Problems and Pitfalls Handling AIA Bond Claims

While the A312-2010 bond forms have many good qualities and are a big improvement over predecessor AIA bonds and many other bond forms in use today, the potential for liability exceeding the penal sum is a serious problem for the surety under the A312-2010 Performance Bond.

This article was prepared in conjunction with a 2011 continuing
education presentation for surety claims departments.

In 1970, The American Institute of Architects (“AIA”) released its landmark AIA Document A311 bonds – Performance Bond and Labor and Material Payment Bond (“A311-1970 Performance Bond” and “A311-1970 Payment Bond”). Thereafter, in 1984, the AIA released its AIA Document A312 bonds – Performance Bond and Payment Bond (“A312-1984 Performance Bond” and “A312-1984 Payment Bond”). The most recent version of AIA bonds, released in 2010, are the A310-2010 Bid Bond and the A312-2010 Bonds – Performance Bond and Payment Bond (“A312-2010 Performance Bond” and “A312-2010 Payment Bond”). Since these bond forms are, by far, the most commonly used bonds in the surety industry, surety claims professionals closely track how courts have interpreted the bond coverage provisions (including conditions precedent to coverage, limitations upon coverage, notice provisions and recoverable damages). Trends have emerged from these court decisions, in some cases correct interpretations and in other cases clearly wrong interpretations of the bonds. More troubling for sureties, there is yet another category of conflicting court decisions leading to uncertainty as to surety liability exposure under particular AIA bonds.

The need for clarity, and even more important for consistency in court rulings interpreting the bonds, is what led the AIA to undertake the major project of updating its A312 bond forms. Revision of the A312 bond forms began in April 2009 and was the collaboration of many leading construction industry organizations, including the American Bar Association Forum Committee on the Construction Industry, the Associated Builders & Contractors, the American Subcontractors Association, the Associated General Contractors of America, the Associated Specialty Contractors, the Construction Owners Association of America, the National Association of Surety Bond Producers, the Surety & Fidelity Association of America, the National Society of Professional Engineers, the American Council of Engineering Companies, the American Insurance Association, the Engineers Joint Contract Documents Committee, and the American College of Construction Lawyers. The long wait for the new bond forms ended on June 10, 2010 when the AIA released the A310-2010 Bid Bond and A312-2010 Performance and Payment Bonds.

Issuance of the A312-2010 bond forms does not mean the end to use of the earlier A311-1970 and A312-1984 bonds. Although the A311 is no longer an official bond form of the AIA, and the A312-1984 is being phased out at the end of 2011 by the AIA (an 18 month long transition to the A312-2010 bond forms), all sureties who are members of the Surety & Fidelity Association of America (“SFAA”) may use current and prior bond forms (and even put the bond forms on their own letterhead) under a license agreement with the AIA. But the real reason for continued use of the older bond forms is that owners and their design professionals continue to specify these bond forms and, as a consequence, sureties continue to issue the older bond forms. It is thus important for surety claims professionals to understand the nuances of coverage under all three sets of AIA bond forms.

Attached as exhibits are the bond forms which will be discussed in this article:

This article will examine coverage under each of the bonds, however this article will not be an in-depth discussion of all coverage issues which may arise under these bonds. Rather, this article will focus upon those bond provisions which have led to conflicting and sometimes erroneous court decisions – in other words, those provisions that cause the most problems for the surety’s handling of bond claims. Because the A312-2010 bonds are so new, there are no reported cases on these bonds as of date of this article. But this article will examine how the AIA resolved, in its new bonds, coverage issues that had arisen under its prior bonds. As stated above, the A312-2010 bonds are the product of a massive collaborative effort by many construction industry organizations; the result is a series of bond forms which are clearer and contain less ambiguities then the AIA predecessor bonds. The hope, of course, is that improved drafting of the new bonds will lead to less coverage misinterpretations by the courts. The negative from the surety’s perspective, also to be discussed below, is that important surety rights and defenses were sacrificed in negotiations with other trade groups which resulted in the new bonds. Bottom line, in the authors' opinion, is that the surety industry lost ground in exchange for clarity (or at least better clarity) as to coverage under the A312-2010 bonds.

Not so long ago, the A311-1970 Performance Bond was the workhorse of the surety industry. However, with the introduction of the longer form A312-1984 Performance Bond, the surety industry chose to less frequently use the A311-1970 Performance Bond. Notwithstanding its decreased popularity, the A311-1970 Performance and Payment Bonds are still often issued on current projects by owners and their design professionals, and so sureties must still adjust claims made against these bonds.

The A311-1970 Performance Bond is an old fashioned bond form which is short, skimpy on details and relies upon common law and/or case law to determine rights and obligations of the parties thereto. The A311-1970 Payment Bond has a few more details than its Performance Bond counterpart. But both bonds are written in archaic language and coverage under both bonds is described in the negative (“If Contractor shall promptly and faithfully perform said Contract, then this obligation shall be null and void.”). As a practical matter, the reader has to know what the intended coverage is and then work backwards to determine the extent of the surety’s obligations under these bonds.

Whether the operative language of the A311-1970 Performance Bond creates a condition precedent to the surety’s performance has been a critical issue as courts have struggled to construe this bond form. The particular language in this bond, which has been the subject of hotly debated court decisions, is as follows:

(A) _______________, as Principal, hereinafter called Contractor, and _________________, as Surety, hereinafter called Surety, are held and firmly bound unto ___________, as Obligee, hereinafter called Owner, in the amount of $__________ . . .

(B) WHEREAS, Contractor has…entered into a contract with Owner . . ., which Contract is by reference made a part hereof, . . .

NOW THEREFORE, THE CONDITION OF THIS OBLIGATION IS SUCH THAT, if Contractor shall promptly and faithfully perform said Contract, then this obligation shall be null and void; otherwise it shall remain in full force and effect.

(C) Whenever Contractor shall be, and declared by Owner to be in default under the Contract, the Owner having performed Owner’s obligations thereunder, the Surety may promptly remedy the default, or shall promptly

(2) Obtain a bid or bids for completing the Contract…and make available as Work progresses . . . sufficient funds to pay the cost of completion less the balance of the Contract price…

Conditions precedent to bond coverage, such as the declaration of default condition quoted above, are extremely important to the surety’s handling of a performance bond claim. Until a bond’s conditions precedent are satisfied, the surety’s obligations have not been triggered and so the surety does not have the right to take over the bonded project or even discuss project issues with subcontractors and other project participants. Indeed, the surety can face liability for tortious interference with the contractor’s business relations if it acts too early. U.S. Fid. & Guar. Co. v. Braspectro Oil Servs. Co., 369 F.2d 34, 51 (2nd Cir. 2004). On the other hand, if the surety waits too long to act, it may face significantly higher liability exposure due to worsening conditions at the bonded project.

Unfortunately, the case law has been conflicting as to what is meant by the above-quoted default language of the A311-1970 Performance Bond – therefore, there is uncertainty as to when the default condition precedent of the bond has been satisfied. The leading case decision for the surety, construing the default condition of the A311-1970 Performance Bond, is L&A Contracting Co. v. S. Concrete Serv., Inc., 17 F.3d 106, 111 (5th Cir. 1994). In L&A Contracting, the Fifth Circuit Court of Appeals observed that “the bond in this case imposes liability on [the surety] for [its bond principal’s] breach only if two conditions exist. First, [the bond principal] must have been in default of its performance obligation under the subcontract. Second, [the bond obligee] must have declared [the bond principal] to be in default.”

As to what constitutes a sufficient declaration of default to invoke the surety’s obligation under the A311-1970 Performance Bond, the L&A Contracting Court provided a bright-line rule of coverage. In clear and unequivocal language, “the declaration must inform the surety that the principal has committed a material breach or a series of material breaches of the subcontract, that the obligee regards the subcontract as terminated, and that the surety must immediately commence performing under the terms of the bond.” L&A Contracting, 17 F.3d at 111 (emphasis added).

