9. Surety Bonds

Key Words and Concepts

  • Hired guarantees
  • Surety
  • Principal
  • Obligee
  • Guarantee
  • Penal sum
  • Premium
  • Indemnitor
  • Indemnity agreement
  • Differences between surety bonds and insurance contracts
  • Requirements for serving as surety
  • Surety belief in principal
  • Bid bond
  • Performance bond
  • Determination of surety obligation
  • Common owner misconception about performance bonds
  • Effect of excess early contract payments
  • Contractor’s protection of bonding capacity
  • Labor and material payment bonds
  • Mechanic’s liens
  • Claimants
  • Used or reasonably required in performance of construction contract
  • Work guarantee bonds / Lien discharge bonds
  • Second-tier bonds / Third-tier bonds / Subcontract performance bonds
  • Labor and material payment bonds / Material supplier bonds
Surety bonds are unique examples of important construction industry documents that flow from prime construction contracts. Essentially, they are hired guarantees. Guarantees of what? Who makes them and to whom? On whose behalf are the guarantees made? Why are the guarantees required? What happens when demands are made that the guarantees be made good? This chapter deals with these issues.

Relevant Parties and Surety Bond Terms

To understand the purpose and operation of the various construction industry surety bonds, you should become familiar with the following commonly used terms:

  • Surety
  • Principal
  • Obligee
  • Guarantee
  • Penal sum
  • Premium
  • Indemnitor

Surety

The surety (sometimes called the obligor or the bonding company) is a financial institution possessing great wealth and stability. Sureties will be required to furnish convincing evidence of their financial strength and are often required by the terms of prime construction contracts to be registered as approved sureties and to appear as such on a published list maintained by the U.S. government.

Principal

The entity that actually furnishes the bond is called the principal. The surety is the entity that furnishes the guarantee that the bond promises.

Obligee

The guarantee promised by the bond is made to an entity called the obligee. In the case of bid bonds and performance bonds furnished by the prime construction contractor, the owner of the project being constructed is the obligee. In the case of labor and material payment bonds furnished by the prime contractor, the owner is usually the obligee for the use and benefit of subcontractors and material suppliers. In some jurisdictions, the subcontractors and material suppliers themselves are considered to be the obligees. When performance bonds are furnished by a subcontractor, the prime contractor is the obligee.

Guarantee

The guarantee is a promise made by the surety to the obligee that, if the principal should fail to carry out fully and faithfully whatever particular duty to the obligee is stated in the bond, the surety steps in and either performs that duty or causes it to be performed by others. The exact nature of the guarantee varies, depending on the type of surety bond involved. This concept is different from that of an insurance policy where the insurer agrees to pay for a loss resulting from some unexpected catastrophe or from claims made by third parties to the construction contract. Essentially, the guarantee is a case of the surety underwriting the performance of the principal.

Penal Sum

Although the surety guarantees the performance of the principal, there is a monetary limit to the guarantee called the penal sum of the bond. The amount of the penal sum is stated in different ways, depending on the type of bond. For example, the penal sum of one type of surety bond, called a bid bond, is usually 10% of the amount of the bid, whereas the penal sum of performance bonds and labor and material payment bonds is usually 100% of the contract price. The penal sum is the upper limit of the surety’s potential financial liability to the obligee.

Premium

The premium is the fee that the principal pays to the surety in exchange for providing the guarantee to the obligee. Before 1985, bond premiums on large contracts for well-established contractors ranged from 1⁄2 to 3⁄4% of the total contract price for a package consisting of the bid, performance, and labor and materials payment bonds. The cost of the same bond package in the small contract market was between 1 1⁄2 and 2% of the construction contract price. Bond premiums have escalated, then stabilized somewhat, since that time.

lndemnitor

An indemnitor is a person or entity who promises to pay the surety back for any cost that the surety incurs if called upon to make good the guarantee. The principal always is an indemnitor. A surety often also requires personal indemnification from the officers or owners of the entity that is the principal. This concept of personal indemnification is the origin of the oft-repeated expression “going on the line.” If the principal is a subsidiary company of some other entity, the surety generally wants indemnification from the parent company as well as from the subsidiary. In other words, the surety makes sure that it is indemnified by the entity “where the money is” and from which the assets cannot be transferred by accounting manipulations in the face of an impending claim against the bond.

