Legal Blog

Bonds

My word is my bond. That expression may have had meaning in the distant past, but certainly has no validity in the construction bonding industry. All bonding agreements require the contractor to indemnify the surety, many require the contractor’s principals to indemnify the surety, and some require the principals or the contractor to post security (e.g. cash, mortgages on land, the first-born child etc.). However, like all other agreements (no matter how one-sided the wording), there is always room for disagreement. We discuss two recent cases: Western Surety Co. v. Hancon Holdings Ltd., a 2007 British Columbia Supreme Court decision, and Stratton Electric Ltd. v. Guarantee Company of North America, a 2006 Ontario Superior Court of Justice decision.

Western Surety

The contractor had delivered a labour and material bond to the owner. Before the surety issued the bond, it had entered into a general indemnity agreement with the contractor and its principals.

The contractor suffered financial reversals and could not pay its subs on the project. The surety and the contractor entered into the following payment agreement:

a)   The surety would pay subs with proper claims.

b)   The contractor would pay interest at prime plus 3%.

c)   The parties would agree to a repayment schedule, but, in any case, the contractor would fully repay the surety by December 31, 2001.

d)   The contractor would sign a consent to judgment for the amounts advanced. The surety could use it if the contractor defaulted under the payment agreement.

e)   The contractor would grant a mortgage, as security for the payment agreement, on 29 pieces of land.

f)   Any money the owner was still to pay to the contractor would be paid directly to the surety.

The surety then paid the subs under the bond; the contractor directed payment from the owner to the surety; and the contractor repaid $25,000 to the surety. By the end of these payments, the contractor still owed $159,000 to the surety.

On May 14, 2001, the surety, never having received a repayment schedule, took out its “consent” judgment and registered the mortgage against the 29 properties.

On March 6, 2002 the contractor paid an additional $21,000 to reduce the debt to $138,000. On March 13, 2002, the contractor had the consent judgment set aside on grounds that the underlying payment agreement was uncertain and ambiguous (e.g. a payment schedule to be agreed upon in the future is uncertain).

Findings 

The trial judge held that the payment agreement was not enforceable. She felt that the surety offered no consideration for the concessions that it obtained from the contractor under the payment agreement. The surety already had an obligation under the bond to advance money to the subs.

The surety had argued that, under the payment agreement, it would forbear and did forbear to collect the money that it advanced until the contractor breached its obligations. The trial judge agreed that forbearance itself was consideration, but held that the surety did not grant extra time under the payment agreement because the debt was to be paid from all available cash flow and in full upon demand. For example, since the payment agreement said the debt was due on demand, then, under the payment agreement, the debt could have been called immediately; accordingly, the surety did not bind itself to forbear. The fact that it did forbear was irrelevant.

Since the payment agreement was not enforceable, the surety could not claim interest at 3% over prime and the parties were to have a separate hearing to determine the appropriate interest rate.

Further, although the general indemnity agreement called for the contractor to pay all of the legal fees that the surety incurred, the judge only awarded the surety its costs to obtain judgment on the bond and for its dealings with the claimant subs. The judge awarded the contractor its costs of the trial because of its success at trial.

Finally, the judge held that, when the surety registered its mortgage against all 29 properties, the surety was liable for abuse of process and slander of title. The judge noted that the surety never attempted to ascertain the equity in the properties, had no intention of selling the properties to pay the debt owed, and registered the mortgage only to pressure the contractor to pay the debt quickly. In essence, the registration of the mortgage on all the lands was overkill.

We have some problem with this aspect of the decision. Since the surety was doing exactly what the payment agreement contemplated, why would the surety be acting in bad faith in doing so? The fact that the payment agreement was subsequently set aside does not somehow change the surety’s motives from proper to improper. Fortunately for the surety, the contractor could not prove that it suffered any damages and the judge awarded only $20,000. The judge recognised that the contractor could have sold the properties to pay the debt due to the surety and did not do so.

Upshot 

The surety obtained judgment against the contractor and the indemnitors for $138,000 less the $20,000 in damages; the surety will receive interest on this amount at a rate that will be less than prime plus 3%; and the surety will not receive all of its costs and, instead, will pay some of the costs of the contractor and other indemnitors.

Stratton 

A sub sued both the general and the surety under a labour and material bond. The sub was claiming for extras; the general claimed that it had not approved the extras and, in any case, that the sub had delayed the project.

The action almost went to trial before the general and sub settled. The general then reneged and the sub obtained a judgment for $26,000 against the general. The surety, having been involved in the action from the start and knowing of the claims of the sub, agreed to pay the sub $16,000 to settle the sub’s claim against it.

The surety claimed against the general and the individual indemnitors for its payment of $16,000 and its legal and consulting fees of $26,000 in defending the sub’s action.

The general took the position that the surety should not have paid because the sub made its claim after the time prescribed in the bond.

The bond allowed the surety to compromise and pay any claim made under the bond. The trial judge held that this meant that the surety had to be reasonable and act in good faith in making its settlement. Once the surety passed that test, the surety did not have to demonstrate that it would have been unsuccessful against the claimant at trial. The trial judge stated, “Good faith does not require proof that the claim being settled would have succeeded, but an honest and reasonable belief that the risks and costs of pursuing the defence of the claim to trial outweigh the potential benefit.”

The trial judge held that the surety had acted reasonably and in good faith and awarded the full $44,000 that the surety had claimed.

Costs 

The surety also claimed $60,000 for costs of its action, including a three-day trial, under the Simplified Rules (i.e. no examinations for discovery). The judge agreed that the bonding agreement required the general and the other indemnitors to pay the solicitor-client legal fees and disbursements of the surety. However, he felt that this clause did not trump the court’s discretion regarding the quantum of the fees claimed.

Costs to be awarded in an action must be proportional to the amount in issue. As to a $60,000 claim in costs for a $44,000 award, he stated that “The amount claimed is so disproportionate to the amount in issue as to create a justifiable sense of injustice in those called upon to pay. If these costs were awarded as claimed, there would be a chilling effect on persons contemplating litigation over modest claims.” He awarded $20,000 plus GST and disbursements.