In the years since the Fifth Circuit handed down its decision in L&A Contracting, many courts have embraced the Fifth Circuit’s reasoning and likewise held that the operative language of the A311-1970 Performance Bond creates condition precedents to a surety’s performance obligations. See N. Am. Specialty Ins. Co. v. Ames Corp., No. 08-80966-CIV, 2010 WL 1027866, at *6-8 (S.D. Fla. May 18, 2010) (granting summary judgment in favor of surety where bond obligee’s letters to surety failed to declare bond principal in default, which is a condition precedent to the surety’s performance bond obligation); Hunt Constr. Group, Inc. v. Nat’l Wrecking Corp., 587 F.3d 1119, 1122 (D.C. Cir. 2009) (affirming district court’s grant of summary judgment in favor of surety on the ground that “the requirements listed in Paragraph C are properly read as true conditions precedent, in the absence of which the surety has no liability on the bond”); CC-Aventura, Inc. v. Weitz Co., LLC, No. 06-21598-CIV, 2008 WL 2937856, at *3-4 (S.D. Fla. July 14, 2008) (no dispute that bond obligee was required to provide notice of bond principal’s default in order to recover performance bond); Current Builders of Florida, Inc. v. First Sealord Sur., Inc., 984 So.2d 526, 529-31 (Fla. Dist. Ct. App. 2008) (affirming trial court’s denial of motion for new trial on the ground that bond obligee failed to provide notice of bond principal’s default to surety); Elm Haven Constr. Ltd. P’ship v. Neri Constr. LLC, 376 F.3d 96 (2d Cir. 2004) (affirming summary judgment in favor of surety and recognizing that “[in] order to trigger [surety’s] liability under the performance bond, two conditions had to be met. First, [the bond principal] had to be ‘in default’ under the subcontract agreement, and second, [the bond obligee] has to ‘declare [the principal] to be in default under the’ subcontract agreement”); Balfour Beatty Constr., Inc. v. Colonial Ornamental Iron Works, Inc., 986 F. Supp. 82, 85-86 (D. Conn. 1997) (“[p]erformance bond requirements for notice of default and demand that surety step in and perform under the bond must be met before an obligee can recover under the performance bond); Ins. Co. of N. Am. v. Metro. Dade County, 705 So.2d 33, 35 (Fla. Dist. Ct. App. 1998) (holding that bond obligee’s “failure to comply with [the] bond’s notice provisions stripped the surety of its bargained for right and relieved the surety of its liability”); Dragon Constr., Inc. v. Parkway Bank & Trust, 287 Ill.App.3d 29, 33-34, 678 N.E. 55, 57-58, 222 Ill.Dec. 648,650-51 (Ill. Ct. App. 1997) (holding that the “[obligee’s] failure to provide adequate notice of [bond principal’s] termination and their hiring of a successor contractor before [surety] received the late notice stripped [surety] of its right to limit its liability and constituted a material breach of contract which rendered the surety bonds null and void”). All of these cases share a common holding: unless and until the bond obligee declares a default in clear and unequivocal language and terminates the bonded contract, the surety is not obligated to perform under the A311 Performance Bond.

On the opposite end of the spectrum are those case decisions that expressly reject the reasoning of L&A Contracting and its progeny and hold that the operative language of the A311-1970 Performance Bond does not create conditions precedent to a surety’s performance obligations. The leading case against the surety is Colorado Structures, 161 Wash.2d 577, 167 P.3d at 1125 (Wash. 2007), in which the Washington Supreme Court expressly rejected the reasoning of the Fifth Circuit in L&A Contracting and held that the bond obligee was not required to formally declare the bond principal in default before the surety’s liability on its A311-1970 Performance bond was triggered. The Colorado Structures Court went so far as to state that L&A Contracting was “wrongly decided” declaring that “[t]he linchpin of the L&A court’s conclusion is its assertion . . . . that the events described in the preamble to Paragraph C condition not just the use of the remedies described in Paragraph C, but also the liability described in Paragraph A. To do so, however, plainly violates the language of the bond.” (167 P.3d at 1128, emphasis in original).

In Colorado Structures, the bond obligee/general contractor chose to supplement a bond principal/subcontractor in order to minimize financial penalties for late performance. The obligee informed the surety of the subcontractor’s untimely work, but never terminated the subcontract. At the conclusion of the project, it was determined that the cost of supplementation exceeded the subcontract balance, and so the obligee sought recovery under the A311-1970 Performance Bond. According to the Court, the obligee did not have to meet any condition precedent for surety liability under Paragraph A of the bond; Paragraph A is subject to only a single condition subsequent, i.e., the principal’s prompt and faithful performance. Although the obligee did not sufficiently declare a default for Paragraph C purposes, the principal was in fact in material default and so the obligee was entitled to recover from the surety under the Paragraph A bond coverage.

In the authors' opinion, the Colorado Structures, case was wrongly decided – to the extent that it makes use of the A311-1970 Performance Bond potentially dangerous for a surety. The bond was never intended to provide two alternative paragraphs of coverage to the bond obligee; this is a fiction, or at best a misreading, by the Colorado Structures court. The effect of this ruling is that the surety is deprived of any opportunity to minimize damages caused by a misperforming principal – the surety cannot take over the project until the principal is terminated by the obligee, so it must wait while the principal continues to misperform and thus build upon the damages for which the surety will ultimately be liable to the obligee. This is not the risk which the surety assumed when the Performance Bond was written, and greatly increases the surety’s liability exposure. Fortunately, this very serious coverage interpretation problem was corrected by the AIA in the A312 bonds.

Notwithstanding that Colorado Structures was wrongly decided, a number of courts in various jurisdictions have chosen to follow the Colorado Structures holding and rule against the surety (although not always following the extreme surety-adverse dicta of the Colorado Structures opinion). Nova Casualty Co. v. Turner Construction Co., No. 14-09-00733-CV, 2011 WL 480599 at *4-5 (Tex. Ct. App. Feb. 10, 2011) (obligee entitled by subcontract to supplement principal subcontractor and charge surety with excess cost, without termination of subcontract or notice to surety); RLI Ins. Co. v. St. Patrick’s Home for the Infirm and Aged, 452 F. Supp.2d 484, 488 (S.D.N.Y. 2006) (distinguishing Elm Haven on the ground that “unlike the bonds at issue in [Elm City and like cases], the performance bond in this case does not include an explicit notice requirement”); Walter Concrete Constr. Corp. v. Lederle Lab., 99 N.Y.2d 603, 605, 788 N.E. 2d 609, 610, 758 N.Y.S.2d 260, 261 (N.Y 2003) (holding that “[u]nlike the AIA-312 bond …. an action on the AIA-311 bond is not tied to a declaration of default, the principal’s cessation of work or the surety’s refusal to perform under the bond …. Had the parties to the contract desired notice as a precursor to liability under the bond, they would have elected to issue a more specific AIA-312 ….”); DCC Constructors, Inc. v. Randall Mech., Inc., 791 So.2d 575, 576-77 (Fla. Dist. Ct. App. 2001) (holding that “[t]here is no language in the performance bond …. which requires termination of the subcontract as a condition precedent to [the surety’s] obligations”); Menorah Nursing Home, Inc. v. Zukov, 153 A.D.2d 13, 21-22, 548 N.Y.2d 702, 708 (N.Y. App. Div. 1989) (rejecting surety’s argument that action against surety should be dismissed because the bond obligee failed to declare principal in default under the subcontract on the ground that “the bond contains no provision which expressly requires a notice of default as a condition precedent to any legal action on the bond”); Dooley and Mack Constructors, Inc. v. Developers Sur. And Indemn. Co., 972 So. 2d 893 (Fla. Dist. Ct. 2007) (obligee has option to complete the bonded work and hold the surety liable for all damages and expenses, without notifying surety because notice not required under the bonded subcontract).

There is a clear split of authority around the country on this very important point of coverage, and it is difficult to predict whether L&A Contracting or Colorado Structures will be the prevailing view in a jurisdiction which has not yet addressed this issue in a reported decision.

A related, but distinctly different, issue is the surety’s defense when the obligee fails to give prompt notice to the surety or otherwise fails to promptly act upon default by the principal contractor. Blackhawk Heating and Plumbing Co. v. Seaboard Surety Company, 534 F. Supp. 309 (N.D. Ill. 1982) involved a performance bond similar to the A311-1970 bond form. The principal/subcontractor’s work was untimely, yet the obligee/general contractor did not declare a default and call upon the bond for what the surety contended was an unreasonably long period of time. The court agreed with the surety and allowed a defense to the performance bond claim – to the extent that the surety could prove delay in notice by the obligee prejudiced the surety and added to the surety’s costs of completion. Other courts have also ruled that the surety has a pro tanto defense, i.e., to the extent of prejudice, for late notice by the obligee. Plowden and Roberts, Inc. v. Conway, 192 So.2d 528 (Fla. Ct. App. 1966); Bayer and Mingolla Construction Co. v. Deschenes, 348 Mass. 594, 205 NE.2d 208 (Mass. 1965). This defense due to the obligee’s failure to give prompt notice (really a mitigation of damages defense) is in sharp contrast to the defense due to the obligee’s failure to meet bond conditions precedent. The former is to the extent of defense and places the burden of proving prejudice (sometimes a highly difficult burden to meet) on the surety; the latter is a full defense for the surety regardless of the extent (or even the absence) of prejudice.