How do Surety Bonds Work?

The potential liability assumed by a surety greatly exceeds the premium charged for underwriting the performance of the principal. In part, the surety is operating on an actuarial basis, but additional considerations lie behind the willingness of the surety to assume the liability involved. These other considerations are explained in this section.

Indemnity Agreement

The surety bond proper is a legal instrument that results from a separate contract between the surety and the principal, in which the surety agrees, for a price (the premium), to guarantee the principal’s performance with respect to some obligation to the obligee that the principal has assumed. In this sense, the bond is the evidence that the obligee wants to see that this separate contract exists. The separate contract, which the obligee never sees directly, is called an indemnity agreement. In addition to specifying that the surety will provide the required guarantee to the obligee, the indemnity agreement will provide that the principal and all other named indemnitors who may be a party to the agreement will pay the surety back for any losses that the surety incurs in making good the guarantee.

Surety Bonds v. Insurance Contracts

What are the differences between surety bonds and insurance contracts? Under an insurance contract, the insurer agrees, for the premium, to pay damages or replace something that has been lost or destroyed as a result of the occurrence of a covered event, such as an accident or a fire (including claims made against the insured by third parties arising from these occurrences). Surety bonds are very different. In the event of a call against a surety bond, the surety’s obligations are not triggered by an event such as an accident or fire. Instead, the call against the surety’s guarantee is made as a result of some kind of alleged failure of the principal to perform.

How Good Is the Guarantee?

The guarantee is as good as the financial resources and integrity of the surety. The main requirement for serving as surety is that the entity must be perceived as having great financial strength with a history and reputation of living up to its obligations. The obligee would not have confidence in the guarantee unless these requirements were met.

Surety’s Belief in the Contractor’s Ability to Perform

The potential cost to the surety in the event of a call on its guarantee can be enormous. (The penal sum of the performance bond for the Lock and Dam No. 26 contract discussed in Chapter 4 was the full contract price of $227 million.) Insurance contracts may also involve large risks, but there is a key difference. In providing insurance to a contractor, the insurer is betting that it can predict the likelihood of losses on an actuarial basis accurately enough so that it makes money on the average. The competence and financial strength of the contractor are not key factors in the insurer’s decision-making process.

The surety bond case is very different. Since it is the performance of the principal that is being guaranteed, the surety has to believe in the principal and be convinced that the principal has the intention, the resources, and the ability to perform. Even though protected, at least on paper, by the terms of the indemnity agreement, sureties simply will not furnish bonds to construction contractors if they have any doubt about the contractor’s ability to perform.

Bid Bonds

An important element of the bidding process is that owners have the assurance that the bidding contractor who is awarded the contract will accept and sign it and will furnish all insurance policies and additional surety bonds required by the bid documents. If the successful bidder refuses to sign the contract, the owner must accept a higher price for the work or rebid the project. Neither alternative is desirable. Even though the owner can sue the low bidder for damages, the project will be delayed, and it may not be possible to recover all of the costs. The bid bond protects the interests of the owner against this potential loss.

Bid Bond Guarantee

The guarantee of the bid bond is twofold:

  1. The surety guarantees to the obligee (the project owner) that the principal will enter into the contract in the event of an award; and
  2. The principal will furnish the performance bond and insurance policies required by the contract.

