce its rights against the surety.

The notice discussed in this section is not required to trigger the surety's obligation under the bond, but rather is required before suit may be filed against the surety for failure to perform.

E. Checklist for Asserting Claim Against Performance Bond

1. Review underlying construction contract and identify performance failures based upon terms of the contract and comply with any necessary notice requirements for declaration of default and/or termination.

2. Mail or hand-deliver written notice to surety and contractor that Owner is considering declaring a Contractor Default and request conference with surety and contractor.

3. Twenty (20) days after providing the written notice described in paragraph 2, mail or hand-deliver written notice to contractor that specifically and unequivocally states that Owner declares a Contractor Default and terminates contractor's right to complete the construction contract.

4. Mail or hand-deliver written notice to surety that states Owner has declared a Contractor Default, has terminated the contractor's right to complete and demands performance by the surety under the bond.

A.  Overview

In general, the surety's obligations under the performance bond are co- extensive with the contractor's obligations under the construction contract. The surety is required to complete performance of the project for the contract price and is also required to repair any construction defects on the project. Further, the surety is liable to the owner for delay damages, including liquidated damages if provided for in the construction contract. The remedies available under the bond are, however, limited by the bond amount and the surety will not be required to expend sums beyond the bond amount to provide one of the remedies specified in the bond.

The surety can fulfill is obligations under the performance bond in a variety of ways, ranging from a cash settlement to the hiring a new contractor to complete the work of the defaulted contractor. The owner has considerable input in determining the remedy to be provided by the surety, and, in fact, can reject proposed remedies by the surety. Various factors, such as the stage of construction, time constraints and the complexity of the project, will determine which remedy best fits the owner's needs. This section discusses the remedies available under a performance bond and issues the owners should consider in determining which remedy is most appropriate for its project.

B.  Specific Remedies Provided for in the Performance Bond

The performance bond describes five actions the surety may choose from in responding to a claim asserted against the performance bond. They are as follows: completion of the construction contract by the defaulted contractor, completion of the construction contract by the surety, completion of the construction contract by a new contractor who enters into a contract with the owner, a cash settlement, and denial of liability. The first four options are discussed below.

C.  Completion By Defaulted Contractor

The first remedy discussed in the performance bond allows the surety to "arrange" for the defaulted contractor to perform and complete the construction contract. Since this remedy involves work by the defaulted contractor, it requires the owner's consent. At first blush, this remedy seems illogical since the contractor has obviously failed to perform under the contract, resulting in a claim against the bond. However, this remedy may serve the owner's purposes under certain circumstances.

First, it may be that the owner is generally satisfied with the contractor but had certain issues with the contractor's performance that were either unresolved or unaddressed by the contractor. Declaring a contractor default and involving the surety will certainly get the attention of the contractor and may facilitate resolution of outstanding issues between the owner and the contractor.

Second, it may make sense to the owner, given the status or progress of the project, to keep the contractor in place and extract concessions from both the contractor and surety that certain actions be undertaken to resolve the contractor's default. If the project is fairly far along, it may create more problems for the owner to bring in another contractor. Therefore, the owner may agree to retain the contractor provided both the contractor and the surety agree, for instance, to increase the work force, to work overtime, to correct construction defects, or to take other steps necessary to correct the default. The owner benefits by keeping the contractor familiar with the project and inducing the surety to stand behind measures to be taken by the contractor to cure the existing default. The surety also benefits by avoiding the costs and headache of finding a new contractor to complete the project at a reasonable cost.

In the final analysis, of course, the owner must determine whether the contractor is capable of completing the contract and curing the default. This must be weighed against the status of the project and the difficulties of bringing in a new contractor in the middle of a project.

1.  Performance of Construction Contract by Surety

The surety has the right, even without the owner's consent, to complete performance of the construction contract itself by, primarily, hiring "independent" contractors to perform the remaining work. While the surety has the right to select the contractor, the owner can insist upon full completion of and compliance with the construction contract, including the correction of defective work and the payment of delay costs. The advantage to the owner of the surety completing the contract is the owner is relieved of the responsibility of finding and selecting a replacement contractor and can look to the surety for any failure of the surety's contractor to comply with the construction contract.

The downside for the owner is that the surety has complete control over selecting the replacement contractor. Again, however, the owner can insist upon full compliance with the construction contract regardless of the replacement contractor brought in by the surety.

2.  Negotiation of Contractor Acceptable to Owner

The third remedy available under the contract calls for the surety to obtain bids or negotiate proposals from "qualified contractors" that are acceptable to the owner for completion of the construction contract. Under this remedy, the surety takes the responsibility of obtaining bids and proposals, preparing a contract to be executed by the owner and replacement contractor and agrees that performance and payment bonds will be executed by a qualified surety to insure performance of the contract. Finally, the surety must also agree to pay any damages, such as delay damages, that may be due the owner under the contract.

For obvious reasons, this remedy may be the most attractive to the owner if the owner has determined that it in fact wants a new contractor to complete the construction contract. The surety undertakes the responsibility of soliciting bids and proposal but the owner retains the right to select the contractor from the bids or proposals received. Moreover, the contract between the owner and the contractor will be backed by performance and payment bonds to ensure performance of the work. The advantage to the surety in this remedy is that, unlike performance of the contract by the surety itself, the surety can bring in another contractor, and perhaps, another surety, and satisfy its obligations under the bond. Once the new contractor and the new bonds are in place, the surety has satisfied its obligations and has no future liability except for possible delay claims.

This remedy is quite attractive for the owner, but usually is tied to a resolution of any other claims, primarily delay damages, that the owner may have under the construction contract. Typically, if the surety pursues this remedy, it will seek a final resolution of all claims so that it can bring to a conclusion its liability and involvement in the project. The owner must be cautious, however, in attempting to quantify its delay damages for completion of the project. The owner must weigh the advantage of having a contractor it selects, backed by payment and surety bonds, with the risk of possibly underestimating its delay and other potential damages covered by the bond.

3.  Cash Settlement

While this remedy appears to be self explanatory, there are a number of issues and risks the owner must consider in reaching a cash settlement with the surety. The risk involved in a cash settlement is that the owner must attempt to quantify what its future cost will be to complete the contract and what delay and other damages it might incur as a result of the contractor's default. If the owner underestimates the cost to complete, or other damages that might be recoverable under the construction contract, the owner will not be able to recover the shortfall from the surety. Therefore, before reaching any cash settlement with the surety, the owner should prepare a thorough estimate of the cost to complete the construction contract, including possible contingencies, as well as any delay or other damages it may be entitled to under the construction contract. A cash settlement is a one-shot deal and the owner will be stuck with the amount agreed to regardless of the actual cost to the complete the construction contract and any other damages the owner may incur.

A cash settlement may be more attractive to the owner if the project is nearing completion and is small in size or complexity. If it is early on in the project, or if the project is of substantial size or complexity, there will be unavoidable risk in any cash settlement because of the vagaries of any construction project. The owner, may, of course, wait until the project is complete before agreeing to a cash settlement. However, this requires the owner to front the costs to complete the project. Moreover, the surety mat not be willing to allow the owner to control completion of the project and simply wait to receive a bill for the completion costs.

There are a variety of remedies provided for in the A312 that are intended to provide flexibility to both the owner and the surety in fashioning a remedy for a Contractor Default that meets the needs of the owner and is cost effective for the surety. In choosing the appropriate remedy, the owner should determine what are the most critical factors to the owner at the stage of the project when the Contractor Default occurs. The owner should also bear in mind that a blend of remedies may be utilized, with the consent of the surety of course, to achieve the most effective method for completing the project.