Shocking Bond Forms
September 20, 2022
In this Surety Today Blog post, we will take a look at some of those terrible, bad, no good bond forms that are out there in the surety world. Sure, we have all seen those large general contractor manuscript bonds that give the surety about ten minutes to correct a year’s worth of mismanagement, but these bonds we will discuss today take bad bond writing to a whole new level. Let’s start our terrifying journey through this house of bond form horrors with a bond form from Pennsylvania.
Pennsylvania Waste Management Facility Bond
This bond form presents a treasure trove of nightmares for every surety. First, this is essentially a penal sum forfeiture bond. That means that if there is a violation, the full penal sum of the bond can be demanded. Second, the bond guarantees compliance with all applicable existing laws and any amendments or changes in the law that may come into effect later. So, if there are sweeping code changes in the future, the surety bonded them. Third, the bond is effective until 10 years after waste disposal operations are completed, and if during that period a violation occurs, the bond continues until such violation is corrected. So, this is a very, very long tail bond. Fourth, the scope of coverage of the bond is astounding and includes violations that occurred even prior to the issuance of the bonded permit:
You really have to do your due diligence before issuing this bond. Fifth, the bond contains a waiver of the material alteration defense by providing:
Additionally, the bond provides that the surety waives any performance rights:
Sixth, the bond mandates that any collateral held by the surety for its indemnification against bond losses, is to be held in trust for the government!
Seventh, while the surety may cancel the bond, such cancellation is not effective for 120 days, and, if during that period, the principal cannot find a replacement bond, the “cancelled” bond can be forfeited. So, the surety cannot actually cancel unless a replacement bond is already in hand or it risks forfeiture of potentially the entire penal sum.
Finally, the bond allows for confession of judgment against the surety.
I hope the premium for issuing this bond is the penal sum of the bond and that the surety gets 110% collateral up front.
New York Independent System Operator Bond
NYISO has to do with providing energy and the power grid in New York. This bond form reads more like a letter of credit. Under this bond the Surety is required to pay the amount specified by the obligee upon receipt of a demand for payment. The obligee’s demand for payment may be made without prior demonstration of the validity of the demand. So, a demand can be made and must be paid immediately with no proof or justification. The obligee may demand multiple payments limited only by the penal sum. That is a relief, at least they are holding to the penal sum with their unsubstantiated demands. The surety shall pay amounts owed pursuant to this Surety Bond in full not later than the first business day following receipt of the demand for payment. Can any surety pay a demand in one business day? The bond provides that:
This Surety Bond is not conditioned upon the NYISO first attempting to collect payment, resorting to any other means of security or collateral, or pursuing any other remedies it may have. The obligations of Surety hereunder are independent of the obligations of Principal, and the NYISO may bring an action against Surety without bringing an action against Principal. Surety’s liability under this Surety Bond is not conditioned upon the validity or enforceability of Principal’s obligations to the NYISO.
The first part of the above paragraph is fairly standard under surety law, but how can a surety be held liable on a bond when the validity of the principal’s obligation to the obligee is not a condition of liability. That can be read to say that the bond covers invalid claims.
Like the Pennsylvania bond above, this bond also has another illusory “cancellation” provision that is more like a penalty. The surety can terminate the bond upon sixty (60) days written notice however, the surety’s liability survives such termination and remains in full force and effect as to obligations incurred by principal during the term of the bond; (that part is fairly standard), but – in the event that principal fails to provide an acceptable form of replacement security at least fifty (50) days prior to the termination, surety is required to deliver cash collateral to the obligee not later than the next business day in the amount of the full remaining value of the bond as security for principal’s obligations. So, if the surety has the audacity to cancel a bond, there is essentially a ten day window in which the replacement bond must be provided or the surety has to post cash collateral potentially in the penal sum amount.
Okay, those two bond forms are very esoteric, but it is interesting to see what is out there and from now on when I see a Walsh Construction bond form, or Clark Construction bond form, I will feel a little relieved knowing it could be a lot worse.
Commonwealth of Virginia Standard Performance Bond
This next bond form is a new performance bond form just recently adopted by the Virginia Department of General Services. This bond form will come into play on certain state-level public projects in Virginia going forward. In Section 3 of the bond, in response to the obligee’s notice of default, the surety has 14 days to request a meeting with the obligee to discuss methods of completing the contract. If the surety fails to request or attend such meeting it “shall be declared in default.” 14 days is not a lot of time especially for the larger surety’s and considering that the notice will in all likelihood be sent to the agent that issues the bond. If you miss the deadline, the bond says you are in default.
Assuming the meeting takes place, in Section 4 of the bond, the State has graciously given the surety 30 days after the initial meeting to investigate and otherwise analyze the project and at the end of this time period the surety must make an election among the performance rights provided in the bond, which I will get to in a moment. But, first, the bond has some dangerous language, in the provision ostensibly allowing the surety to select its performance option, it says:
Surety shall . . . notify the Owner in writing that it is taking one of the following actions, “which shall be acceptable to the Owner, at the Owner’s sole discretion:”
This language is a little confusing but it seems to be saying that although the surety can “choose” between the performance options, the option chosen by the surety must be or shall be acceptable to the Owner and that the Owner has the “sole discretion” as to whether the option chosen by the surety is acceptable or not. That language essentially strips the surety of its option to choose and converts it into the option to choose what the obligee wants. But wait, it gets even worse. The performance options that the bond allows the surety to “choose” from includes: First, takeover, and with consent of the obligee the surety could use its principal to complete. Second, and here the bond again provides “if acceptable to the obligee and at the obligees sole discretion,” and with reasonable promptness, the surety may waive the right to complete and pay all amounts owed to the obligee, including costs to complete, correct defects, any additional legal, design professional and delay costs, liquidated damages. Third, deny liability in writing stating the reasons. If the obligee and surety cannot agree on the amount owed under option 2, the “blank check option” or if the surety denies liability, the obligee can enforce any remedy available and complete using any available means.
The bond form specifically takes away the option to tender a completion contractor by stating “however, due to conflicts with the Virginia Public Procurement Act the owner may not directly contract with an otherwise qualified independent contractor produced by the surety.” No tender option.
So, the surety’s choices are – takeover, essentially agree to write a blank check or deny the claim. But, the surety doesn’t really have a choice, because any choice made has to be acceptable to the obligee in its sole discretion. Thus, in theory under this bond, the surety could elect to deny the claim, but the obligee could say, no that is not acceptable to me, choose another option. Or, the surety could say it elects to takeover, but the obligee could say no, choose another option. Essentially, the obligee could always choose the “blank check option.” In general, the “sole discretion” power that the obligee has would need to be exercised in reasonableness and with good faith, but this is a bad, ill-conceived bond form.
Perhaps the most troubling aspect of this bond is that there is no clear statement that the penal limit of the bond is the surety’s limit of liability. Instead, in Section 6 of the bond, it states that if the surety elects to takeover or pay the obligee, its “responsibilities” shall not be “greater or less than those of the contractor to the obligee under the contract.” Basically, that means unlimited liability and certainly not liability limited by the penal sum of the bond. It also equates the surety liability with the principal’s liability, which may preclude typical surety defenses.
To date, there has not been any litigation regarding this bond form because it is still relatively new. Therefore, if you are dealing with a project in Virginia where the Commonwealth is the Owner, keep an eye out for the “Standard Performance Bond” document DGS-30-084.
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (410-659-1321/mstover@wcslaw.com) or any member of the Surety and Fidelity Practice Group.