Bid Bond Penal Sum

The penal sum for bid bonds can be expressed in one of two distinctly different ways:

  1. As either a fixed amount of money or as a percentage of the bid total, which serves as liquidated damages for failure to enter into the contract. According to the terms of the bond, the obligee does not have to prove actual damages but must merely show that the principal failed to enter into the contract and/or failed to furnish the required insurance policies and other required bonds.
  2. The penal sum can be stated in the form of actual damages suffered, up to a stated limit. Here, the obligee must prove the extent of actual damages before the surety will pay on the guarantee.

The first method is more common, and 10% of the total bid is usually the stated amount. However, even though the bond is written in this form, courts sometimes limit the owner’s recovery to actual damages.

Some bid documents provide that bidders furnish a certified check in the amount of 10% of the bid price instead of a bid bond. The checks are returned to all unsuccessful bidders the day following the bid opening—and to the successful bidder when the signed contract and the required insurance policies and bonds are received by the owner.

Performance Bonds

Owners naturally want assurance that, once they have awarded a contract, the contractor will perform according to the contract’s terms. This assurance is provided by the performance bond.

Performance Bond Guarantee

The guarantee is the surety’s promise to fulfill the principal’s obligations to perform the separate contract that the principal has made with the obligee if the principal is unwilling or unable to perform. Before a call against the guarantee can be legally sustained, the obligee must clearly establish that the principal is in default of the terms of the contract. It is sometimes unclear whether the contractor principal is truly in default or if the principal’s performance or lack of performance has been caused by an act or failure to act of the owner obligee or has been the result of some other condition of force majeure. Under these circumstances, establishing a de facto (actual) default can be a complicated matter, which often is settled only in court following protracted litigation.

Surety’s Options to Make Good the Guarantee

Once convinced that the principal is truly in default, the surety has three options for making good the guarantee to the obligee. The second and third methods are more common.

  1. Assist the principal to remedy the default. Ordinarily this would be accomplished by advancing funds to the principal but not taking control of the contract.
  2. Take control of contract performance and complete the work by engaging another contractor or by retaining the principal and subsidizing project operations and actively directing the work.
  3. Allow the obligee to complete the contract by engaging another contractor and, when the work has been completed, pay money to the obligee for any excess costs incurred in completing the work.

Penal Sum—How Much Does the Surety Pay?

The penal sum for performance bonds is usually 100% of the contract price, the upper limit of that surety’s monetary exposure in the event of a default. Determination of surety obligations can be reached in various ways. One method is for the surety and the obligee to negotiate a fixed amount to discharge the guarantee (up to the penal sum limit) to be paid by the surety “up front” before the balance of the work is completed. If the actual costs incurred by the obligee in completing the work exceed this amount, the surety pays nothing further. If the actual costs are less than the agreed-upon amount, the obligee keeps the difference. This method amounts to the surety buying their way out of the liability.

A second more common procedure is for the surety to agree to pay the obligee’s actual costs to complete the contract work, less any unpaid contract balance, plus any liquidated damages that may be due under the contract. The amount that the surety must pay is limited to the penal sum of the performance bond. The way that the surety’s payment is calculated under the second method is illustrated with the following hypothetical example:

A contractor defaults on a $5,000,000 construction contract after beginning work and receiving a total of $1,500,000 in progress payments for work completed prior to the default. The contractor has furnished the owner with a performance bond with a penal sum equal to the full contract price. The surety agrees that the owner (obligee) should complete the work, which costs the owner $4,750,000. In addition, the project is finally finished well after the required completion date of the original contract and, under the terms of that contract, $300,000 in liquidated damages are due.

Unpaid Balance = $5,000,000 – $1,500,000 = $3,500,000

Surety’s Obligation = $4,750,000 – $3,500,000 + $300,000 = $1,550,000

If it had cost the owner $5,750,000 to complete the work, the surety’s obligation would increase to $2,550,000. However, if the owner had spent $8,750,000 to finish the work, the surety would have to pay only $5,000,000, the amount of the penal sum of the bond, not the $5,550,000 that would otherwise be calculated.

