Legal Blog

Bonds & Sureties

Bonds are used for a variety of reasons. Before we go further, we will give you a description of the players in the bond game. The surety is the bonding company. The principal is the entity that is promising to do something, a promise that is being upheld by the surety. The obligee is the entity that is to receive the benefit of the promise. A claimant is also to receive the benefit of the promise. The construction industry deals with three types of bonds: labour and material payment bonds, performance bonds, and bid bonds.

Bond Types 

1.   Labour and Material Payment Bond 

This bond is used mainly in two situations. An owner requests a general to post the bond to ensure that the subs of the general are paid. The owner wants a smooth project; if the general defaults, the owner wants to know that the subs, who are actually providing the work and materials to build the project, will get paid for their work and, therefore, will continue to work. The surety promises that if the general does not pay its subs, the surety will do so, to the maximum set out in the bond. Each of the subs of the general is a claimant and can enforce the terms of the bond.

Similarly, a general may request a bond from its major subs, usually the mechanical and electrical subs. The bond, in this case, is for the benefit of the general and protects the subsubs of the sub that posted the bond.

2.   Performance Bond 

This bond usually goes hand in hand with the labour and material payment bond. It is posted either by a general or a by a major sub or both. For example, if the general posts the bond, the general promises to complete the project and the surety promises to ensure that, if the general defaults, the project is completed to a maximum upset amount stipulated in the bond. The owner wants this bond because it ensures that the owner is not left with an uncompleted project in the event of default by the general.

3.   Bid Bond 

This bond is usually only requested of generals who are tendering a project. The surety promises that if the general’s tender is accepted and if the general refuses to enter into the construction contract on the basis of the tender, the surety will pay to the owner the penalty sum set out in the bond.

Not Insurance 

Some may confuse a bond with insurance. Do not do so. A bond is a promise by a surety to the obligee or claimant that the surety will step in and perform work or pay monies upon default of the principal. This does not absolve the principal of its obligations to the surety. If the surety has to pay monies, it will look to the principal, the general or sub who posted the bond, for reimbursement.

Sureties are not stupid. They know that, in many cases, the main asset of a contractor is the goodwill of its reputation and the reputation of its individual owners. Once a contractor defaults, usually there are no assets remaining to sell; the goodwill is gone. Therefore, for a contractor to obtain bonding facilities, the contractor will usually have to post security for its promise to indemnify the surety for all monies paid by the surety under its bonds.

Further, the obligations of the contractor to the surety are usually guaranteed by individuals who control the principal and the surety will look to the guarantors for payment. Often, the guarantors have to provide security for the guarantee, such as land or their first-born children, and the surety will look first to the security for repayment of its money.

Don’t Wanna Pay 

In one respect, bonds are similar to insurance: neither an insurer nor a surety really wants to pay anything. Each will look closely at its contract to find any reason in law that can be relied upon as a reason not to pay. Premium receipt good; payout bad! Accordingly, we often see litigation relating to sureties who have refused to pay, for one reason or another.

Limitation Period  

In Controls & Equipment Ltd. v. Ramco Contractors Ltd., a 1999 decision of the New Brunswick Court of Appeal, a sub sought payment from the surety under a labour and material payment bond given by the general. The bond disallowed any action against the surety if commenced after the expiration of one year following the date on which the general ceased work on the project. The general had ceased work for more than one year but the sub had performed work, under its contract with the general, after the general had ceased work and within one year from the date that the sub commenced the action.

The question to be answered was whether the work of the sub constituted work of the general for purposes of the bond. The court, appreciating the nature of the players in a construction project, found that it did. The court noted that the purpose of the bond was to protect the subs. If the subs’ work was not subsumed under a general’s work and the one year limitation period started to run after a general ceased work, a finishing sub could lose the benefit of the bond before it even started to perform its work. Since this interpretation made no sense, the court rejected it. The sub’s action was allowed to continue.

Delivery

Before a bond is effective, it must be delivered to the obligee (beneficiary) who has requested it – or must it? In D’Aoust Construction v. Markel Insurance, a 1999 decision of the Ontario Court of Appeal, the owner requested the general to deliver a performance bond. The general arranged for the bond with the surety; the surety and the general each signed it. However, the general never delivered it to the owner. The owner made a progress payment to the general; the general then defaulted; the owner terminated the construction contract and called on the surety under the bond.

In a 2-1 decision, the court allowed the surety’s defence. To be effective, a bond must be delivered to the party for whose benefit the bond is issued. In this case, that party was the owner. No delivery, no effective bond. The owner was out of luck because of its inability to ensure that “minor” details were observed.

Worry 

In the D’Aoust case, the owner was prejudiced because of its negligence. However, if the bond was a payment bond, the subs would have been prejudiced. Would this have changed the decision? Would the subs have had a cause of action against the owner for negligence? We do not know and, no doubt, a case will arise in which these questions will be decided.