Legal Blog

Bond Rules

Bonds often have a set of very specific rules that the persons for whose benefit the bond has been given, the obligees, must follow to make a valid claim against the surety. The law relaxes some of these provisions in certain circumstances, but it is always better to fall within the provisions of the bond, rather than to go cap in hand to the court to force the surety to pay. This was demonstrated in Whitby Landmark Development Inc. v. Mollenhauer Construction Ltd., a 2003 decisions of the Ontario Court of Appeal.

Coverage 

The owner retained the general to construct a major project. The owner and the general agreed that there would be a guaranteed maximum price of $17.6 million, but that any cost savings would be split 75% to the owner and 25% to the general.

To ensure that the owner knew how to calculate the cost savings, the general was to supply a certificate of the cost of the project, “as soon as possible but not later than 150 days after the date of substantial completion.” The general never delivered the certificate. Substantial completion was February 1, 1992, the certificate was to have been delivered by June 30, 1992, and the general ceased carrying on business on February 3, 1993.

The owner ultimately determined that, with the cost savings, it had overpaid the general by $602,000.

The general had supplied a performance bond and the owner claimed against the surety under the bond. The surety denied the claim and the owner sued. The trial judge held in favour of the surety and the owner appealed.

Terms of Bond 

The surety argued that the bond covered completion cost only, not cost savings. It argued that all of its underwriting analyses depended upon the cost of the project and the start and end dates of the project. It claimed that it never even read the general contract in determining the appropriate premium.

The court discounted this argument. It looked to the terms of the bond itself to determine coverage. Since the bond specifically referred to and incorporated by reference the terms of the construction contract, the court held that the surety was bound by the construction contract. Accordingly, the surety was obliged to do what the general was bound to do under the contract.

Defences  

The surety then argued that the owner did not follow the terms of the contract; it did not declare the general in default when June 30, 1992 came and went with no certificate of cost and then immediately claim against the bond. Accordingly, it argued, the failure was a breach of the conditions of the bond entitling the surety to deny coverage.

The owner then had to advance arguments to counter the wording of the bond.

The owner argued that it should not have to declare a general in default for minor breaches. It argued that the failure to supply the certificate was a minor breach that would not warrant the termination of a contract that was still being adequately completed. The court agreed that a minor default would not cause the owner to terminate, but disagreed that the failure to provide the certificate was minor. That very breach caused the owner’s ultimate claim.

The owner then argued that the surety was not prejudiced by the owner’s failure to terminate and call on the bond in June 1992. After all, the surety already knew by that date that the general was in financial difficulty. The court disagreed. Awareness of a financial difficulty is not the same as awareness of a claim. Further, had the surety received timely notice, it may have had a chance to call upon the general while the general still had some funds; alternatively, the surety could have attempted to shore up its security within the 8 months that the general remained alive. The failure of the owner to give the surety those opportunities to reduce its loss prejudiced the surety.

The owner lost the appeal. If only it had followed the provisions of the bond.