Owner’s Misconception About Performance Bonds

A common misconception about performance bonds by owners is that they sometimes mistakenly feel that they have absolute power over the contractor because they hold a performance bond. They believe that the surety will immediately respond to complaints and force the contractor to do whatever the owner wants done. This expectation is not likely to be fulfilled for a number of reasons.

First, the surety will not act until and unless they believe that the principal is truly in default and will not or cannot cure the default. The surety is even less inclined to act if the principal is financially strong. The principal has indemnified the surety. If the principal has substantial assets, the surety knows that it will recover any money that it might have to pay if the owner sues to enforce performance of the bond guarantee and if the decision of the court supports the owner’s position. Therefore, there is less incentive for the surety to act immediately.

A second factor may motivate the surety not to act on the guarantee in questionable cases. Under the legal theory of subrogation, the surety has all of the contractual rights of the principal and is not likely to remedy an alleged default until all viable legal defenses to the owner’s claim of default have been investigated and found to be of no avail. If the surety should pay the obligee when there is a viable legal defense to the claim of default, it may be legally found to be a volunteer and be unable to recover the money paid to the obligee from the principal and other indemnitors.

Thus, the owner/obligee may be surprised to find that the surety sides with the contractor/principal when faced with a call on the guarantee. To collect eventually on the performance bond guarantee, the obligee must be legally correct on the facts of the alleged default, or both the principal and surety will be excused from their obligations. However, if the allegation of default is legally correct, the obligee eventually is made whole, but only up to the penal sum limit of the bond.

Excess Early Contract Payments

It has previously been mentioned that the obligee’s recovery is limited to the penal sum of the bond. However, the obligee may recover less than the excess costs required to complete a defaulted contract even though the penal sum of the performance bond has not been exceeded. Suppose that at the time of the default, the owner had overpaid the contractor for work completed in terms of the actual cost of the work completed relative to the actual cost of the work remaining.

Under these circumstances, the effect of excess early contract payments is that the owner/obligee may be unable to collect the full cost to complete the work less the unpaid balance of the contract, even if that total is less than the penal sum of the performance bond. The surety will contest its obligation to pay the full amount by showing that the owner improperly overpaid the contractor for the work actually performed. This will reduce the unpaid contract balance at the time of the default and increase the amount that the owner is asking the surety to pay. If the surety can prove overpayment to the contractor, it will reduce the amount to be paid to the obligee accordingly. This is a real danger to the owner in paying out on contracts where payment schedules have been heavily front-end loaded—that is, payment heavily unbalanced in favor of work items scheduled to be performed early in the contract.

Contractor Protection of Bonding Capacity

It may appear from the preceding discussion that the performance bond provides little protection for the obligee after all. This would be more true if it were not for the necessity of contractor/principals to protect their bonding capacity. Since so much construction work is bonded, contractors must maintain their ability to obtain performance bonds. Smaller contractors particularly do not want their surety to receive complaints about their performance, jeopardizing their ability to secure bonds for future projects. For this reason, they are more likely to respond to owners’ demands when complaints over performance arise.

If being declared in default looms as a real possibility, contractors generally do everything possible to avoid the surety taking over their contracts for two main reasons:

  1. If the surety should take a loss, the contractor will find it difficult to ever get another bond.
  2. Since the surety is indemnified, the contractor loses control of expenditures in the event of a takeover but not the legal obligation to pay the surety back for them. As long as they can maintain operations, contractors naturally prefer to spend their money themselves rather than have the surety or the owner spend it for them.

Labor and Material Payment Bonds

Private construction contracts are subject to mechanic’s lien laws, which enable subcontractors or suppliers to file liens, or legal claims, against the project property if they are not paid by the owner’s contractor for their services or furnished materials. Payment bonds assure that such persons or entities are paid by the surety if the contractor/principals refuse or are unable to pay. If there is no bond and liens are perfected-where, through a lawsuit, liability to pay the amount of the lien is established by a court-owners have to pay the claimant to avoid having their property sold to satisfy the lien. For this reason, private owners want payment bonds.

