-Partners in Practice -

In late 1984, the AIA and the Engineers' Joint Contract Documents Committee released a new set of standard bond forms. It was a largely unheralded event--hardly the stuff of which headlines are made. It represented, nevertheless, the culmination of an extensive, industry-wide effort to clarify rights, responsibilities, and options for the benefit of all concerned.

The new forms incorporate sweeping and potentially significant changes. They deserve a certain amount of attention, for an understanding of their terms and conditions just may enable you to guide an otherwise deeply troubled project to a successful outcome. Examination of the new performance bond helps to explain why.

The members of the industry task force formed to revise the language of the bond were bound by a common purpose: Their aim was to reduce conflict over the nature and extent of the surety's responsibility to make good on its guarantee of the contractor's performance. Guided by more than a decade of case law and constrained by the need to balance a wide range of interests, the drafters detailed the conditions under which an owner might seek recourse under the bond. Obligations were clarified, procedures delineated, ambiguities resolved.

The changes cannot help but spell at least some relief from litigation over the extent of your responsibility for the contractor's failure to perform. True, the argument can always be made that, but for your negligence, the problem would never have arisen in the first place. But this argument is far less likely to emerge in an environment in which there is a clear, written understanding as to who is obligated to do what in an effort to get things back on track. Your mastery of the details of that understanding just may afford you with important opportunities to hold conflict in check long enough for the effort to succeed.

The surety has no duty to act as long as the contractor complies with the terms and conditions of the construction contract. Should the contractor fail to do so, the surety may be required to step in. It is the owner's obligation to initiate the process.

Before the surety can be expected to intercede, the owner must meet the following conditions: 1) He or she must not be independently in default; 2) both the contractor and the surety must be notified in writing that a declaration of default is being considered; 3) a meeting must be sought for the purpose of reconciling differences; and 4) failing reconciliation, the owner must declare default and formally terminate the contractor's right to complete the work. The owner must also agree to pay any unpaid balance due under the construction contract.

Clearly, the greatest potential value to be derived from the meeting of these obligations lies in the requirement to initiate an effort to diffuse conflict, resolve the problem, and effect satisfactory completion of the work. This affords the surety with an opportunity to assume the role of mediator and bring both its influence and its resources to bear on producing a satisfactory outcome. It affords you with an opportunity to contribute. If the surety is successful in its efforts, everyone wins. It not, the drama continues.

Once responsibility passes to the surety, it must act promptly, in good faith, and at its own expense. It has the option of pursuing one of the following courses of action: 1) It may arrange, with the consent of the owner, for the original contractor to complete the work under the existing contract; 2) it may complete the work itself, using either its own forces or a subcontractor of its choosing; 3) it may arrange for the preparation of a new set of bid documents and the selection of a new, bonded contractor acceptable to the owner; 4) it may determine the extent of its liability to the owner and pay that amount; or 5) it may deny liability, in whole or in part, and set forth the reasons for its denial in writing.

Should the surety fail to meet any of its obligations, including the obligation to act with reasonable promptness, the owner has the option of issuing a 15 day demand that it do so. Failure to act within this 15 day period constitutes default on the part of the surety. This is yet another safety valve. Its benefit lies in the pressure it places on the surety to maintain constant communication with the owner as respects its efforts to meet its responsibilities under the bond.

The surety is specifically required to pay additional design fees occasioned by the contractor's default. It is also obligated to compensate the owner for damages, including any necessary legal expenses and costs of delay. The surety is not liable, however, for obligations of the contractor which are unrelated to the construction contract (disputes with creditors, for example), and the owner generally does not have the option of withholding payments due as security for the meeting of such obligations.

Under the terms and conditions of the bond, neither the owner, nor the contractor is required to inform the surety of any change to the construction contract. This is a misleading and potentially dangerous carryover from the old form. Prevailing case law makes clear that the surety has an undisputed right to be informed of and to consent to any "major, material, or cardinal" change.* What may constitute such a change is far less clear.

Efforts by the drafters to incorporate this right into the language of the bond and to quantify it in some fashion were unsuccessful. Architects and engineers feared that any attempt to specify the conditions under which the surety must be notified of a change would create an impossible administrative burden.* Perhaps so, but we are left with an ambiguity which, if contested, may well be interpreted against those responsible for drafting it.

This is something you might want to keep in mind as change orders begin to alter the scope and cost of the work, for unless the surety consents to "major, material, or cardinal" changes, your client may forfeit the protection of the bond. At a minimum, you might recommend that insurance and legal advisors be consulted on keeping the surety abreast of (and the bond current with) developments on the project.

The new forms are no panacea, and the extent to which the purpose and the expectations of the drafters will be met remains to be seen. There is still ample room for dispute. But many of the sources of past conflict have been eliminated, and on balance, there is cause for optimism. This can only be good news for the profession.
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* Britt, Ray H., "The New AIA Payment and Performance Bond Forms-What They Mean to the Surety Owner and Subcontractor," American Bar Association, New York, January 1985.

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