A performance bond ensures that the bonded contractor or subcontractor will complete its work on a project. If a bonded contractor or subcontractor defaults, the surety should step in and exercise one of its options under the bond, which typically includes arranging for the completion of the defaulted contractor’s work.

Often, before a surety’s obligation to complete the defaulted contractor’s work is triggered, the surety must be given written notice of the contractor’s default. This gives the surety the chance to choose one of its options under the bond.

If an owner or contractor fails to provide any required written notice before hiring a replacement contractor or subcontractor to complete the work, the surety may assert the lack of written notice as a defense to a performance bond claim.

But what happens when an owner or contractor fails to timely provide the required written notice of default and the surety, once it learns of the default, indicates that the owner or contractor’s decision to hire a replacement contractor or subcontractor is fine?

In that situation, it’s possible that the surety may have waived its right to timely written notice. A recent federal court case—VEC, Inc. v. Joyce Electrical, Inc.—recently addressed such a situation.

In VEC, a private owner and a general contractor entered into a contract for the construction of an electric substation. The contractor subcontracted the electrical work to a subcontractor. After work on the project progressed, the contractor defaulted the subcontractor and hired a replacement subcontractor to complete the electrical work.

Eventually, the contractor sued the subcontractor and the subcontractor’s surety that issued a performance bond for the $1.3 million in completion costs and other damages that the contractor incurred. (For more on construction completion costs and the burden of proof, click here.)

The subcontractor and surety filed a motion for partial summary judgment in which they argued, among other things, that the breach of bond claim against the surety had to be dismissed because the contractor failed to provide reasonable written notice before hiring the replacement subcontractor as required under the performance bond.

The contractor had provided written notice of the subcontractor’s default via a letter that the contractor mailed to the surety. That letter, however, was sent the same day that the contractor entered into a new agreement with the replacement subcontractor. That meant that even if the letter had been sent by overnight mail, the surety did not receive notice until after the replacement subcontractor had already been hired. The court concluded that was not “reasonable notice” under the bond.

But the court then considered whether the surety waived its right to reasonable notice under the bond. The court noted that there was evidence that once the surety had been informed of the contractor’s decision to complete the work with a new subcontractor, the surety approved. If true, “a reasonable inference could be made that [the surety] intended to waive its right to receive reasonable notice of [the original subcontractor’s] default before [the contractor]’s arrangement with other subcontractors.”

Based the above, the court concluded “there exists a genuine dispute of material fact as to [the contractor]’s performance bond claim against [the surety].” Thus, the court denied the partial summary-judgment motion and left it to the fact finder—potentially a jury—to determine whether the surety waived its right to reasonable written notice.

Bottom Line: When exercising your rights under a performance bond, make sure to pay particular attention to any written notice requirements. The contractor in the VEC case potentially could have avoided the surety’s entire argument if the contractor had provided written notice before it hired the replacement subcontractor. Now, however, that is an issue that a jury may have to resolve at trial, and it may be a complete defense for the surety.

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