A mechanic’s lien cannot be placed against federal government or other public property. However, at the federal level, and in most states, public policy demands that subcontractors and suppliers on public projects be paid for their work. Thus, Congress has enacted the Miller Act, and many of the state legislatures have enacted “Little Miller Acts,” both of which, among other things, require labor and material payment bonds on public construction contracts, federal and state respectively.

Labor and Material Payment Bond Guarantee and Claimants

The guarantee of a labor and material payment bond is the surety’s promise that it pays claimants if the principal is unable or refuses to pay them. To understand the guarantee depends on understanding the definition of a claimant. For a person or entity to be a proper claimant, a number of conditions must be met.

First, a construction contract between the principal and the obligee must exist, and this contract must be referenced in the bond. The bond then defines claimants as those persons or entities who have contracts with the principal to perform services or furnish materials on the project pursuant to the principal’s construction contract with the obligee. Thus, someone who wants to collect on a payment bond must first be sure that this requirement is satisfied—that is, that the claimant has a contract with the principal who, in turn, has a contract with the obligee. Some payment bonds go further, including as claimants those persons or entities who have contracts with other entities that, in turn, have contracts with the principal.

In the case of federal contracts for which a Miller Act bond is required, sub-subcontractors and material suppliers to subcontractors of the principal are also treated as claimants. So are material suppliers to sub-subcontractors. Material suppliers to the principal are always considered to be claimants. However, second-tier material suppliers to first-tier material suppliers who hold a purchase order contract with the principal do not qualify.

The federal practice is mirrored in the laws of some states, as the following Kansas case illustrates. The City of Wichita awarded a prime contract to a general contractor for construction of a sewage digester. The general contractor (Penta) then awarded a contract to Wells Products Corp. for furnishing the digester floating cover and gas compressor system. Penta also furnished a public works payment and performance bond in accordance with the Kansas “Little Miller Act” statute. Wells Products Corp. failed to pay J. W. Thompson Co., one of its suppliers, who then brought a claim against the prime contract payment bond. As in federal contracts, Kansas public works payment bonds protect only suppliers to subcontractors, not suppliers to suppliers. It, therefore, became important for the trial court to decide whether Wells Products Corp. functioned as a subcontractor or as a supplier to Penta. J. W. Thompson Co., who was, in effect, a second-tier supplier, argued that Wells Products Corp. had furnished personnel on site for the purpose of assisting in adjusting and starting up the equipment and, therefore, was functioning as a subcontractor. The prime contractor claimed that the agreement with Wells Products Corp. was a sales agreement since the actual contract evidenced all of the “trappings” of a sales agreement and contained none of the clauses usually found in subcontracts. The trial court concluded that Wells Products Corp. was a subcontractor, making J. W. Thompson Co. a proper claimant under the prime contract labor and material payment bond. The Kansas Supreme Court reversed the trial court, deciding instead that Wells was a material supplier, not a subcontractor. The Kansas Supreme Court stated:

Modern conditions frequently demand a high degree of specialization in manufacturers and suppliers. The facts that Wells had the duties to inspect Penta’s installation of the components purchased from Wells, to be present at the start up, and to instruct the City of Wichita employees on the use of the gas compressor system were key factors in the trial court’s conclusion that Wells was in fact a subcontractor. But it is clear that such activities are common in the construction of sophisticated systems.

Since J. W. Thompson Co. was determined by the Kansas Supreme Court to be a supplier to a supplier, they could not recover against the payment bond.[1]

This case illustrates that, in claims against labor and material payment bonds, the determination of who qualifies as a claimant and who doesn’t can become a very complicated matter that will be decided based on the specific facts in each case and on the statutes that apply in the particular jurisdiction involved. The specific wording of the bond itself is also very important in defining who may qualify as a claimant.