Turning to other coverage issues under the A311-1970 Performance Bond, the bond does not explicitly address whether delay damages/liquidated damages are recoverable and again there is a split in the cases interpreting this bond. In the leading surety-favorable case, American Home Assurance Co. v. Larkin General Hospital, Ltd., 593 So.2d 195, 196 (Fla. 1992), the court held that “a surety cannot be held liable for delay damages due to the contractor’s default unless the bond specifically provides coverage for delay damages.” See Downington Area School District v. International Fidelity Insurance Co., 769 A.2d 560, 565-66 (Pa. 2001). On the other hand, the court in Cates Construction, Inc. v. Talbot Partners, 980 P.2d 407 (Cal. 1999) held a surety liable for delay damages under the A311-1970 Performance Bond due to the bond language “…including other costs and damages for which the Surety may be liable.” There is no clear answer as to whether actual delay damages or liquidated damages are recoverable against an A311-1970 Performance Bond in a jurisdiction which has not addressed this issue – a problem of lack of clarity in the bond form which was corrected (although not in the surety’s favor) in the A312 bond forms.

Another troubling issue in the A311-1970 bond form is when the bond limitations period has expired. The limitations period of the A311-1970 Performance Bond provides as follows:

Any suit under this bond must be instituted before the expiration of two (2) years from the date on which final payment under the Contract falls due.

While no case law was found directly addressing the limitations clause of the A311-1970 Performance Bond, there have been quite a few cases which considered similar clauses in other bond forms setting limitations deadlines triggered by when final payment to the bond principal became due. As examples are a series of New York opinions which have reached inconsistent holdings. In Clyde-Savannah Cent. Sch. Dist. v. Naitzker, Thorsell & Dove, 73 AD 2d 810 (NY App. Ct. 1979), a subcontract bond stated suit could be filed no later than two years from the date final payment became due. The court turned to the subcontract and determined final payment required acceptance of subcontractor’s work by the owner and/or the architect. Despite the fact that payment was actually made more than two years before suit on the bond was filed, the surety’s limitations defense was rejected because there was no evidence of acceptance of subcontractor’s work by the owner or architect. On the other hand, in a more recently decided New York case involving similar facts, Yeshava Uni v. Fid. and Deposit Co. of Maryland, 116 AD 2d 49, 500 NYS 2d 241 (NY App. Ct. 1986), the court accepted the surety’s limitations defense because the subcontractor had been paid and the owner/architect’s acceptance was implied by taking occupancy of the building.

Both of the above New York cases involved claims for latent defects in performance discovered after the project was completed. In yet a third New York latent defect case, Town of Esopus v. Brinnier and Larios, 135 AD 2d 935, 522 NYS 2d 337 (NY App. Ct. 1987), the court approved the surety’s limitations defense and dismissed the surety, notwithstanding the obligee/ owner’s position that principal/contractor had covered up its defective sewer work and so final payment was fraudulently induced. The Yeshava opinion was cited approvingly, and it is fair to say that Yeshava is now the prevailing view in New York.

In BDI Const. Co. v. Hartford Fire Ins. Co., 995 So.2d 576 (Fla. Dist. Ct. App. 2008), the applicable Florida five-year limitations period ran from when final payment was due to the principal/subcontractor. Rejecting the general contractor’s argument that final payment never really became due to the subcontractor because of its defective stucco and drywall work, the court ruled that the limitations period ran from when final payment to the subcontractor was actually made. In agreement with BDI are Fed. Ins. Co. v. Southwest Florida Retirement Center, Inc., 707 So.2d 1119 (Fla. 1988) (Florida Supreme Court ruled bond limitations period ran from date of acceptance of construction) and La Liberti, LLC v. Keating Building Corp., 2007 WL 4323687 (E.D. Pa. Dec. 11, 2007) (bond limitations period ran from date of final payment to principal subcontractor). On the other hand, for a case which follows the Clyde-Savannah reasoning, see Hagerstown Elderly Assoc. Ltd. P’ship v. Hagerstown Elderly Building Assoc. Ltd. P’ship, 368 Md. 351, 793 A.2d 579 (Md. Ct. App. 2002) (court looked to bonded contract and determined final payment did not become due until a loan closing had occurred). Although these cases are irreconcilable as to the event which triggers the running of the bond limitations period, there is consensus on one important point: no distinction is made between patent and latent claims and courts do not apply a discovery exception to the time limitations requirement of the A311-1970 or similar form performance bonds.

As another point of discussion regarding bond limitations clauses, it must be remembered that many states have statutorily prescribed the minimum period for suits to be filed on insurance claims (including surety bond claims) and attempts to shorten the minimum time period are invalid. See, e.g., Conn. Gen. Stat. § 38a-290 (2010) (minimum time limit to bring suit on performance bond in Connecticut is three years from date principal last performed work); 8 V.S.A. § 3663 (2010) (limitations period of less than twelve months to file suit on performance bond from date of default is null and void as against public policy in Vermont; A.R.S. § 20-1115(A)(3) (in Arizona, time within which an action must be brought on an insurance claim, including a bond claim, cannot be less than two years after cause of action accrues); S.D. Codified Laws § 53-9-6 (2010) (for time to enforce surety contract to be valid in Texas, the time period cannot be less than two years after the cause of action has accrued). The point is that it is not sufficient for the surety claims handler to simply apply the limitations clause found in the A311-1970 Performance Bond or any other bond form – the law of the jurisdiction in which the bond is issued must be reviewed to determine if the bond limitations clause is enforceable.

Finally, regarding limitations clauses contained in bonds, the rogue case of City of Santa Fe v. Travelers Casualty & Surety Company, 228 P.3d 483 (N.Mex. S. Ct. 2010) must be discussed. This case involved an A312-1984 Performance Bond, but its holding is equally applicable to the A311-1970 Performance Bond. In this case, an A312-1984 Performance Bond was issued on behalf of a general contractor for a City of Santa Fe public project. Although the bonded contract was silent as to time to sue and so was subject to a six-year statute of limitations, the bond contained a two-year limitations clause. The New Mexico Supreme Court ruled that the two year limitations clause in the bond was not binding on Santa Fe, because Santa Fe had not “agreed” to the shorter time period of the bond. Although it would not have violated public policy for Santa Fe to make this agreement, the Court held such agreement could not be implied from Santa Fe’s acceptance of the bond prior to commencement of construction. Thus the surety Travelers was bound to a six-year, not a two-year, time period to sue on the performance bond. No authority was cited by the Court for its bizarre holding. While unprecedented, this case is the law in New Mexico. Accordingly, sureties issuing bonds in New Mexico are advised (if feasible) to get public and private obligees to actually sign issued bonds indicating their approval of the terms and conditions therein; otherwise there will be uncertainty as to enforceability of limitations clauses and perhaps other bond provisions.

Since its release by the AIA, the A312-1984 Performance Bond has been the surety industry’s preeminent performance bond form. In contrast to the A311-1970 Performance Bond, the A312-1984 Performance Bond is a long bond form which provides obligees, principals and sureties with a “roadmap” explicitly detailing each parties’ rights and obligations under the bond (including important condition precedents that must occur before the surety’s performance bond obligations are triggered). The A311-1970 bond is a short form bond and the A312-1984 is a long form bond. When the AIA undertook its update project in 2009, it expressly decided not to include a short form performance bond in its revised series and instead opted to only update its long form A312-1984 bond.

The pertinent condition precedent language of the A312-1984 Performance Bond is as follows:

3. If there is no Owner Default, the Surety’s obligation under this Bond shall arise after:

3.1 The Owner has notified the Contractor and the Surety at its address described in Paragraph 10 below that the Owner is considering declaring a Contractor Default and has requested and attempted to arrange a conference with the Contractor and the Surety to be held not later than fifteen days after receipt of such notice to discuss the methods of performing the Construction Contract. If the Owner, the Contactor and the Surety agree, the Contractor shall be allowed a reasonable time to perform the Construction Contract, but such an agreement shall not waive the Owner’s right, if any, subsequently to declare a Contractor Default; and

3.2 The Owner has declared a Contractor Default and formally terminated the Contractor’s right to complete the Contract. Such Contractor Default shall not be declared earlier than twenty days after the Contactor and Surety have received notice as provided for in Sub-paragraph 3.1; and

3.3 The Owner has agreed to pay the Balance of the Contract Price to the Surety in accordance with the terms of the Construction Contract or to a contractor selected to perform the Construction Contract in accordance with the terms of the contract with the Owner.

Notably, consistent with the A312 philosophy of eliminating archaic language previously used in other bond forms, the parties are referred to in the A312 bonds as “Owner,” “Contractor” and “Surety.”

As a threshold matter, it should be noted that there should not be a Colorado Structures misinterpretation of the A312 bond form. There are not two surety obligation paragraphs in the A312-1984 Performance Bond, and so there is simply no way to logically read alternative coverages (one subject to conditions precedent, the other not subject to conditions precedent) into this bond.

