A performance bond ensures that the contractor or subcontractor that obtains the bond will complete its work under the parties’ contract. When a bonded contractor or subcontractor defaults, the surety that issued the bond should step in and exercise one of its options under the bond.

One of the surety’s options is to complete the defaulted contractor’s or subcontractor’s work. Frequently, the performance bond provides that a surety will not have an obligation to step up and complete the work unless the contract with the contractor or subcontractor has been terminated.

The United States Court of Appeals for the First Circuit very recently considered whether a surety was liable for over $3 million in remedial costs that a prime contractor incurred to repair the work of one of its bonded subcontractors. See Arch Ins. Co. v. Graphic Builders, LLC, 36 F.4th 12 (1st Cir. 2022).

The issue was raised after the surety brought a declaratory-judgment action against a prime contractor. The surety sought a declaration that its obligations under the performance bond were discharged because the prime breached the performance bond.

The prime contractor filed a counterclaim against the surety for the surety’s failure to pay for the remediation work and provide a warranty for the windows at issue. The surety filed a summary-judgment motion and argued that it had no liability under the bond because the prime contractor failed to terminate the subcontractor.

The prime contended that it did not have to terminate the subcontractor because the prime contractor demanded the subcontractor provide a required warranty for the windows the subcontractor installed and the subcontractor failed to provide the warranty.

Since that was not true “completion work,” the prime argued it did not have to first terminate the subcontractor. The prime also asserted that it did not have to terminate the subcontractor to trigger the surety’s liability under the bond because the subcontractor had substantially completed its work, so the subcontract could not be terminated.

The district court did not agree with the prime’s arguments and granted the surety’s summary-judgment motion.

On appeal, the court affirmed the district court’s decision to grant the summary-judgment motion. The court reasoned that the performance bond was clear–the prime’s termination of the subcontract was an express condition precedent to the surety’s liability under the bond.

The language of the performance bond provided the following:

§ 3 If there is no [Contractor]7 Default under the [Subcontract], the Surety’s obligation under th[e] Bond shall arise after:
.1 the [Contractor] first provides notice to the [Subcontractor] and the Surety that the [Contractor] is considering declaring a [Subcontractor] default. Such notice shall indicate whether the [Contractor] is requesting a conference among the [Contractor], [Subcontractor] and Surety to discuss the [Subcontractor]’s performance ….
.2 the [Contractor] declares a [Subcontractor] Default, terminates the [Subcontract] and notifies the Surety; and
.3 the [Contractor] has agreed to pay the Balance of the [Subcontract] Price in accordance with the terms of the [Subcontract] to the Surety or to a contractor selected to perform the [Subcontract].

By failing to terminate the subcontract, the prime precluded the surety from exercising one of its options under the bond.

The court also seemingly did not believe the prime’s assertion that the subcontractor had substantially completed its work because the prime had asserted in multiple letters that the subcontractor had not substantially completed its work while the parties’ dispute was developing. Thus, the court affirmed the order granting summary judgment in favor of the surety.

Bottom Line: For most all performance bond claims, if you want to hold a surety accountable for a bonded contractor’s or subcontractor’s breach of a contract, you will need to first terminate the contract in question unless the performance bond provides otherwise.

If you have any questions about pursuing a performance bond claim, please feel free to reach out.

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