Claimant status, in and of itself, does not guarantee the right to recovery under the bond. Although the wording of individual bonds may differ, most generally require that additional tests be met. Claimants must prove that they have not been paid within a period of time stated in the bond after completing services or furnishing materials and that the services or the materials they furnished were used or reasonably required in the performance of the construction contract. The phrase “used or reasonably required” originally meant literally “bricks and mortar in place at the site of the work,” and courts would exclude such items as the delivery costs of materials because they were not incurred on the work site. Modern courts tend to construe the meaning of the phrase more broadly, but many cost items are still excluded. For example, the overhead expense of a home office, expense of estimating material and subcontract quotations, and cost of negotiating and preparing purchase orders and subcontract agreements are ordinarily excluded.

Other First-Tier Bonds

A number of less common first-tier bonds are also used in the construction industry.

Work Guarantee Bonds

In a work guarantee bond, the surety guarantees that the completed construction work of the principal will meet the requirements of a warranty contained in the contract. A roofing bond, for example, could be written with respect to an explicit warranty stated in the contract that the completed roof will not leak or require replacement for a minimum of five years after it is accepted by the owner. Such contracts sometimes permit the owner to hold part of the retention until the end of the warranty period. By putting up a bond, the contractor can secure the release of the retained funds. The specific guarantee of this bond is that, if the roof leaks and the contractor either cannot or will not return and repair it, the surety will pay the cost of repairs.

Lien Discharge Bonds

In a lien discharge bond, the surety guarantees that the principal pays the obligee in the event that the obligee is compelled at some future date to satisfy a lien placed on the facility constructed by the project because the principal had not paid the lien claimant. A prime contractor who refused payment to a supplier or subcontractor who had filed a lien because of a dispute over that party’s performance would obtain a lien discharge bond. This bond protects the owner against a possible adverse judgment on the lien placed on the owner’s property by the subcontractor or supplier. Therefore, the owner need not withhold money from the final payment to the prime contractor to protect its interests. If the contractor had previously furnished a payment bond, the owner already has that guarantee and would not require an additional lien discharge bond.

Subcontract Bonds and Material Supplier Bonds

All of the bonds previously discussed have been first-tier bonds. Many possible lower levels, or tiers, of contracts can relate to the same project. For example, the prime contractor’s subcontractor may subcontract a portion of the subcontract work to yet another entity. This situation gives rise to the need for subcontract second-tier bonds and sub-subcontract third-tier bonds.

Typically, the first-tier bonds that can be obtained for lower tiers are subcontract performance bonds and subcontract labor and material payment bonds. Each serves the same purposes and operates in the same general manner for lower tiers as for the first tier. Essentially, the parties simply change seats and shift down one tier. For example, in the case of a subcontract performance bond, the contractor becomes the obligee instead of the owner, the subcontractor becomes the principal instead of the contractor, and so on. The surety position would remain the same as for a first-tier bond. The wording of lower-tier bonds differs slightly from that of first-tier bonds, but they operate the same way.

Material supplier bonds are another example of lower-tier bonds that are available. Generally, they are intended to cover claims from a subcontractor (or material supplier) against a material supplier holding a material supply contract with the prime contractor. If such material suppliers fail to pay their own material suppliers or subcontractors, the surety would respond.

Determining the need for lower-tier bonds requires business judgment as well as legal advice from attorneys knowledgeable in the bonding field.

Conclusion

This chapter explained that surety bonds are very different than insurance policies in that they are essentially hired guarantees rather than protection from the consequences of some physical catastrophe. Relevant surety bond terms and the way in which surety bonds work were then discussed. The details of operation of the bonds in common construction industry use followed, including subcontract and material supplier bonds.

The following Chapter 10, on construction joint-venture agreements, concludes the examination of the normal industry contracts that are closely related to the prime construction contract.

