Performance, and Labour and Materials Payment Bonds – Avoiding the Pitfalls of the Surety’s Defences to a Bond Claim

(Introduction)

I have been asked to speak on the topic of how to avoid the pitfalls of the surety’s defences to a bond claim. In speaking to you today I shall attempt to avoid, where possible, boring you with endless legal jargon and instead provide you with some practical advice from someone who primarily acts for sureties. This area of the law can be perilous and the comfort provided by a surety bond can be lost easily if one does not cross one’s T’s and dot one’s I’s. However, by being aware of the defences most often raised by sureties you can chart a course that reduces the likelihood that the surety bond ends up as nothing more than a souvenir of a construction project gone wrong.

Today I will focus on the two types of bonds most relevant to the construction industry:

1. Performance bonds; and,
2. Labour and material payment bonds.

Both types of bonds involve a least three parties:

1. The obligee;
2. The principal; and,
3. The surety.

These legal terms are likely unhelpful to most of you so let me put them into context.

In the context of labour and material bonds, the obligee is the person entitled to be paid—e.g. subcontractors or tradesmen. The principal (the contractor) is the person responsible for making the payment. The surety is the person that agrees to ensure that the obligee gets paid if the requirements of the bond are fulfilled.

When dealing with performance bonds, the obligee is the person for whom the obligation will be performed – usually the owner. The principal is the person that is supposed to perform the obligation (the contractor). The surety is the person that agrees to ensure the performance of the obligation.

A bond, simply put, is a contract which enunciates terms and conditions between the parties, primarily enunciating the surety’s obligations under a performance bond to the owner, and under a labour and material payment bond to subcontractors. However, owners, contractors and subcontractors have obligations under bonds which if they fail to meet contractually entitles the surety to deny liability under the bond. The legal deniability entitling a surety to deny liability for claims under a bond primarily rests with owners, contractors and subcontractors. The primary focus of this paper is to enlighten all present as to the preventative steps that should be taken to ensure that a surety cannot deny liability under the bond by reason of the acts and/or omissions of owners, contractors and subcontractors. By being aware of the most common surety defences, you can conduct yourself in a way that decreases the likelihood that the surety is entitled to deny liability under the bond.

The most common, and the four defences that I will discuss today, are:

1. The Material Change in the Underlying Contract Defence (a.k.a. the “that’s not the contract which I agreed to bond”);
2. The Failure to Notify the Surety Defence
3. Timing Defences
4. Reliance Upon Defences Available to the Principal

After discussing these defences four things that should be very clear to you are:

1. Read the bond;
2. Adhere to the bond provisions;
3. Work with your surety; and
4. Keep your surety informed. 

Please see PDF link at top for full text.