An often-overlooked part of contract negotiations is the language included in the performance bond. While the owner or contractor (bond obligee) requires a performance bond and pays for it, negotiating efforts are typically spent on the main contract language itself rather than the bond. A common go-to performance bond form used in the construction industry is the AIA A312-2010 (A312). If the bond obligee fails to make a simple change to the A312 form language, it can end up costing the bond obligee far more later when it seeks to enforce the bond and the surety declines coverage.
The A312 includes several express conditions precedent that must be satisfied before a surety’s obligation to respond to a claim on the bond is triggered. The conditions precedent are contained in Section 3 of the A312. Section 3 requires the bond obligee to provide notice of its intention to declare a default, an opportunity to cure, the declaration of default, and actual termination of the subject contract. Section 5 of the A312 identifies the surety’s response options after the bond obligee satisfies the conditions in Section 3. Many courts have held that the failure to strictly comply with all of the A312 Section 3 requirements renders the bond null and void and completely discharges the surety from all obligations under the bond. A general contractor in Massachusetts recently learned this the hard way.
In Arch Insurance Co. v. Graphic Builders, LLC, 36 F.4th 12 (1st Cir. 2022), the contractor (bond obligee) made a claim under an unmodified A312 performance bond against a window supplier and its surety to pay for the multi-million-dollar cost to correct defective windows and to get a window warranty. The contractor declared a default, but did not terminate the window supplier’s contract on the legitimate belief that since the work was substantially complete, such an option would have been a wrongful termination under Massachusetts common law. The Circuit Court of Appeals acknowledged the contractor’s dilemma, but enforced the termination requirement in Section 3 in the A312 and affirmed the district court’s entry of summary judgment discharging the surety from liability on the bond. The Court simply enforced the language in the bond to which the contractor had agreed. As a result of not modifying the A312, the contractor was stuck not only with the cost of the bond and the window repair costs, but also significant legal fees to arrive at this court decision.
It is not uncommon for a claim against a performance bond to be asserted at the end of a project, after a party to the contract learns something went wrong and needs to be fixed. To avoid the fate of the contractor in Graphic Builders, a bond obligee should remove the termination requirement in section 3.2 of the A312 (and from any other performance bond containing similar language), while negotiating the overall contract, to limit the final condition precedent in the bond to the declaration of a contractor default. The bond obligee should not have to terminate the contract before the surety’s obligations are triggered and deal with the other potential issues that might accompany such an action late in a project. Notice to the surety and principal that the bond obligee is considering declaring a default, providing an opportunity to cure, and a declaration of default should be all that is necessary before the bond obligee is entitled to the benefits of the performance bond for which it has paid.