The above-quoted Paragraph 3 of the A312-1984 Performance Bond requires that the Owner must be in compliance with its obligations under the bonded contract as a condition to the Surety’s liability under the bond. Moreover the bond, in Paragraphs 3.1 through 3.3, explicitly provides for three conditions precedent to the Surety’s liability. Consistent with the express language of Paragraph 3, a majority of courts from around the country have concluded that Paragraph 3 creates three condition precedents. See Travelers Cas. And Sur. Co. of Am. v. Crystal Towers, LLC, No. 08-0518-KD-C, 2009 WL 5068823, at *14-15 (S.D. Ala. Dec. 17, 2009) (granting surety’s motion for summary judgment on breach of contract claim, recognizing that surety’s duties under Paragraph 4 of the A312 Performance Bond are not triggered until after the conditions precedent in Paragraph 3 are met); Stonington Water Street Assoc. v. Hodess Building Co. Inc., 2011 WL 861688 (D. Conn. March 9, 2011) (surety dismissed on summary judgment because owner failed to follow Paragraph 3 of A312 Performance Bond, and thus deprived surety of opportunity to mitigate its damages); Klewin Building Co., Inc. v. Heritage Plumbing & Heating, Inc., 42 A.D.3d 559, 560, 840 N.Y.S.2d 144, 145 (N.Y. 2007) (denying surety’s motion for summary judgment on the ground that it failed to establish that any of the condition precedents set forth in Paragraph 3 of the performance bond were not satisfied by the bond obligee); U.S. Fid. and Guar. Co. v. Braspetro Oil Ser. Co., 369 F.3d 34, 57-61 (2d Cir. 2004) (recognizing that Paragraph 3 of the A312 Performance Bond contains a number of conditions precedent to the surety’s obligations and concluding that contrary to the surety’s assertion, the bond obligee did comply with Paragraphs 3.2 and 3.3); Enter. Capital, Inc. v. San-Gra Corp., 284 F. Supp.2d 166, 179-81 (D. Mass. 2003) (noting that the language of Paragraph 3 does in fact create conditions precedent and concluding that various letters from bond obligee to surety failed to satisfy the requirements of Paragraph 3.2 that the declaration of default and notice of termination of the bond principal be clear, direct, and unequivocal); but see Commercial Cas. Ins. Co. of Georgia v. Mar. Trade Ctr. Builders, 257 Ga.App. 779, 783, 572 S.E.2d 319,322 (Ga. Ct. App. 2002) (rejecting surety’s argument that notice to the surety of the bond principal’s default was a condition precedent to recovery under the A312 Performance Bond on the ground that “[t]he plain language of the executed documents leads to only one reasonable interpretation, that the contractor was not required to give the surety notice before supplementing the subcontractor’s labor and material to collect under the performance bond”).

The first condition under Paragraph 3.1 requires the Owner to notify the Contractor and the Surety that the Owner is considering a Contactor Default (a defined term of the bond), and the Owner requests a conference within 15 days to discuss methods of performing the construction contract. A majority of case decisions have strictly enforced the requirements of Paragraph 3.1. See Breath of Life Christian Church v. Travelers Ins. Co., No. W2009-00284-COA-R3-CV, 2010 WL 1172080, (Tenn. Ct. App. 2010) (affirming trial court award of summary judgment in favor of surety on action against performance bond and rejecting bond obligee’s argument that “section three of the bond is merely a notice provision that should be dispensed with where [surety] had some indication of the difficulties between [the owner and bond principal]”); Podsiadlo v. W. Ins. Co., No. C056936 (Super.Ct.No. SC20050080), 2009 WL 2901950, (Cal. Ct. App. 2009) (unpublished opinion) (letter sent by bond obligee to surety advising surety of the earlier termination of bond principal, which also stated that bond obligee was willing to meet and confer, did not satisfy the condition precedent found in Paragraph 3.1); U.S. for Use of Platinum Mech., LLC v. U.S. Sur. Co., No. 07 Cv. 3318 (CLB), 2007 WL 4547849, (S.D.N.Y. 2007) (concluding that bond obligee failed to comply with Paragraph 3.1 where bond obligee did not provide any evidence in its papers filed in opposition to surety’s motion for summary judgment that it mailed the notice of default letter to the address provided for in Paragraph 10 of the bond). However, courts do not require the Owner’s notice to the Surety to track the precise terminology of Paragraph 3.1. See CC-Aventura, Inc. v. Weitz Co., LLC, No. 06-21598-CIV, 2008 WL 2557434, (S.D. Fla. 2008) (concluding that although a letter from bond obligee to surety “did not use the precise terminology of Paragraph 3.1 in stating it was ‘considering’ declaring a default,” the letter nonetheless created an issue as to whether the bond obligee fulfilled the condition precedent in Paragraph 3.1); Developers Sur. and Ind. Co. v. Dismal River Club, LLC, No 4:07CV3178, 2008 WL 2223872, (D.Neb. 2008) (concluding that letter from the surety which did not use the terminology of Paragraph 3.1, but nonetheless indicated that there was a Contractor Default, created a jury issue as to whether the bond obligee effectively fulfilled the conditions of Paragraph 3.1).

Also note that the United States District Court in RLI Ins. Co. v. Indian River Sch. Dist., EDis, 566 F. Supp.2d 356 (D. Del. 2008), applying Delaware state law, refused to find Paragraph 3.1 of the A312-1984 Performance Bond to be a condition precedent to the Surety’s obligations on the ground that it contradicted the Delaware Procurement Act; thus, the Surety’s defense based on failure of a bond condition precedent was rejected. Another case ruling against the surety is Carnell Construction Corp. v. Danville Redevelopment & Housing Authority, Case No. 4:10-cv-7 (W.D. Va. Jan. 27, 2011), in which the owner prevailed despite not giving required notices under the A312-1984 Performance Bond because the bonded contract’s HUD General Conditions controlled over the bond.

The second condition precedent under Paragraph 3.2 to the Surety’s performance bond obligations is that the Owner has “declared the Contractor in default and formally terminated the Contractor’s right to complete the contract.” Furthermore, Paragraph 3.2 requires the Owner to wait at least twenty days after the Contractor and Surety have received notice of the pre-default conference before declaring such contractor default. Generally, the reported case decisions construing Paragraph 3.2 of the A312-1984 Performance Bond have applied the L&A Contracting standard and required that an owner’s declaration of default must be made in clear, direct, and unequivocal language. Those case decisions finding the owner’s notice to be insufficient include instances where the notice merely included threats about declaring a Contractor default, or the owner actually affirmed the bonded contract. See CC-Aventura, Inc. v. Weitz Co., LLC, No. 06-21598-CIV, 2008 WL 2557434 (S.D. Fla. 2008) (concluding that letter from obligee to surety which reiterated earlier notice of bond principal’s deficiencies, requested a conference as provided for by Paragraph 3.1, and stated the obligee was willing to consider any proposed resolution “could not reasonably be interpreted to declare bond principal in default in clear, direct, and unequivocal language”); Developers Sur. and Ind. Co. v. Dismal River Club, LLC, No 4:07CV3178, 2008 WL 2223872 (D.Neb. 2008) (finding that bond obligee failed to comply with Paragraph 3.2 where bond obligee’s letters to the bond principal and its surety never formally terminated the bond principal’s right to complete the project); CC-Aventura, Inc. v. Weitz Co., LLC, 2007 WL 2986371 (S.D. Fla. 2007) (finding that letter from bond obligee addressed to contactor and surety, which affirmed the contract with the bonded contractor and indicated that it still looked to the contractor to perform the contract, did not meet the requirements of Paragraph 3.2); Bank of Brewton, Inc. v. Int’l Fid. Ins. Co., 827 So.2d 747, 754 (S. Ct. Ala. 2002) (concluding that bond obligee’s notices to surety, which detailed many threats to declare a contractor default, were insufficient under Paragraph 3.2 because “a mere threat is not sufficient to trigger the obligations of a surety”). On the other hand are those cases which found the owner’s notice to have complied with the condition precedent requirement in Paragraph 3.2 and rejected a surety’s overly technical notice argument. Mid-State Sur. Corp. v. Thrasher Engineering, Inc., 575 F. Supp.2d 731, 740-43 (S.D. Va. 2008) (rejecting surety’s overly technical argument that bond obligee’s letter, which did not expressly state that the bond principal’s right under the contract had been terminated, failed to meet Paragraph 3.2 requirement to declare the bond principal to be in default); U.S. Fid. and Guar. Co. v. Braspetro Oil Ser. Co., 369 F.3d 34, 57-58 (2nd Cir. 2004) (rejecting surety’s argument that allowing the principal to remain on the project under new financial arrangements independent of the bonded contracts negated the obligee’s termination of the principal, and holding that obligee’s notices to surety which stated the principal’s rights had been cancelled were sufficient to expressly and unequivocally terminate the principal’s rights under the contract). See also Travelers Cas. And Sur. Co. of Am. v. Crystal Towers, LLC, No. 08-0518-KD-C, 2009 WL 5068823, at *14-15 (S.D. Ala. Dec. 17, 2009) (rejecting obligee’s argument that surety waived the condition precedent in Paragraph 3.2 because “the fact that some of the action taken by [the surety] may have been the same as it would taken had the duty to perform arose is not sufficient evidence from which a reasonable jury could find that [the surety] waived its contractual right”).

