General contractors, to reduce and mitigate risk to the owner, may want a subcontractor to furnish a performance bond. A general contractor will want a subcontractor performance bond if it is furnishing a performance bond to the owner (unless the general contractor has the subcontractor enrolled in its subcontractor default insurance policy/program).
The general contractor must appreciate the language of the subcontractor’s performance bond and the steps it needs to implement in order to properly perfect the obligations under the performance bond. This way, if there is a subcontractor default, the general contractor has perfected its rights under the subcontractor’s performance bond in order to trigger the role and obligations of the performance bond. Otherwise, what could happen is that the performance bond’s obligations were never properly triggered meaning the general contractor’s recourse against the subcontractor’s performance bond for a cost overrun relating to the performance of the subcontract is nonexistent.
For instance, in a recent case, a general contractor sued a subcontractor’s performance bond for a huge cost overrun it incurred in the performance of the subcontractor’s work. However, the general contractor never formally declared the subcontractor in default, terminated the subcontractor, or agreed to pay any contract balance to the performance bond so that the performance bond could apply that balance to remediate the default. These were obligations under the performance bond and, in fact, are very common obligations under industry from performance bonds (such as an AIA performance bond) that requires a declaration of default of the subcontractor which many courts interpret as an actual termination of the subcontract. As a result of the general contractor not strictly complying with the obligations under the performance bond, the court found that it failed to properly perfect the obligations of the bond to cover its cost overrun. This is clearly not what the general contractor wanted to hear!
For this reason, there is value from the general contractor’s perspective in taking the lead in drafting the performance bond form that it wants the subcontractor’s performance bond surety to execute. This way the general contractor can clearly draft the steps, if any, it needs to undertake to perfect recourse against the performance bond to create the argument, for example, that it does not need to terminate the subcontractor in order to pursue recourse against the bond.
Please contact David Adelstein at firstname.lastname@example.org or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.