Contract documents

February 28, 2023

Strict adherence to a surety bond’s terms is often required when asserting a claim. A recent case out of the Northern District of Illinois found this to be true for not only the bond’s obligee, but the bond’s additional obligee as well. In MCM Management Corp. v. Hudson Insurance Company, the court, while ruling in favor of the surety, held that the surety owed no duties to an additional obligee due to its failure to comply with conditions precedent of notifying the surety under the AIA Contract Documents A312^®-2010 Performance Bond. Additionally, the court held that the additional obligee was not a proper claimant under the A312^®-2010 Payment Bond.[1]

The dispute between the parties arose out of a demolition project on the south side of Chicago. MCM Management Corp. (“MCM”) entered into a contract for demolition and removal services. MCM subcontracted with JEI for various portions of MCM’s scope of work. JEI then entered into two separate sub-subcontracts with MTS for: (i) oversight and support services for environmental remediation work; and (ii) remediation physical set-up. For the second sub-subcontract, MTS procured the A312-2010 Performance and Payment Bonds from Hudson Insurance Company, as surety. The Performance and Payment bond named MTS, as principal, and JEI, as obligee and construction manager. Later, MCM was added as an additional obligee.[2]

Following JEI’s default under the second sub-subcontract, MCM sent a demand letter to the surety for payment under the bonds. The demand letter was the first notice that the surety received about problems at the project. MCM’s letter described, in part, JEI’s default, the removal of MTS, and MCM’s resulting damages. The surety denied the claim for payment, which resulted in a lawsuit between the parties.[3]

The issues before the court included, in part, (i) whether MCM failed to comply with the conditions precedent of the Performance Bond; (ii) whether MCM, as additional obligee, was exempt from complying with the Performance Bond’s terms when asserting a claim, and (iii) whether MCM was a proper claimant under the Payment Bond.

Under the Performance Bond, if no Construction Manager default occurred, the surety’s obligations arose, in part, after the Construction Manager (i) notified the surety that the Construction Manager is considering declaring default; (ii) declared a subcontractor default after the surety received notice; and (iii) agreed to pay the remaining subcontract balance to the surety.

In its opinion, the court detailed the purpose of notice requirements in surety bonds. “Given the consequences that follow a declaration of default, it is vital that the declaration be made in terms sufficiently clear, direct, and unequivocal to inform the surety that the principal has defaulted … and the surety must immediately commence performing under the terms of its bond. Sureties deprived of this clear rule for notices of default would be reluctant to enter into otherwise profitable contracts.”[4] The court pointed out that the plain language of the bond bolsters this reasoning because it describes the surety’s obligations as arising “when” the obligee complies with the bond terms. Specifically, the Performance Bond provided that when the conditions precedent are met, the surety had “several options, including: (a) getting the subcontractor to perform; (b) performing itself; or (c) paying the costs to have someone else perform.”[5]

Because the surety was to be notified before a subcontractor default was declared, and the parties were to meet and confer about a potential default, the court held that MCM failed to comply with conditions precedent to the surety’s performance under the Performance Bond. Further, in light of JEI’s default, the court found that the surety’s obligations were never triggered under the plain language of the Performance Bond.[6]

The court also found that MCM’s Payment Bond claim was improper. Under the Payment Bond, the surety agreed to pay laborers and suppliers if the obligor failed to pay. Because MCM did not supply labor or supplies to MTS, it did not meet the Payment Bond’s definition of “Claimant”. Thus, MCM, as additional obligee, was not a proper claimant under the Payment Bond.[7]

This case exemplifies the importance of strictly adhering to the terms of a surety bond when asserting a claim. As the court discussed in its opinion, notice requirements to a surety exist for significant reasons. Sureties are entitled to certain rights under the bond, and if a party fails to properly notify the surety under the bond, the surety may be deprived of those rights. In all, failure to comply with the terms of the bond can have steep consequences, and may ultimately lead to the denial of a payment or performance bond claim.

AIA Contract Documents has provided this article for general informational purposes only. The information provided is not legal opinion or legal advice and does not create an attorney-client relationship of any kind. This article is also not intended to provide guidance as to how project parties should interpret their specific contracts or resolve contract disputes, as those decisions will need to be made in consultation with legal counsel, insurance counsel, and other professionals, and based upon a multitude of factors. 

[1] MCM Mgmt. Corp. v. Hudson Ins. Co., No. 21 C 4255, 2022 WL 17583756 (N.D. Ill. Dec. 12, 2022)

[2] Id. at *2-*3.

[3] Id. at *4.

[4] Id. at *6.

[5] Id. at *7.

[6] Id. at *8.

[7] Id. at *9.