The third condition precedent under Paragraph 3.3 to the Surety’s performance bond obligations is that the Owner agrees to pay the balance of the contract price to the Surety or to the Surety’s replacement contractor. A majority of case decisions recognize Paragraph 3.3 as a condition precedent to the Surety’s performance obligations; however, some courts have refused to require strict compliance with the duty to agree to turn over the remaining contract balance where no such balance exists. See Mid-State Sur. Corp. v. Thrasher Engineering, Inc., 575 F. Supp.2d 731, 743 (S.D. Va. 2008) (concluding that “since there was no balance to be paid to [surety] on the Completion Agreement at the time of [bond principal’s] breach, it was not possible for [bond obligee] to comply with Paragraph 3.3 of the Performance Bond and it was excused from doing so”); U.S. Fid. and Guar. Co. v. Braspetro Oil Ser. Co., 369 F.3d 34, 58-59 (2d Cir. 2004) (observing that with respect to compliance with Paragraph 3.3., “the relevant inquiry is whether the Obligees actually agreed to pay the Balance of the Contract Price – not, as the Sureties urge, whether the Obligees agreed with the Sureties’ assessment of what the respective Balances were at the time of the declarations of default,” and holding that Obligees’ letters stating that they agreed to pay the balance of the contract price to the Sureties, but unfortunately there is no balance remaining, complied with Paragraph 3.3). Other courts have likewise dispensed with a formalistic reading of Paragraph 3.3 and rejected the Surety’s argument that the Owner’s notice must track the language of Paragraph 3.3 verbatim. See Sleeper Village, LLC v. NGM Ins. Co., No. 09-cv-44-PB, 2010 WL 1434306 (D.N.H. 2010) (not for publication) (rejecting surety’s argument that bond obligee’s notice did not comply with Paragraph 3.3 because it never explicitly agreed to pay the balance of the contract price to the new contractor, and alternatively, it failed to specifically identify the balance of the contract price that was available to fund the completion contract, on the grounds that surety’s letter in response to declaration of default acknowledged that the bond obligee had agreed to tender the contract balance, and moreover, the language of the performance bond does not require the obligee to disclosure the exact contract balance in its notice); LBL Skysystems (USA), Inc. v. APG-Am., Inc., Civil Action No. 02-5379, 2006 WL 2590497 (E.D. Pa. 2006) (concluding that bond obligee had complied with the condition precedent found in Paragraph 3.3 of the A312 Performance Bond where the obligee’s letter stated that it would pay the balance of the contract price to the surety in accordance with the terms of the construction contract or to a contractor selected to perform the construction contract in accordance with the terms of the contract with the obligee and agrees to comply with all other provisions of the performance bond required to be performed by obligee). However, courts have rejected arguments by owners that compliance with Paragraph 3.3 was not required because the surety did not specifically request an owner pay the contract balance. See Solai & Cameron, Inc. v. Plainfield Cnty Consol. Sch. Dist. No. 202, 374 Ill.App.3d 825, 871 N.E.2d 944 (Ill. Ct. App. 2007) (rejecting bond obligee’s argument that it was not obligated under the A312 Performance Bond to agree to pay the surety the balance of the contract because the surety did not specifically request the bond obligee to pay the surety the balance due on the contract ), or because the owner otherwise did not state in its notice to the surety that it agreed to pay the contract balance. See Developers Sur. and Ind. Co. v. Dismal River Club, LLC, No 4:07CV3178, 2008 WL 2223872 (D.Neb. 2008) (finding that bond obligee failed to comply with Paragraphs 3.2 and 3.3 where obligee’s letters to the principal and its surety never formally terminated the bond principal’s right to complete the project nor agreed to pay the balance of the contract price to complete the project); Bank of Brewton, Inc. v. Int’l Fid. Ins. Co., 827 So.2d 747, 752-54 (S. Ct. Ala. 2002) (holding that obligee/bank’s letter to surety failed to state that the obligee agreed to the balance of the contract to price to the surety or to a contractor selected to complete the original contract; thus the bank did not substantially comply with the performance bond).

The A312-1984 Performance Bond sets forth Surety’s performance options in the event the Owner satisfies the condition precedents provided for under Paragraph 3. Under Paragraph 4, a Surety has the right to elect one of four options. Paragraph 4 of the bond provides as follows:

4. When the Owner has satisfied the conditions of Paragraph 3, the Surety shall promptly and at the Surety’s expense take one of the following actions:

4.1 Arrange for the Contractor, with consent of the Owner; to perform and complete the Construction Contract; or

4.2 Undertake to perform and complete the Construction Contract itself, through its agents or through independent contractors; or

4.3 Obtain bids or negotiated proposals from qualified contractors acceptable to the Owner for a contract for performance and completion of the Construction Contract, arrange for a contract to be prepared for execution by the Owner and the contractor selected with the Owner’s concurrence, to be secured with performance and payment bonds executed by a qualified surety equivalent to the bonds issued on the Construction Contract, and pay to the Owner the amount of damages as described in Paragraph 6 in excess of the Balance of the Contract Price incurred by the Owner resulting from the Contractor’s default; or

4.4 Waive its right to perform and complete, arrange for completion, or obtain new contractor and with reasonable promptness under the circumstances:

Like Paragraph 3 cases, most reported cases addressing an obligee’s failure to permit the surety to exercise its performance options, under Paragraph 4, have discharged the surety without a showing of prejudice. See St. Paul Fire & Marine Ins. Co. v. VDE Corp., 603 F.3d 119, 123-24 (1st Cir. 2010) (affirming district court’s finding that obligee materially breached the bond by insisting that surety could not employ the bond principal as completion contractor under Paragraph 4.2, which entitled surety to discharge of its obligations to perform under the bond); Fidelity & Deposit Company of Maryland v. Jefferson County Commission, 2010 WL 48 79115 (N.D. Ala. Nov. 17, 2010) (same holding); Solai & Cameron, Inc. v. Plainfield Cnty. Consol. Sch. Dist. No. 202, 374 Ill.App.3d, 825, 871 N.E.2d 944 (Ill. Ct. App. 2007) (holding that obligee exceeded its authority under the Performance Bond by hiring its own replacement contractor first and thereafter declaring a subcontractor default and termination, which negated the surety’s options under Paragraphs 4.1, 4.2 and 4.3 of the Performance Bond and thereby nullified the surety’s duty to perform); Seaboard Sur. Co. v. Town of Greenfield, 370 F.3d 215 (1st Cir. 2004) (owner’s refusal to allow completion by surety pursuant to Paragraph 4.2 and failure to issue 15 day notice of alleged surety default prior to undertaking owner completion constituted a material breach of the bond discharging the surety); Enter. Capital, Inc. v. San-Gra Corp., 284 F. Supp.2d 166, 179-81 (D. Mass. 2003) (concluding that obligee’s failure to comply with notice requirement of Paragraph 3 of the A312-1984 Performance Bond was a material breach that precluded surety from exercising its completion options under Paragraph 4 of the bond, resulting in the bond being null and void).

The leading and most influential case in this field is St. Paul Fire & Marine Ins. Co. v. City of Green River, 93 F.Supp.2d 1170 (D. Wyo. 2000), aff’d 6 Fed. Appx. 828 (10th Cir. 2001). At issue in Green River were Paragraph 4.1 (which allows Surety to arrange for Contractor, with the consent of Owner, to complete the project) and Paragraph 4.2 (which gives Surety the right to complete through its agents or through independent contractors). The Surety opted under Paragraph 4.2 to complete by using its bond principal, but Owner objected under Paragraph 4.1 to completion by the Contractor without Owner’s consent, refused Contractor access to the jobsite, and ultimately terminated Surety’s right to perform and completed with its own forces. The Green River court ruled for the Surety and discharged the bond. Its analysis was that Paragraph 4.2 contains no limitation on who the Surety may utilize to complete, and Paragraph 4.1 (which requires Owner consent) is fundamentally distinct from Paragraph 4.2 (which does not require Owner consent). Under Paragraph 4.1 where Surety arranges for completion by its principal, Surety does not assume primary responsibility for completing the contract. In contrast, under Paragraph 4.2, Surety assumes primary responsibility to complete the contract, and with that “the freedom to assemble the project team of its choosing.” Based on this premise, the Green River court reasoned as follows:

While it makes sense that the owner would have the right to object to such a “shotgun wedding” to the contractor it just terminated, it does not follow that the [owner] would have this right when the surety assumes primary contractual responsibility. In fact, the surety performance options contained in the performance bond are standard in the industry, and it is common practice for a surety that elects to perform the project itself hire the principal’s employees under the direction of a consultant, just as St. Paul did here.

