Contract documents

June 27, 2023

Bond obligees have responsibilities and obligations under payment and performance bonds. If an obligee breaches the terms of the bond, serious consequences may follow. A recent unpublished case out of the New Jersey District Court demonstrates the ramifications of interfering with a surety’s rights under a performance bond, and the resulting consequences on the project itself.

In Lexon Ins. Co. v. Borough of Union Beach, CV1914655GCJBD, 2023 WL 3727791 (D.N.J. May 30, 2023), Union Beach, as owner, entered into a construction contract with Brunswick Builders, as general contractor, to complete the Union Beach Municipal Building. Lexon Insurance Company, as surety, issued AIA Contract Documents A312®-2010 Performance Bond on behalf of Brunswick and in favor of Union Beach. [1] During construction, the owner concluded that Brunswick was not properly performing the work. The owner, surety, and general contractor agreed that a separate contractor, Rocon Construction Group, would provide assistance in completing the project. Despite this assistance, the project experienced water leaks and other damage. The owner declared the general contractor in default, terminated the construction contract, and made a claim under the performance bond.

At the time of the bond claim, the owner and surety agreed that Rocon would perform repair work at the site, due to potentially unsafe conditions. However, the owner disapproved of Rocon’s repair work and consequently, did not agree to Rocon taking over the work.

The parties were unable to agree on the terms of surety’s takeover of the project.[2] Despite no executed takeover agreement, the surety told the owner that Rocon was to be the completion contractor, to which the owner did not agree. Instead, the owner demanded the surety to appoint a separate contractor to complete the work.

At issue in the case was whether the owner breached the terms of the A312-2010 Performance Bond when it refused to accept the surety’s choice of completion contractor.[3] In its opinion, the court explained that the performance bond provides the surety with four options upon default of a bond principal: 1) arrange for the contractor, with the owner’s consent, to complete the construction contract; 2) undertake and complete the construction contractor itself, through its agents or independent contractors; 3) obtain bids or negotiate proposals from qualified contractors acceptable to the owner, and arrange for a contract to be prepared for the owner’s signature and a contractor selected with the owner’s concurrence; or 4) waive its right to perform, arrange for completion, or obtain a new contractor after investigation to determine the amount it may be liable to the owner or deny liability in whole or in part. The court concluded that the bond is silent as to whether the owner’s consent is necessary when the surety chooses to perform the work itself through its agents or independent contractors.[4] The court cited several cases similarly interpreting the terms of the A132 Performance Bond and holding that when a surety opts to takeover the project, an owner may not unreasonably interfere with the surety’s selection of the completion contractor.

The court ultimately held that the surety was entitled to summary judgment on the breach of contract claims against the owner. Section 5.2 (unlike Sections 5.1 and 5.3) of the A312 Performance Bond does not grant a bond obligee the right to review and reject the surety’s selection of completion contractor. In a situation such as this, an owner’s remedy is limited to a contractual claim against the surety, not a veto of the surety’s choice of contractor. The court found that the owner materially breached the terms of the bond by refusing the surety to select Rocon as the completion contractor. Due to this breach, the surety was released from its obligations to perform under the A312 Performance Bond.

This case demonstrates how crucial it is for bond obligees to follow the plain language of the bond, and the consequences that flow from interfering with the surety’s rights. The obligee may be held to be in breach of contract. Moreover, the surety can be released of its obligations under the bond, which can result in a project owner spending substantially more to finish the project. It is important to be aware of a surety’s rights under performance bonds, and to precisely follow the terms and procedures set forth in the bond.

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] Id. at 2.

[2] Id. at 3.

[3] Id. at 4.

[4] Id. at 6.