Bonds in Construction: Part Two

BY ROBERT KENNALEY AND JOSH WINTER

In our September column we addressed the general nature of bonds in construction and provided an overview of the process of obtaining a bond. In what follows, we will provide an overview of the types of bonds, applicable limitation periods and claims against bonds.

The bid bond

Contractors who wish to bid for a contract which is out to tender are often required to post a bid bond with their tender submissions. Under the bid bond, the Surety generally secures the obligation of the Principal to enter into the construction contract according to its terms if the Principal is awarded that contract. If the Principal (in this case the bidding contractor) fails to enter into the contract in accordance with the tender documents, the Obligee (in this case the owner) may call on the bond to recover any losses or damages it might incur in awarding to another bidder or re-tendering the project, up to the maximum value of the bond (which is usually 10 per cent of the Principal’s bid price).

If the construction contract itself requires that the contractor post a performance or labour and material bond, the bid bond will generally also secure the Principal’s obligation to provide those bond(s) if awarded the contract.

The labour and material payment bond

Labour and material payment bonds generally secure the obligation of the Principal to pay its subcontractors and suppliers for the supply of services or materials to the project in question. Those who have supplied labour and material to the Principal, and who have not been paid, may claim against the labour and material payment bond so long as they meet the conditions of the bond.

It must be noted that most standard form labour and material payment bonds only allow those who have contracted directly with the Principal to claim under the bond. Others who are further down in the construction pyramid and who have not provided labour or material directly to the Principal are generally unable to claim under the bond. In Ontario, recent changes to the Construction Act provide additional protection down the pyramid in relation to public contracts with a contract value of $500,000 or more.

The Surety who pays out to subcontractors or suppliers under a labour and material payment bond will be entitled, through subrogation, to pursue the subcontractor’s remedies to recover the amounts it has paid.

The performance bond

A performance bond generally secures the obligations of the contractor, as Principal, to perform all of its obligations under the prime contract with the Owner/Obligee. Under most standard form performance bonds, if the Principal defaults in its performance of the underlying contract (and so long as the Obligee has met its obligations under the underlying contract), the Obligee may declare the Principal to be in default and call on the Surety under the bond.

Where a claim has been properly made against a performance bond, the Surety generally then has two basic options: take steps to remedy the Principal’s default or step in and complete the prime contract on behalf of the Principal. If the latter option is utilized, the Surety generally has the option of either retaining subcontractors and suppliers to complete the contract work or solicit bids to have a contractor finish on its behalf.

The Surety is only required to remedy or complete the work of the Principal up to the financial limits of a bond. The limit is generally 50- or 100 per cent of the contract price. Should the Surety step in under the bond to complete the contract, the Surety is entitled to any balance owed to the Principal. The Surety can also set-off against funds otherwise owed by the Obligee to the Principal for the cost of deficiencies or incomplete work on the project. In addition, subrogation allows the Surety to step in and commence legal proceedings for any issues relating to the underlying contract.

In recent years, owners of large projects have at times required major subcontractors (mechanical, electrical or structural steel) to post a performance bond to secure their obligations under subcontracts. These performance bonds, under which the subcontractor is the Principal, operate in the same fashion as the performance bond under which the contractor is the Principal.

Lien bonds

A lien bond is a bond which is posted with the Court to lift, or vacate, a claim for lien. It stands in Court as security for the claim for lien and takes the place of the land against which the lien was registered in most cases. Generally, any person who needs or wishes to lift the lien by paying monies into Court can utilize a bond to do so. (If bonding is not available, cash or letter of credit will generally suffice, but reference will have to be made to the rules in each particular province in that regard).

Limitation periods and claims against bonds

In Ontario, the Limitations Act establishes a two-year limitation period during which proceedings must commence to avoid the expiry of the claim. The two-year period commences from the date the cause of action was discovered. The bonds themselves, however, may provide that claims must be initiated within specified time periods, failing which the claims will expire. The particular bond in question should accordingly always be referenced to determine what limitation periods might apply.

Concluding comments

Contractors and major subcontractors are often required to provide bonds for projects they wish to perform work on. Bonds also provide a vehicle for those who provide materials or services to a project in getting paid. Further, bonds help owners/financiers ensure they will not suffer excessive cost overruns. Accordingly, understanding the operation of bonds and how they are placed, secured and called upon, is important in the construction industry.

Robert Kennaley and Josh Winter practice construction law in Toronto and Simcoe, Ont. They speak and write on construction law issues and can be reached for comment at 416-700-4142 or at rjk@kennaley.ca and jwinter@kennaley.ca. This material is for information purposes and is not intended to provide legal advice. Readers who have concerns about any particular circumstance are encouraged to seek independent legal advice in that regard.

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