Questions and Problems

  1. What is a surety? Who is a principal? An obligee? What is the general nature of a surety bond guarantee? What is a penal sum? The premium? Who is an indemnitor?
  2. How do surety bonds work? What is the essence of a surety bond? What is an indemnity agreement?
  3. How do surety bonds differ from insurance contracts?
  4. What is the primary requirement for an entity to serve as a surety? What belief must a surety hold with regard to a principal before the surety will furnish a bond?
  5. What is the purpose of a bid bond? What does the guarantee of the bond promise? What are the two parts of a bid bond guarantee? What are two ways of stating the penal sum for bid bonds? Which way is more common?
  6. What is the purpose of a performance bond? What does the guarantee of the bond promise? What fact must be clearly established before a surety can properly be expected to make good on the guarantee?
  7. What three options does a surety normally have once it becomes convinced that the principal is in default? Which options are more commonly utilized? When the surety agrees to pay money to the obligee, what two alternate means are used to determine the surety’s obligation? Which of these latter two methods is the more common? What is the top limit of the surety’s obligation in any case?
  8. What is the misconception that owners sometimes hold about performance bonds? Is the surety as likely to act to cure an alleged default if the principal is financially strong and has the means to cure the default? Why not? What is another factor that a surety will carefully consider in making the decision on whether to cure an alleged default? If an owner is legally correct in alleging that the principal is in default, will recovery under the bond ultimately be realized?
  9. Even when the surety agrees to cure a default by paying the owner/obligee money, under what two circumstances could the owner be paid less money than the excess costs expended in completing the contract?
  10. What is a typical construction contractor’s mindset in regard to bonding capacity? Why will contractors at all costs try to avoid a surety’s taking over performance of their contract?
  11. What is the reason that labor and materials payment bonds are required by owners on projects subject to mechanic’s lien laws? Why are they required on public contracts that are not lienable? What are the Miller Act and “Little Miller Acts”? What do they provide with regard to payment bonds?
  12. What is the guarantee of a labor and materials payment bond? Who is a claimant? What does an entity who has not been paid have to establish in order to be considered a claimant?
  13. Payment can be claimed for what kind of things under a payment bond? What did the words “used or reasonably required” originally mean to courts? What do the words mean today?
  14. What is a work guarantee bond? How is it used? What is the guarantee? Answer the same three questions with respect to a lien discharge bond. What are second-tier bonds? What are the shifts in position of the various parties from first-tier bonds to second-tier bonds?
  15. A contractor entered into a $6,755,000 subcontract with a subcontractor, who furnished a performance bond of 100% of the subcontract price. After the contractor paid the subcontractor $5,252,000 for work completed, the subcontractor became bankrupt, and the contractor terminated the subcontract for default. With the agreement of the surety, the contractor engaged another subcontractor who completed the work of the original subcontract for a total additional cost to the contractor of $3,927,000. The work was completed 185 calendar days later than the subcontractor was contractually bound to complete the original subcontract. The liquidated damages for the original subcontract were $1,500 per calendar day. The subcontractor’s surety refused to pay the amount of its normal obligation on the grounds that the contractor had grossly overpaid the subcontractor for work completed. The contractor sued the surety. At the trial, the court determined that the contractor had, in fact, overpaid the subcontractor prior to the default by $1,403,000.
    1. What is the actual unpaid balance of the subcontract in dollars at the time of the default?
    2. What should the unpaid balance have been in dollars at the time of the default according to the ruling of the court?
    3. What would the surety’s monetary liability in dollars have been if the court had ruled that there had been no overpayment to the subcontractor prior to the default?
    4. What was the surety’s monetary liability in dollars in view of the court’s actual decision?

  1. J. W. Thompson Co. v. Wells Products Corp., 758 P.2d 738 (Kan. 1988).

License

Icon for the Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License

Construction Contracting by Estate of Stuart H. Bartholomew is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.