Accordingly, the court held that St. Paul’s proposed use of its principal’s personnel did not constitute an anticipatory breach, and owner, City, did not have the right to terminate St. Paul. Having determined that the City did not have the right to terminate St. Paul, the court then evaluated the implications of the City’s wrongful termination. The court started from the premise that “[i]f the [City’s] action constituted a material breach, St. Paul is excused from further performance under the contract.” The court went on to note that “[c]ourts have consistently held that an obligee’s action that deprives a surety of its ability to protect itself pursuant to performance options granted under a performance bond constitutes a material breach, which renders the bond null and void.” Based on this, the court concluded that because St. Paul would not have entered into the performance bond in the absence of its performance options under Paragraph 4, the City’s action depriving St. Paul of those options was a material breach which discharged St. Paul from any further duty under the bond. Accordingly, the court granted judgment in favor of St. Paul.

In the discussion of the A311 Performance Bond, page 12 above, it was explained that courts interpreting the A311 Performance Bond have disagreed as to whether actual delay damages or liquidated damages are recoverable by the obligee against the surety. This debate was resolved against the surety in the A312-1984 Performance Bond, Paragraph 6, which reads as follows:

6. After the Owner has terminated the Contractor’s right to complete the Construction Contract, and if the Surety elects to act under Subparagraph 4.1, 4.2, or 4.3 above, then the responsibilities of the Surety to the Owner shall not be greater than those of the Contractor under the Construction Contract, and the responsibilities of the Owner to the Surety shall not be greater than those of the Owner under the Construction Contract. To the limit of the amount of this Bond, but subject to commitment by the Owner of the Balance of the Contract Price to mitigation of costs and damages on the Construction Contract, the Surety is obligated without duplication for:

6.3 Liquidated damages, or if no liquidated damages are specified in the Construction Contract, actual damages caused by delayed performance or non-performance of the Contractor.

Clearly the surety is responsible, under this bond form for actual delay damages or liquidated damages to the same extent as the principal and to the limit of the bond. Notably this provision was not changed in the A312-2010 Performance Bond (although the numbering was changed to Paragraph 7).

Paragraph 9 of the A312-1984 Performance Bond imposes a limitation period, different than the A311-1970 Performance Bond, upon which a suit may be commenced upon the bond. Paragraph 9 provides in pertinent part that:

Any proceeding, legal or equitable, under this Bond may be instituted in any court of competent jurisdiction in the location in which the work or part of the work is located and shall be instituted within two years after Contractor Default or within two years after the Contractor has ceased working or within two years after the Surety refuses or fails to perform its obligation under this Bond, whichever occurs first. If the provisions of this Paragraph are void or prohibited by law, the minimum period of limitation available to sureties as a defense in the jurisdiction of the suit shall be applicable.

A number of courts have recently handed down decisions construing the two year limitation period in the A312 Performance Bond with mixed results for sureties. In ADP Marshall, Inc. v. Noresco, LLC, C.A. No. 07-129ML, 2010 WL 1753585 (Dist.R.I. Apr. 30, 2010), the Rhode Island District Court enforced the two year limitation period found in the A312-1984 Performance Bond, and rejected the bond obligee’s argument that the limitation period tolled based upon the obligee’s having filed cross-claims in a state court lawsuit which solely involved payment bond claims. On the other hand, see City of Santa Fe v. Travelers Cas. & Sur. Co., 228 P.3d 483 (N.M. 2010), already discussed in the prior A311-1970 section of this article addressing bond limitations clauses. The City of Santa Fe court’s problem with the surety’s position had nothing to do with how the A312 bond was drafted, rather the court rejected the surety’s argument that the obligee had agreed to the bond limitations clause when it accepted the bond. To say the least this was an outcome-driven decision, and to reach that decision the court had to employ questionable legal analysis.

Another case wrongly decided against the surety is Millsboro Fire Co. v. Constr. Mgmt. Serv., Inc., C.A. No. 05C-06-137-MMJ, 2009 WL 846614 (Del. Super. Ct. 2009) (unpublished opinion). In this case, the date of Contractor Default and the date Contractor ceased working were both considerably more than two years before suit by Owner was filed against Surety Fidelity and Deposit Company of Maryland (“F&D”). The only date in Paragraph 9 of the A312-1984 Performance Bond, which was within two years of filing suit, was F&D’s denial of the claim. But the court could not bring itself to dismiss F&D on its bond limitations defense. According to the court, the limitations period of the bond does not begin to run until the insurer denies coverage and notifies the insured of the rejection of any claim for such benefits (“Until denial of coverage, there is no justiciable controversy”). Thus, F&D’s limitations defense was rejected by the Millsboro Court. Further, the Millsboro Court also reasoned that “[g]enuine issues of material fact exist as to whether F&D, as surety, dealt fairly with MFC in responding to MFC’s requests for F&D’s position on payment of claim, thereby creating [a] triable issue of estoppel.”

In this article’s A311-1970 Performance Bond discussion of its limitations period, pages 14-15 above, the reader was cautioned that if the bond limitations period is shorter than the minimum time prescribed by statute in a particular jurisdiction, the clause will be invalidated. One important difference in the A312-1984 Performance Bond is that the bond limitations clause, Paragraph 9, has a savings provision as follows: “If the provisions of this Paragraph are void or prohibited by law, the minimum period of limitation available to sureties as a defense in the jurisdiction of the suit shall be applicable.” By changing from an invalidated limitations clause (found in the A311-1970 Performance Bond) to a minimally permitted limitations clause (found in the A312-1984 Performance Bond), the AIA significantly reduced “late” bond claims which may be filed against sureties. Savings clauses in bonds are generally upheld by courts. See e.g., City of Santa Fe v. Travelers Cas. Sur. Co., 147 N.M. 699, 703, 228 P.3d 483, 487 (N.M. 2010).

The reader will note that there has been no discussion thus far in this article about AIA payment bonds. The reason is that the A311-1970 Payment Bond is straightforward and non-controversial. The same cannot be said, however, of the A312-1984 Payment Bond.

The controversial clause of the A312-1984 Payment Bond is Paragraph 6, which reads as follows:

6. When the Claimant has satisfied the conditions of Paragraph 4, the Surety shall promptly and at the Surety’s expense take the following actions:

6.1 Send an answer to the Claimant, with a copy to the Owner, within 45 days after receipt of the claim, stating the amounts that are undisputed and the basis for challenging any amounts that are disputed.

Paragraph 6 refers to the Claimant satisfying the conditions of Paragraph 4, which reads as follows:

4.1 Claimants who are employed by or have a direct contract with the Contractor have given notice to the Surety (at the address described in Paragraph 12) and sent a copy, or notice thereof, to the Owner, stating that a claim is being made under this Bond and, with substantial accuracy, the amount of the claim.

Essentially, these two clauses require that when a proper payment bond claim is submitted to the Surety, the Surety must respond to the claim within 45 days: if the response is a denial, in whole or in part, within that 45 day time period the Surety must state the amount of the claim that is undisputed and the basis for such dispute of the claim. Although no time period is expressly stated, within a reasonable time thereafter the Surety must pay the undisputed amount to the Claimant.

But, in reality, some payment bond claims are complicated and require more than 45 days to determine. What happens under the A312-1984 Payment Bond if the Surety does not timely respond to the Claimant? Unfortunately under the case law interpreting Paragraph 6, the answer is that the Surety has waived its right to dispute the claim. See National Union Fire Insurance Co. v. Bramble, 388 Md. 195, 213 879 A.2d 101 (Md. Ct. App. 2005) (“Therefore, the effect of the provisions in Paragraph 6 is that the entirety of the claim is undisputed and the sureties are required to promptly pay the claims submitted by Wadsworth and Bramble”); Casey v. Seaboard Surety Co., 2006 WL 3299932 (E.D. Va. 2006); Gibson Plastering Co. v. XL Specialty Insurance Company, 521 F.Supp.2d 1326 (M.D. Fla. 2007).

These cases were extremely troubling for the surety industry, as the belief of most surety claim professionals was that these cases were not only wrongly decided but, as a practical matter, made it unreasonably difficult for the surety to avoid waiver of defenses. In response to Bramble and other cases following Bramble’s holding, in May, 2008 the AIA (at the SFAA’s urging) issued a stopgap Amendment to the A312-1984 Payment Bond as follows:

§ 6 When the Claimant has satisfied the conditions of Section 4, the Surety shall promptly and at the Surety’s expense take the following actions:

§ 6.1 Send an answer to the Claimant, with a copy to the Owner, within 4560 days after receipt of the claim, stating the amounts that are undisputed and the basis for challenging any amounts that are disputed.

