Surety Case Law Note: Conditions Precedent in AIA A312 Performance Bond Apply to Claims for Delay Damages Under New York Law
August 27, 2024
In this Surety Today: The Blog post we consider a Case Law Note addressing the issue of whether the conditions precedent in the AIA A312 performance bond apply to claims for damages for delay under New York law. The case is:
JDS Dev. LLC v. Parkside Constr. Builders Corp., No. 1608-09, 2024 WL 3817696, at *1–8
(N.Y. App. Div. Aug. 15, 2024)
This case arose out of the construction of an 85 floor skyscraper in New York City. Do to bonding capacity issues, the surety could only issue bonds to cover its principal, the superstructure subcontractor’s construction from the basement to the 36th floor of the structure. The penal sum of the performance bond, an AIA A312 bond form, was $24,940,383. The court noted that the A312 bond was developed to define clearly the ‘trigger’ of the surety’s obligation to perform. With regard to the “trigger” of the surety’s obligation, as everyone knows, paragraph 3 provides that the surety’s obligation under the bond shall arise after the obligee (1) has notified the surety and the principal that it is considering declaring a default and offered to confer with the surety and the principal to discuss how to proceed, (2) has declared a default and formally terminated the principal’s right to complete the contract no earlier than 20 days after the aforementioned notice, and (3) has agreed to pay the balance of the contract price to the surety or to a new contractor chosen by the surety.
In the subcontract, the principal assumed liability to the obligee and the property owner for any losses caused by delay of the timely progress of the work. Under the contractual schedule for the principal’s work, completion of the 36th floor was due on October 13, 2016. Within a short time after the issuance of the bond, the obligee began to be concerned that the principal was failing to keep pace with the construction schedule. In May 2016, the obligee began considering terminating the principal and, to that end, solicited bids from possible replacement contractors. Ultimately, however, the obligee decided against terminating the principal because “the cost to make that switch would be worse and more damaging than fighting through the job with [the principal] until the end.” The obligee testified that the potential replacement contractors would not be able to start working immediately, which would have had a greater schedule impact. So, for that reason it decided given that the principal at least had men on the job, and men available, it would stick with the principal. It does not appear that the obligee shared any of these concerns or considerations with the surety.
As a result of the delays in the principal’s performance, the principal did not complete its work through the 36th floor until October 31, 2017 – more than a year after the contractual due date. Surprisingly, in November 2017, the obligee paid the principal in full for its work through the 36th floor. Indeed, the obligee even granted the principal a contract adjustment that increased the price of the principal’s work through the 85th floor by more than $19 million above the original contract price, including $16 million for the basement through the 36th floor work already performed.
The principal continued its work on the project from the 36th floor through between the 55th and 60th floors, until May 16, 2018, when indictments against the principal and its owners for wage theft and workers compensation insurance fraud were unsealed. At that point, the principal abandoned the project.
On June 1, 2018 – approximately 6 months after the principal completed the work covered by the bond and had been paid in full for that work – the obligee sent the surety and principal a letter purporting to comply with paragraph 3.1 of the bond, advising that it was “considering declaring a contractor default” and requesting that a conference be held within 15 days “to discuss methods of performing the Construction Contract.” On August 9, 2018, the obligee sent the surety and principal a letter formally declaring a default and five days later another letter terminating the principal. Subsequently, the obligee contended that the requirement of subparagraph 3.3 of the bond (“agree to pay the Balance of the Contract Price) was inapplicable because the claims exceed any available balance of the subcontract and called upon the surety to timely fulfill its obligations under the bond. The obligee estimated that the total liability significantly exceeded the penal sum the bond and totaled $89,485,264.51, of which the large majority – $78,256,061.86 – comprised additional costs that the obligee attributed to the principal’s 382–day delay in completing the superstructure through the 36th floor.
In November 2018, the obligee filed suit seeking the full penal sum of the bond – $24,940,383.00. Cross motions for summary judgment were subsequently filed. The surety contended that the obligee failed to comply with the conditions precedent in the bond and that the specific plaintiff bringing the action did not have standing to bring the case. The trial court granted the surety summary judgment and denied the obligee’s motion.
