Payment Bond Claims for Costs Arising After Principal’s Termination
June 6, 2023
By: Cynthia Rodgers-Waire, Esq.
When a principal is default terminated from a bonded contract, its surety is understandably most concerned about the potential performance bond exposure. While this focus is appropriate, it is important for the surety not to ignore opportunities to mitigate potential payment bond exposure. One vexing issue faced by sureties is payment bond claims for labor/material costs and equipment rental charges incurred after the principal’s termination. These claims can occur in a number of circumstances: 1) the principal fails to notify the claimant of the principal’s termination and the claimant unknowingly continues its performance; 2) the claimant becomes aware of the principal’s default but continues its own performance due to either choice or uncertainty where the principal has not taken the contractual steps to terminate the claimant’s contract; or 3) the claimant learns of the principal’s default but accedes to a request from either the principal or the obligee to continue its own performance or at least “standby” and be prepared to re-commence performance.
Sureties contesting such claims have not met with a lot of success. A very recent case illustrates the difficulties. In McLean Contracting Co. v. Great Am. Ins. Co., 2023 WL 3618847 (N.D. Ind. May 24, 2023), the surety for a general contractor moved for summary judgment related to a subcontractor’s claim for equipment rental costs, consisting entirely of “standby” costs, incurred between the date of the principal’s termination and the date the claimant reached a new subcontract agreement with the replacement contractor hired by the owner. The surety argued that the equipment was not “furnished for use in the performance of the Construction Contract” per the bond terms due to the principal’s termination. The court rejected this argument, holding that the bond only required that the equipment be “furnished for use” and not actually used. Further, the court found that factual disputes existed as to whether the principal had either informed the subcontractor of its default termination per notice provisions in the subcontract or directed the subcontractor to keep the equipment on site in the hopes that its contract termination would be rescinded by the owner, thereby precluding resolution through summary judgment. Id. at *5-6.
Sureties have also lost this argument in circumstances where the principal did not direct its subcontractor to keep equipment on site but did fail to formally terminate the subcontract. In Chapman v. EI Constructors, Inc., 1995 WL 91391 (Conn. Super. Ct. 1995), judgment aff’d, 239 Conn. 708, 687 A.2d 506 (1997), the claimant kept its labor crew on standby and its materials and equipment on site, which ultimately resulted in the obligee impounding the claimant’s materials and equipment by exercising its contractual rights upon default to take possession of materials and equipment to complete the work. The Connecticut appellate court agreed with the trial court that the surety was liable for the payment bond claim, including standby labor and idle equipment charges, other than the claim for lost profits on work not performed.
In order to mitigate its potential payment bond losses, the surety must take proactive steps in these circumstances. First, through a site visit or other method of confirmation, the surety needs to assess what materials and equipment remain on the job site after termination that are subject to accruing rental charges or other cost claims or are at risk of obligee confiscation. Second, it is important for the surety to review whatever contracts and other project information is available to determine: 1) who owns or leases the materials or equipment on site; 2) what has already been paid and by whom; and 3) what contractual notice and termination provisions apply and have or have not been exercised. Finally, the surety needs to quickly make a preliminary evaluation of the default and whether the principal intends to contest the default. In the McLean Contracting case, the principal had already prevailed in an arbitration challenging the propriety of the default termination, but the surety remained exposed under the payment bond for the vendor’s idle equipment charges; whether the principal would be able to pass those potential costs back onto the obligee as wrongful termination damages was beyond the scope of the summary judgment ruling. However, in the case of a default termination that is valid or likely valid, it may be more financially prudent for the surety to pay a vendor’s claims for such post-termination charges if that vendor’s labor, materials or equipment are needed to complete the bonded work as the cost to bring in a replacement vendor may be much higher.
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Cynthia Rodgers-Waire (410-659-1310 or crodgers-waire@wcslaw.com) or any member of the Surety and Fidelity Practice Group.
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