Performance Bond Not Conditioned on Declaration of Default
Construction lawyers may have to rethink their reading of the widely used AIA performance bond form as a result of a decision earlier this year by the Washington Court of Appeals.
The performance bond at issue is the widely used AIA Form 312, promulgated by the American Institute of Architects (AIA). Paragraph B of the bond is a traditional bond defeasance clause providing "the condition of this obligation is such that, if [the] Principal shall promptly and faithfully perform said subcontract, then this obligation shall be null and void; otherwise it shall remain in full force and effect." Paragraph C then states what the surety's options are if a default is declared and the contractor's right to proceed with the work is terminated.
The Court held Paragraph A stated the surety's basic obligation and was conditioned only on failure to fully perform--not a declaration of default. Paragraph C didn't apply because the contractor was not terminated. The bond beneficiary allowed the contractor to finish its work then sued the surety to recover the costs incurred to finish incomplete or defective work.
The court declined to follow a contrary holding by Unites States Court of Appeals for the Fifth Circuit in L & A Contracting Co. v. Southern Concrete Services (5th Cir., 1994) because that court did not closely examine the language of the bond.
The Washington case, Colorado Structures, Inc. v. Insurance Company of the West, is critiqued in the Associated General Contractors of America May newsletter:
For decades, surety companies have operated under the belief that the AIA 311 is conditioned on a declaration of default. If that no longer is true in Washington, surety companies are likely to pull the AIA 311 from this market or restrict it to only their most credit-worthy accounts. If sureties continue to offer that product, they may do so only at an increased premium. The Washington Court of Appeals' reading of the AIA 311 is certainly beneficial to owners. As a result, they may insist on the AIA 311 as part of the contract package. If that bond is no longer generally available in Washington, any contractor who could not obtain that bond form would be unable to submit a responsive bid on the project. If the AIA 311 is only at a higher premium, you will have to pass through that increased cost to the owner. As a result, the cost of construction would go up. Either way, the construction industry is ill-served....
I agree the decision upsets long held assumptions about the AIA 311 form. But the sky will not fall in if the decision stands. The decision applies only when the contractor is allowed to complete the work. Owner's not sureties select bond forms. Sureties are often willing to accept bond forms giving them fewer rights than those provided by the AIA 311 without additional charge. The AIA 311 form was developed to correct ambiguities in an earlier form and, if the problem is deemed serious, the AIA will issue a revised form to correct it.