On appeal, the court noted that the obligee’s compliance with the procedures prescribed by paragraph 3 of the A312 bond is a condition precedent to an action to recover upon the bond. See Walter Concrete Constr. Corp. v. Lederle Labs., 99 N.Y.2d 603, 605, 758 N.Y.S.2d 260, 788 N.E.2d 609 (2003)(noting that an action on an A312 bond is “tied to a declaration of default” and that “a precursor to liability under the (A312) bond … [is that] predefault notification be given to the contractor and surety by the owner”). The court stated, since Walter Concrete, New York courts have given effect to the Court of Appeals’ recognition that paragraph 3 of the A312 bond creates mandatory conditions precedent to a valid claim under the bond. Citing Prismatic Dev. Corp. v. International Fidelity Ins. Co., 221 A.D.3d 469, 469, 198 N.Y.S.3d 71(1st Dept. 2023); Independent Temperature Control Servs., Inc. v. Parsons Brinckerhoff, Inc., 159 A.D.3d 636, 637, 70 N.Y.S.3d 847 (1st Dept. 2018); Granger Constr. Co., Inc. v. TJ, LLC, 134 A.D.3d 1329, 1331, 21 N.Y.S.3d 491 (3d Dept. 2015); Archstone v. Tocci Bldg. Corp. of N.J., Inc., 119 A.D.3d 497, 498, 990 N.Y.S.2d 44 (2d Dept. 2014); Tishman Westwide Constr. LLC v. ASF Glass, Inc., 33 A.D.3d 539, 823 N.Y.S.2d 71 (1st Dept. 2006); 153 Hudson Dev., LLC v. DiNunno, 8 A.D.3d 77, 78, 778 N.Y.S.2d 482 (1st Dept. 2004).
The obligee argued that while the paragraph 3 requirements may be preconditions for requiring the surety to complete the defaulting contractor’s work, they should not be deemed to constitute conditions precedent to a claim for delay damages. It reasoned that, since the bonded contractor may be held liable for delay damages even if the delay is not sufficiently egregious to warrant termination, or even if the owner chooses not to terminate, the surety, as guarantor of the contractor’s performance, should be required to pay delay damages under the bond regardless of the beneficiary’s compliance with the paragraph 3 procedures. The obligee concludes that once there has been a delay in performance, the cost of that delay cannot be avoided through the options afforded the surety under paragraph 4 of the A312 bond, so the notice and conferral provisions of paragraph 3 are not essential. The appellate court flatly stated “[w]e are not persuaded.”
The court began by noting that the A312 bond provides clearly that the surety’s obligations “shall arise after” the beneficiary complies with the procedures set forth in paragraph 3 and under New York law, this language creates a condition precedent. Nothing in the bond excluded the surety’s potential obligation to pay delay damages from the scope of “the Surety’s obligation under this Bond” that paragraph 3 directs “shall arise after ” there has been compliance with the procedures set forth in subparagraphs 3.1, 3.2, and 3.3. The appellate court further observed that “a performance bond is not insurance against the cost of any breach by the principal, but rather, a guarantee of the principal’s performance that is triggered only upon the termination of the principal from the project for a breach sufficiently egregious to constitute a default warranting termination.” Thus, the court held that “even though delay damages cannot be avoided once the delay has taken place, the surety’s obligation to pay those past damages is only triggered if, and when, the [obligee] follows the notice and termination procedures of paragraph 3 of the A312 bond.” Citing 153 Hudson, 8 A.D.3d 77, 778 N.Y.S.2d 482, aff’d 2003 WL 25520440 (Sup. Ct., N.Y. County May 13, 2003, No. 603536/00); 120 Greenwich, 2004 WL 1277998, *12, 2004 U.S. Dist LEXIS 10514, *34; Prismatic, 221 A.D.3d at 470, 198 N.Y.S.3d 71; Archstone, 119 A.D.3d at 498, 990 N.Y.S.2d 44.
The obligee also argued that it ultimately did comply with the procedures of paragraph 3 of the bond when it issued the prescribed notices in June and August of 2018, after JDS’s abandonment of its work between the 55th and 60th floors. The court brushed aside this argument stating “[t]he short answer to this contention is that, as previously discussed, a surety’s obligations under a performance bond are triggered, after compliance with other required procedures, by the termination of the principal from the bonded work – an event that can happen only while the bonded work is still in progress.”
Finally, the obligee argued that its decision not to declare a default and terminate the principal was economically rational (mitigation of damages), since it might well have faced a greater loss from the delays attendant on bringing on a new contractor than from continuing to put up with the principal. The court responded that while the obligee may have made the correct business decision, this did not entitle the obligee to obtain the benefits of the bond without complying with that bond’s material terms. The court stated “[t]erminating [principal] to preserve [obligee’s] rights to the benefit of a $25 million bond may not have made economic sense if it would have resulted in even greater delays in the construction of a billion-dollar skyscraper. However, having made the choice it did, [obligee] must now live with the legal consequences of that choice. One cannot have one’s cake and eat it, too.”
Accordingly, the appellate court affirmed the judgment of the trial court in favor of the surety. We have the amazing Mr. Adam Friedman, Esq., who represented the surety, to thank for this decision. I am sure that the fact that the judge who wrote the opinion was also named Friedman had nothing to do with the outcome.
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.