Sureties have many defenses that they like to assert to avoid paying under a performance bond. One of those defenses arises when the obligee (usually the owner or the general contractor terminating a subcontractor) precludes the surety from exercising one of its options under the bond.

While performance bond terms vary, a surety frequently has three options under the bond where a bonded contractor has been default terminated:

(1) the surety can step in and complete the defaulted contractor’s work;

(2) the surety can obtain bids from other contractors to complete the defaulted contractor’s work and tender a new contractor to complete the work; or

(3) the surety can simply pay the obligee (again, typically the owner or the general contractor that defaulted a subcontractor) the cost above the remaining contract balance to complete the defaulted contractor’s work.

If a surety perceives that it was not given a chance to exercise one of its options under the bond, you can rest assured that the surety will argue it is no longer liable for any of the excess completion costs.

The you-deprived-the-surety-of-its-completion-rights defense is playing out in real time right now in a pending lawsuit between a surety and a contractor in Western Surety Company v. PCL Construction Services, Inc.

In PCL Construction, a contractor and subcontractor entered into an agreement for part of the work at a hotel project in Naples, Florida. The subcontractor obtained a performance bond under which a surety guaranteed the subcontractor would properly complete the work.

After the subcontractor completed a portion of its work, the contractor believed the subcontractor was in default. Ultimately, the contractor terminated the subcontractor and allegedly began ratifying contracts with the terminated subcontractor’s key sub-subcontractors over the surety’s objection.

The contractor filed a demand for arbitration against the subcontractor and the surety. That spurred the surety to file a Florida state court lawsuit against the contractor alleging that the contractor breached the terms of the performance bond.

In that lawsuit, the surety alleged that the contractor breached the terms of the performance bond because the contractor deprived the surety “of the opportunity to properly and thoroughly investigate its completion options and by impairing [the surety]’s Performance Bond options.”

Will the surety prevail on its claim that the contractor breached the performance bond by not allowing the surety to exercise one of its options under the bond? Who knows, but we are unlikely to find out anytime soon if the surety’s state court lawsuit is stayed pending the outcome of the arbitration between the contractor and the subcontractor.

Bottom Line: If you plan on terminating a bonded contractor or subcontractor, make sure to carefully review the terms of the bond and comply with those terms. Failure to do so may jeopardize the terminating party’s ability to collect on any judgment they obtain against the terminated contractor for excess completion costs.

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