December 09, 2019 CONSTRUCTION LAW 101

The Surety Trap: Making a Claim under the AIA A311 Bond

Laura J. DePetro

I like the AIA A311 performance bond.  Not because it gives my construction clients security against defaulting subcontractors, but because every time I encounter it, it’s a law school exam question in the making.  It is perfectly ambiguous, leaving the principal, obligee, and surety wondering what their rights are.

On its face, the A311 bond seems perfectly clear:

Whenever Principal shall be, and be declared by Obligee to be in default under the subcontract, the Obligee having performed Obligee’s obligations thereunder:
  1. Surety may promptly remedy the default subject to the provisions of paragraph 3 herein, or;
  2. Obligee after reasonable notice to Surety may, or Surety upon demand of Obligee, may arrange for the performance of Principal's obligation under the subcontract subject to the provisions of paragraph 3 herein;
  3. The balance of the subcontract price, as defined below, shall be credited against the reasonable costs of completing performance of the subcontract . . .

See e.g., Hunt Constr. Group, Inc. v. Nat’l Wrecking Corp., 587 F.3d 1119, 1120 (D.C. Cir. 2009).

Compared to the AIA A312, the A311 bond form looks like a breeze.  The A312 requires two types of notice, a surety meeting, termination, and tendering the subcontract balance, all before the surety’s obligations are triggered.  See e.g., U.S. Fid. & Guar. Co. v. Braspetro Oil Servs. Co., 369 F.3d 34, 41 (2d Cir. 2004).  Then, once all that occurs, only the surety has any rights under the A312: rehire the defaulting subcontractor, complete the subcontract itself, obtain bids from other replacement subcontractors, pay the amount for the obligee to perform, or deny the bond claim altogether.  Id.  This is in stark contrast to the A311, which appears to give the obligee-contractor some options for performance along the way.

Your construction clients might be thinking, “The A311 bond is great! I can keep my subcontractor on the job and have the surety step in to help.  How wonderful that I don’t have to go through the hassle of terminating my subcontractor.”  As our construction clients know, terminating a poor performing, defaulting subcontractor, though contractually permitted, is “disruptive to the entire construction process because it adds to delays and expenses as new subcontractors must be found and retained, often at higher rights because of the premium paid or availability.”  Siegfried Constr., Inc. v. Golf Ins. Co., 203 F.3d 822, at *4 (4th Cir. 2000) (unpublished).

However, even under the A311 bond, sureties are primed and ready to deny a contractor’s bond claim if that contractor does not terminate its subcontractor.  Sureties hang their hat on the United States Court of Appeals for the Fifth Circuit’s decision in L&A Contracting Co. v. Southern Concrete Services, Inc., 17 F.3d 106 (5th Cir. 1994), citing it for the proposition that a surety’s obligations under the A311 bond are never triggered until the subcontractor is terminated.

In L&A Contracting, the general contractor (L&A Contracting) had difficulties with its subcontractor’s (Southern Concrete) failure to timely procure concrete.  L&A Contracting sent Southern Concrete and its surety (Fidelity) numerous letters.  Eventually, L&A Contracting notified Fidelity that Fidelity should take necessary steps to fulfill Southern Concrete’s contract to prevent further delays.  Fidelity did not respond, and Southern Concrete finished the project.  When L&A Contracting sued Fidelity, Fidelity argued its bond obligations were not triggered under the A311 bond because L&A Contracting had not declared Southern Concrete in default as it was never terminated.  The Fifth Circuit agreed, holding, “[t]he declaration [of default] must inform the surety that the principal has committed a material breach of series of material breaches of the subcontract, that the obligee regards the subcontract as terminated, and that the surety must immediate commence performing the terms of the bond.”  Id. at 111.

Many courts around the country cite L&A Contracting with approval, requiring termination.  Other courts are rejecting L&A Contracting, finding that the plain language of the A311 bond does not require termination. Even though the status of L&A Contracting is unclear, what is clear is that sureties are likely to continue to deny a prime contractor’s bond claim under the A311 bond if it does not terminate the subcontractor.  If your client does not terminate its subcontractor, your client will run the likely risk that its bond claim will be denied for failure to terminate.  If your client does terminate, your client can expect continued complications.

Terminations are difficult decisions to make, having potentially harsh consequences: (1) the risk of wrongful termination and subsequent damages; (2) premium prices of replacement subcontractors who are taking over another subcontractor’s job on short notice; and (3) the potential for delays while the contractor finds a replacement.  If a surety is involved, the issues can be compounded because the surety will undoubtedly want to question (1) whether the principal subcontractor was actually in default; (2) whether it received ample, proper, or timely notice of the default; (3) whether the contractor has done anything to impair and prejudice the surety’s rights; (4) whether there are sufficient funds remaining in the subcontract balance; and (5) whether the surety can find a competent replacement subcontractor or simply rehire its defaulting principal (to name a few).

You might be now be thinking, “My contractor’s subcontract gives it the right to takeover and supplement the subcontractor’s work, and that should be sufficient to let it immediately hire a replacement subcontractor.” This will also likely lead your client straight into a denied bond claim with a surety prepared to argue that your client took away its right to remedy the subcontractor’s default.

So what is a contractor to do when it has a defaulting subcontractor who procured an A311 bond?  The options are grim:

  1. Risk terminating the subcontractor and wait for the surety to “investigate,” knowing the surety will take (a long) time to determine if there was a basis to terminate and then find a replacement subcontractor or deny the claim altogether;
  2. Risk terminating the subcontractor and hiring a replacement subcontractor immediately, believing it’s necessary to cure the default and keep the project on schedule, knowing the surety will argue the contractor prejudiced its rights; or
  3. Risk not terminating the subcontractor, knowing the surety will deny the bond claim because the contractor failed to trigger the surety’s liability.

A contractor is left in a “surety trap” where it is damned if it does and damned if it doesn’t – and definitely likely damned for litigation.  Be prepared for the tough talk with your client that there is no risk-free outcome when making a bond claim under the A311 bond.

Here are some potential solutions to help obviate the issues created by the A311 bond:

  1. use the A311 bond and opt for a bond with clear parameters, like the A312 bond. I like the A311 bond because it gives the obligee-contractor an option to arrange for performance unlike most other bond forms, but its ambiguities make it ripe for litigation;
  2.  Consider including express language in your contracts that protect the contractor’s rights and options.  For example, the contractor might include language that the surety’s right to complete the subcontract, remedy any default, or hire a replacement subcontractor is conditioned upon the contractor’s prior written consent.  Or, consider stating that it is agreed the surety’s obligations under any bond are not conditioned upon the contractor’s termination of the subcontractor; or
  3. Consider a manuscript bond that is attached to and required by subcontractors.  Ensure the manuscript bond includes language that protects the obligee-contractor’s rights to terminate or not terminate.

 

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Laura J. DePetro

Woods | Aitken LLP Denver, CO Young Lawyers Division and Division 9, Subcontractors and Suppliers