§ 6.3 The Surety’s failure to discharge its obligations under this Section 6 shall not be deemed to constitute a waiver of defenses the Surety or Contractor may have or acquire as to a claim. However, if the Surety fails to discharge its obligations under this Section 6, the Surety shall indemnify the Claimant for the reasonable attorneys’ fees the Claimant incurs to recover any sums found to be due and owing to the Claimant.

The complete AIA Amendment (really a Rider to the A312-1984 Payment Bond), with AIA explanation for the Amendment, is attached hereto as Exhibit “3.”

The Amendment expressly stated that the Surety’s failure to timely respond to a payment bond claim was not to be deemed a waiver of defenses (although the Surety was then exposed to liability for the Claimant’s reasonable attorneys’ fees). The authors believe the Amendment was a fair and reasonable approach to correct Bramble and other mistaken court rulings. However in the negotiations leading to the revised A312-2010 Payment Bond, this was a hot topic of debate. The surety industry won this point in the new bond form, as will be discussed below, but gave up other points in the negotiations which will clearly hurt sureties in the long run when addressing A312-2010 Performance Bond claims.

By far the most controversial aspect of the A312-2010 Performance Bond is its explicit provisions which make the penal sum inapplicable under certain circumstances.

Paragraph 5 of the Performance Bond gives the Surety four options upon the Owner’s satisfaction of conditions precedent, as follows:

5. When the Owner has satisfied the conditions of Section 3, the Surety shall promptly and at the Surety’s expense take one of the following actions:

5.1 Arrange for the Contractor, with the consent of the Owner, to perform and complete the Construction Contract;

5.2 Undertake to perform and complete the Construction Contract itself, through its agents or independent contractors;

5.3 Obtain bids or negotiated proposals from qualified contractors acceptable to the Owner for a contract for performance and completion of the Construction Contract, arrange for a contract to be prepared for execution by the Owner and a contractor sel3ected with Owner’s concurrence, to be secured with performance and payment bonds executed by a qualified surety equivalent to the bonds issued on the Construction Contract, and pay to the Owner the amount of damages as described in Section 7 in excess of the Balance of the Contract Price incurred by the Owner as a result of the Contractor Default; or

5.4 Waive its right to perform and complete, arrange for completion, or obtain a new contractor and with reasonable promptness under the circumstances:

Paragraph 8 of the Performance Bond limits the Surety’s liability to the amount of the bond if the Surety acts under 5.1 (arranges for the Contractor to complete, with consent of the Owner), 5.2 (tenders new contractor to Owner and pays Owner for any deficiency), and 5.4 (either makes payment to Owner or denies liability to Owner). What is missing from Paragraph 8 is option 5.2 (Surety takes over and completes bonded project). Thus, when the Surety elects to proceed with a takeover under option 5.2, the Surety’s liability is clearly not limited to the penal sum unless the Surety’s takeover agreement with the Owner contains a penal sum limitation clause.

Proponents of the A312-2010 Performance Bond will point out certain case law which holds that a surety’s liability is not limited to the penal sum in a takeover situation unless a penal sum limit is written into the takeover agreement with the owner. See Int’l Fid. Ins. Co. v. City of Rockland, 98 F.Supp.2d 400, 428 (S.D.N.Y. 2000); U.S. Fid. and Guar. Co. v. Braspetro Oil Serv. Co., 369 F.3d 34 (2d. Cir. 2004); Employers Mut. Cas. Co. v. United Fire Cas. Co., 682 N.W. 2d 452, 457 (Iowa Ct. App. 2004). In other words, according to the A312-2010 proponents, Paragraphs 5 and 8 of the Performance Bond are nothing more than a recitation of existing law. Also see page 3 of the AIA Bond Form Commentary and Comparison, Exhibit “6” to this article, which explains the policy reason for not making the bond penal sum applicable to a surety takeover (“this limitation could leave the owner with an unfinished project once the surety has expended the amount of the bond”) unless the owner expressly agrees to the bond penal sum limit in a takeover agreement with the surety. Most surety professionals would disagree with this policy argument; their counter would be that the surety only received consideration for, and assumed risk, to the bond limit and so the owner should bear the costs of project completion in excess of the bond penal sum.

In reality the practical problem, based on the authors' experience, is that the A312-2010 Performance Bond diminishes the surety’s bargaining leverage with the owner and makes it more difficult to negotiate a penal sum limitation in the takeover agreement. Previously the surety’s attorney could effectively argue, for example under Paragraph 6 of the A312-1984 Performance Bond, that the surety’s liability under any option was “the limit of the amount of this Bond.” Now under the A312-2010 Performance Bond that argument is gone and, further, the owner’s attorney can effectively argue that the bond was not intended to give the surety a penal sum limitation in a takeover situation. Unfortunately, it is expected that owners will now be more stubborn on this penal sum issue, forcing the surety dealing with an A312-2010 Performance Bond claim to either elect a takeover without a penal sum limitation or go for another Paragraph 5 option.

Another, less obvious, way that the A312-2010 Performance Bond penal sum can be blown is based on Paragraph 6, which reads as follows:

6. If the Surety does not proceed as provided in Section 5 with reasonable promptness, the Surety shall be deemed to be in default on this Bond seven days after receipt of an additional written notice form the Owner to the Surety demanding that the Surety perform its obligations under this Bond, and the Owner shall be entitled to enforce any remedy available to the Owner. . . .

The above-quoted clause is not substantively different from Paragraph 5 of the A312-1984 Performance Bond, except that the period of time for the Surety to act has been shortened from fifteen days to seven days after receipt of the Owner’s cure notice. If the Surety does respond and exercises one of its Paragraph 5 options, then Paragraph 6 of the A312-2010 Performance Bond states that “the Surety shall be deemed to be in default on this Bond.”

What is the effect of the Surety being deemed in default on the Bond? In Continental Realty v. Crevolin, 380 F.Supp. 246 (S.D. W.Va. 1974), involving a non-AIA performance bond, it was held that if the surety fails to perform in accordance with its bond options, then the surety is in default of the bond and its liability is not limited to the bond penal sum. Notably there are non-AIA bond cases which disagree with Crevolin and hold that a surety’s failure to perform does not expose the surety to bond liability in excess of the penal sum. In re Tech for Energy Corp., 123 B.R. 979 (Bktrcy Ct. E.D. Tenn. 1991); Employers Mut. Cas. Co. v. United Fire and Cas. Co., 682 NW 2d 452 (Iowa Ct. App. 2004). There are no cases directly addressing Paragraph 6 of the A312-2010 Performance Bond or its predecessor Paragraph 5 of the A312-1984 Performance Bond. Thus it is impossible to accurately predict, in most jurisdictions, how courts will treat the liability of a surety who fails to timely respond to an obligee’s cure notice and thus is in default of the A312-1984 or A312-2010 Performance Bond.

In the above discussion of the A312-1984 Performance Bond, it was pointed out that a number of courts have strictly enforced the requirements of Paragraph 3.1 (Owner gives pre-default notice to Contractor and Surety that Owner is considering declaring a default, and Owner requests conference with Contractor and Surety), to the point that failure of the Owner to comply with Paragraph 3.1 was a complete defense for the Surety without a showing of prejudice.

This surety defense was significantly reduced by Paragraph 3 of the A312-2010 Performance Bond, which reads as follows:

3. If there is no Owner Default under the Construction Contract, the Surety’s obligation under this Bond shall arise after

The A312-1984 bond form required the Owner to give notice and request a conference within 15 days, and then declare a default not earlier than 20 days after the notice; the A312-2010 bond form does not require the Owner to request a conference (a conference may still be requested by the Surety) and does not limit when the Owner may declare a Contractor Default. Thus the waiting time periods for the Owner to act were streamlined in the 2010 bond form.

Unfortunately for the surety industry, the case law which provided the Surety with a full defense for the Owner’s non-compliance with Paragraph 3 was given up in the negotiation process. Paragraph 4 of the A312-2010 Performance Bond states:

4. Failure on the part of the Owner to comply with the notice requirement in Section 3.1 shall not constitute a failure to comply with a condition precedent to the Surety’s obligations, or release the Surety from its obligations, except to the extent the Surety demonstrates actual prejudice.

Thus, the Surety now has a pro tanto defense, to the extent of prejudice, due to the Owner’s non-compliance with Paragraph 3.1. Presumably the Surety will still have a full defense due to the Owner’s non-compliance with Paragraph 3.2 (Owner must declare a Contractor Default and terminate Contractor) and Paragraph 3.3 (Owner must agree to pay balance of bonded contract to Surety).

The discussion in this article, page 6-11, regarding the A311-1970 Performance Bond was extensive about the L&A Contracting/Colorado Structures debate as to conditions precedent to bond coverage. In the discussion, pages 17-18, regarding the A312-1984 Performance Bond, it was pointed out that no court should reach a Colorado Structures misinterpretation of this bond form because alternative coverage clauses cannot be read into this bond. The same is true for the A312-2010 Performance Bond. Paragraphs 3 and 4 make clear that 3.1, 3.2 and 3.3 are acts of the Owner which are conditions precedent to coverage, and an Owner’s failure to so act gives rise to either a full defense (3.2 and 3.3) or a pro tanto defense (to the extent of prejudice) for the Surety.

