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February 24, 2017

Early Dispute Resolution for Performance Bond Claims

Robert J. Dietz and Ian H. Frank

Obligees often lament that performance bond claims rarely proceed as they envision. After expending what it considers an inordinate amount of time working with a defaulting principal to maintain project progress, an obligee's call to the surety to perform is made with the hope that, in a matter of days or weeks, the project will be back on track. The surety, however, expects time to investigate the facts and circumstances surrounding the purported default of its principal and, more often than not, is the last one to know of any allegations of default. Furthermore, except where the principal is out of business, the obligee and principal rarely see eye-to-eye on the propriety of the default or termination.  Therefore, the surety finds itself in a dilemma - if the surety performs, the principal will claim performance as a volunteer; however, refusal risks the ire of the obligee, and a potential "bad faith" claim where governing law supports such a theory of relief.

Thus, the surety must perform a thorough investigation of the purported defaults. Before outlaying substantial sums to remedy the defaults - sums that it may need to show were reasonably paid - the surety determines whether it has any defenses upon which it can rely under the bonded contract and the bond itself. However, a lengthy investigation can lead to further disruption to the project schedule, and a decision by the surety to take no action will likely push the parties towards lengthy and costly litigation or arbitration spanning months or years. Luckily, a new performance bond product may help the parties expeditiously resolve the dilemma.

This last fall at the American Bar Association Forum on Construction Law meeting in Chicago, presenter Ian H. Frank of Frantz Ward, LLP discussed how Travelers Casualty and Surety Company of America ("Travelers") had recently released a new performance bond product to address the aforementioned concerns. Developed originally with the intention of marketing to public-private partnerships (P3), the Early Dispute Resolution performance bond ("EDR Bond") was developed under a pre-arrangement with JAMS.  The EDR Bond calls upon the obligee, surety, and principal to engage in a thirty (30) day condensed arbitration, which generates a binding decision that remains the law of the project. The specifics of JAMS' EDR process and the EDR Bond form are discussed below.

JAMS' Dispute Resolution Rules for Surety Bond Disputes

In February 2015, JAMS issued its "Dispute Resolution Rules for Surety Bond Disputes," which govern disagreements concerning a surety's performance obligations following an obligee's demand. JAMS has emphasized that the purpose of the Rules is to ensure a speedy resolution of any disputes between an obligee and a performance bond surety. To effectuate that purpose, JAMS requires that the entire process take approximately thirty (30) days from initial demand by the surety or obligee until a final decision by the Adjudicator.

Either the surety or obligee can initiate EDR by filing a Demand for Adjudication and a copy of the performance bond with JAMS electronically.  An Adjudication Statement setting forth the factual and legal basis for the dispute must be sent within ten (10) days following the demand; however, nothing prevents the obligee from including the Adjudication Statement with its demand in order start the 30-day clock. The parties then have three (3) business days after the Adjudication Statement is filed to appoint an Adjudicator from the JAMS Global Engineering & Construction Panel; otherwise, an Adjudicator will be appointed for them.  Once the Adjudicator has been appointed, and all other initial filings completed and deposits made, the Adjudication is deemed to have commenced.

Upon Adjudication commencement, the Adjudicator has thirty (30) days to render a written decision, unless the parties agree otherwise. During the EDR process, the Adjudicator is provided with broad discretion as to what documents or testimony he or she may consider in rendering the decision, including, but not limited to:

  • Requiring the parties to submit sworn witness statements or other business documents;
  • Interviewing key witnesses;
  • Requesting and considering expert reports; and
  • Calling for memoranda on legal issues.

Ultimately, the Adjudicator must make three determinations:

a)     Is the principal in default of its obligations?

b)    Has the obligee complied in all material respects with its obligations in good faith?

c)     Is the surety liable to perform in accordance with the bond?

Once rendered, the Adjudicator's decision shall be immediately binding and enforceable; however, if a party files a request for clarification within five (5) business days of the Adjudicator's decision, the Adjudicator has five (5) additional business days to provide such clarification. Any payment or performance required shall be made immediately thereafter. Furthermore, the parties are required to comply with the Adjudicator's decision through substantial completion of the project. The decision itself must include the reasons therefor, and can be admissible in any further judicial, arbitral, or administrative proceedings.

The Expedited Dispute Resolution Performance Bond

The corresponding Travelers' EDR Bond obligates the principal, obligee, and performance bond surety to submit their disputes to JAMS under procedures that generally mirror the JAMS' "Dispute Resolution Rules for Surety Bond Disputes." Like the JAMS' Rules, Travelers' EDR Bond emphasizes that its disputes resolution process is to ensure that "disputes are determined quickly, so as to allow for the orderly and timely completion of the Contract\u2026."  Schedule B of Travelers' EDR Bond also includes provisions that supplement the procedures specified by JAMS:

  • Any decision will be "subject to appeal de novo by any party at any time to a court of competent jurisdiction."
  • Pending issuance of the decision, the principal and obligee must continue to perform their contractual obligations, including performing and paying for work.

The EDR Bond also includes additional benefits, such as direct access to a Travelers claims professional assigned to the project, and express liability for liquidated damages and warranties as specified in the contract. Furthermore, Travelers has released an "Advanced Payment Rider" for the Expedited Dispute Resolution Bond, which obligates the parties to proceed with the JAMS EDR Rules in the event that the principal fails to utilize a covered mobilization payment pursuant to a contract.

The Future of the EDR Bond

At the time of this article, the authors know of one project on which the EDR Bond is in use - the $900 million Pennsylvania Rapid Bridge Replacement Project - which is replacing 558 structurally deficient bridges throughout the state over a 36-month period. JAMS has confirmed that, thus far, no demands have been made under the EDR Rules.  This may be short lived - based upon the substantial audience interest in the EDR Bond following Mr. Frank's discussion at the Fall Meeting, we expect that Forum attorneys will soon need to familiarize themselves with the EDR process. The ability to obtain a quick decision eliminates any lengthy interruption of the project's progress, which is ultimately in the best interest of all project participants. However, it is uncertain as to what extent the EDR process reduces the overall duration and cost of finally resolving the dispute when factoring in the potential of a later de novo review at a trial or second arbitration. Further, it remains to be seen what level of deference reviewing trial courts will provide the arbitrator's comparatively-fast decision, and whether the existence of a neutral decision-making process can absolve the surety from any bad faith claims by the parties.  At a minimum, though, the EDR Bond and the JAMS "Dispute Resolution Rules for Surety Bond Disputes" appears to present a welcome alternative for obligees who dread protracted investigation, and potentially expensive litigation, of their performance bond claims during the project.

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Robert J. Dietz

BrigliaMcLaughlin, PLLC, Tysons Corner, Virginia, Division 7 (Insurance, Surety & Liens) and Division 9 (Subcontractors & Suppliers)

Ian H. Frank

Frantz Ward LLP, Cleveland, Ohio, Chair Division 9 (Subcontractors & Suppliers)