Significantly, Paragraph 3 provides another potentially full condition precedent defense for the Surety. The introductory clause to Paragraph 3 states that the Surety’s obligation under the bond arises “if there is no Owner Default under the Construction Contract.” The term “Owner Default” is defined in Paragraph 14.4 to be “Failure of the Owner, which has not been remedied or waived, to pay the Contractor as required under the Construction Contract or to perform and complete or comply with the other material terms of the Construction Contract.” The surety claims professional should carefully review the bonded contract and applicable statutes (for example, a state’s Prompt Pay Act) to determine if the Owner has failed to pay or otherwise materially breached its obligations to the Contractor. If the answer is yes, then the Surety has no obligation to the Owner under the A312-1984 or A312-2010 Performance Bond.

Notably, coverage was broadened under the A312-2010 Payment Bond by expanding the definition of “Claimant” under Paragraph 16.2. Previously, under the A312-1984 Payment Bond, parties with standing to bring a payment bond claim were those in privity with the Contractor or with a subcontractor to the Contractor. Now, under the new A312-2010 Payment Bond, parties entitled to bring a bond claim also includes “any individual or entity that has rightfully asserted a claim under an applicable mechanic’s lien or similar statute against the real property upon which the Project is located.” The rationale of this change is that because the intent of a payment bond is to protect an owner from liens, the payment bond should allow claims by all rightful lien claimants. This change is obviously not applicable to public projects, as these are not lienable projects. With regard to private projects, the surety claims handler will need to investigate local laws to determine if a particular questionable party (for example, a third tier subcontractor) has standing to file a mechanic’s lien and thereby has standing to bring a bond claim under the A312-2010 Payment Bond.

There were other minor changes to the A312-2010 Payment Bond which will not be discussed in this article. The major change, and the topic of much debate within the AIA, was the consequence of a Surety’s failure to timely respond to a payment bond claim. Earlier in this article, when discussing the A312-1984 Payment Bond, it was noted a number of courts have ruled that the Surety’s failure to respond to a claim within 45 days (the time period required by the Payment Bond) resulted in a waiver by the Surety of its bond defenses. These cases were clearly wrongly decided and contrary to the intent of the AIA bond drafters, to the point that in May 2008 the AIA itself recommended a stopgap Amendment to override these cases. This Amendment or Bond Rider is attached as Exhibit “3” to this article.

The A312-2010 Payment Bond adopts the May 2008 stopgap Amendment recommended by the AIA. In Paragraph 7, the Surety is given 60 days (increased from 45 days) to respond to a proper payment bond claim. The Surety’s response must include a statement as to amount of the claim that is undisputed, the Surety must pay the undisputed amount, and the Surety must state in writing the basis for challenging any items of the claim that are disputed. In a major concession to the surety industry, the Surety’s failure to timely respond was expressly stated not to result in a waiver of defenses to the claim. Paragraph 7.3 reads as follows:

7 When a Claimant has satisfied the conditions of Section 5.1 or 5.2, whichever is applicable, the Surety shall promptly and at the Surety’s expense take the following actions:

7.1 Send an answer to the Claimant, with a copy to the Owner, within sixty (60) days after receipt of the Claim, stating the amounts that are undisputed and the basis for challenging any amounts that are disputed; and

7.3 The Surety’s failure to discharge its obligations under Section 7.1 or Section 7.2 shall not be deemed to constitute a waiver of defenses the Surety or Contractor may have or acquire as to a Claim, except as to undisputed amounts for which the Surety and the Claimant have reached agreement. If, however, the Surety fails to discharge its obligations under Section 7.1 or Section 7.2, the Surety shall indemnify the Claimant for the reasonable attorney’s fees the Claimant incurs thereafter to recover any sums found to be due and owing to the Claimant.

Many in the surety industry question whether this victory – i.e., that an untimely response to a payment bond claim no longer results in a waiver of defenses – justifies the other concessions made by the surety industry in the A312-2010 bond forms. This author agrees with the critics of the new AIA bond forms; in the authors' opinion, more was lost than gained by the surety industry in the transition from A312-1984 to A312-2010 bonds.

The A310-2010 Bid Bond is a short and straightforward bond form. It is not a penalty bond, i.e., in the event that the Contractor does not enter into a contract with the Owner, then the Surety is responsible for the excess cost to the Owner of entering into a contract with another party – not to exceed the penal sum of the bond. Among other things, the Bid Bond provides that the time for Owner’s acceptance of bids may be extended for 60 days beyond the bid documents without the Surety’s consent.

Perhaps most striking in the A310-2010 Bid Bond is its requirement that the bond be issued by a “surety admitted in the jurisdiction of the Project and otherwise acceptable to the Owner.” Prevalence of individual sureties and fraudulent bonds is a significant problem in the surety industry. See E. Gallagher, “The Importance of Surety Bond Verification”, 39 Pub. Cont. L.J. 269 (2010). There is no question that the AIA intended to have only sureties, approved and licensed by the local insurance departments, issuing A310-2010 Bid Bonds. See the following passage from the AIA Bond Form Commentary and Comparison, page 2 (Exhibit “6” to this article):

Performance and Payment Bond Surety. A310-1970 required the Contractor, in satisfying its obligations under the bid bond, to enter into the construction contract and provide a bond or bonds as specified in the contract from a “good and sufficient” surety. However, A310-1970 does not make clear what constitutes a “good and sufficient” surety. A310-2010 has been modified to state that any bonds provided by the contractor in fulfilling its obligations under the bidding or contract documents will be issued by a surety admitted in the jurisdiction of the project and otherwise acceptable to the owner. The drafters understand that “admitted” is a term of art in the insurance industry meaning holding a certificate of authority from the insurance commissioner allowing the admitted entity to issue surety bonds in that state.

There is no question that the biggest problem with the A312-2010 bonds is that, under certain circumstances, the surety may be obligated to pay beyond the penal sum of the Performance Bond. Interestingly this is not a problem under the A312-2010 Payment Bond, because this bond form contains an absolute limitation clause as follows:

8 The Surety’s total obligation shall not exceed the amount of this Bond, plus the amount of reasonable attorney’s fees provided under Section 7.3, and the amount of this Bond shall be credited for any payments made in good faith by the Surety.

Liability beyond the bond penal sum is also not a problem under the A310-2010 Bid Bond, because again the bond form expressly states that the Surety’s liability may not “exceed the amount of this Bond.”

Turning to the A312-2010 Performance Bond, it is true that sureties issuing performance bonds have become accustomed (in certain jurisdictions) to claims and lawsuits being filed against them for alleged bad faith conduct. See, e.g., Dodge v. Fidelity and Deposit Company of Maryland, 161 Ariz. 344, 778 P.2d 1240 (S. Ct. AZ 1989) (en banc). Although bad faith claims are frequently abused, it is understandable that a surety may be held liable for extra-contractual damages under certain egregious circumstances. What is not understandable, however, is that a surety may be liable beyond its bond limit if the surety has not engaged in bad faith conduct. This is why the A312-2010 bond forms have been subject to extensive criticism in the surety industry.

There is a solution to the penal sum problem in the A312-2010 Performance Bond. When certain courts misinterpreted the A312-1984 Payment Bond and held the surety to have waived defenses by not timely responding to claims, the AIA acted by adopting its 2008 Amendment to A312-1984 Performance Bond. The AIA called this 2008 Amendment a “stopgap measure” and recommended that a surety include the 2008 Amendment whenever issuing the A312 Payment Bond.

In the authors' opinion, a surety issuing the A312-2010 Performance Bond should consider including the following simple modification to its bond:

Notwithstanding anything to the contrary herein, the Surety’s total obligation under this Bond shall not exceed the amount of this Bond.

This modification may be added to Paragraph 16 of the bond form. The difference between the above modification and the AIA’s 2008 Amendment to the A312-2010 Payment bond (which may also be added to the bond form as a modification) is that the 2008 Amendment was officially sanctioned by the AIA, while the above suggested modification to the A312 Performance Bond is not officially sanctioned. Certainly an objection to the modification may be made by an owner/obligee (perhaps contending that the A312-2010 Performance Bond, with modification, is not the bond specified for the project). But this same objection could be made by owners/obligees to the AIA’s 2008 Amendment, and to the best of the authors' knowledge there have been no such issues arising from use of the AIA’s 2008 Amendment. If an objection is raised to the suggested performance bond modification, then the surety can deal with the objection on a case-by-case basis. Perhaps the surety may have to concede this point on rare occasion, but in most situations the owner/obligee will likely agree to the surety’s very reasonable request that its liability be limited to the bond amount.