COLLECTING ON THAT

PERFORMANCE OR BID BOND

By Jonathan P. Sauer, Esq.

INTRODUCTION

A public owner is a beneficiary or “obligee” of a surety bond given by a general contractor (or by a filed subbid contractor on a bid bond). The insurance company which gives the bond is called the “surety”. The insured, whose obligation the surety is guaranteeing, is called the “principal”. Unfortunately, under various circumstances, a public owner becomes a “claimant”. The purpose of this paper is to discuss how to process a claim on a performance or bid bond.

A. PERFORMANCE BONDS

(1) Important provisions in reading and understanding a bond

Although payment and performance bonds tend to have a lot of arcane language in them, there are three things to look for in looking at any particular payment (or performance bond) - otherwise known as ‘contract’ bond. First, what is the statute of limitations contained in that bond; this is the period of time within which you have to bring suit to perfect your rights. Secondly, are there any "notice or conditions precedent" provisions as to parties to whom you must give notice to protect (and perfect) your claim. Notice provisions typically apply to those who do not have a direct contract with the bonded principal on the payment bond side. Thus, as involves a general contractor's payment bond, frequently, a subcontractor would not have to give notice to a general contractor for a claim against a general contractor's bond but the subcontractor's subcontractors (so-called 'second tier' subcontractors) would. When dealing with performance bonds, an Obligee often will be required to give a surety a certain amount of time to investigate the claim and to come up with potential completion contractors. This type of notice is often construed as being a “condition precedent” before the Obligee has a right to expect (or insist on) surety performance.

The third provision to be concerned with does not apply at this point in time: namely, is there any specific 'venue' provision, which provides where suit against the bond has to be brought.

Keep in mind that most payment bonds are only actionable (you can only sue them) for a period of not more than one year. (Performance bonds often allow for suit for two years.) One must look at the amount of time that an Obligee has to perfect its claim by filing suit; the author is unaware of any minimum times prescribed by rule or statute on a Massachusetts performance bond. On the payment bond side - sometimes also applicable to performance bonds - the ‘one year' can be figured two different ways. The more restrictive way (for claimants) is one year from the date the claimant last performed labor or furnished services for which claim is being made; that is essentially the standard for suit against a general contractor's payment bond on Massachusetts public and Federal general contractors' bonds. Some bonds figure the one year period from the date the principal (bonded party) last worked. This is, obviously, a more liberal standard to a claimant inasmuch as in almost every circumstance, a general contractor will be at the job for a longer period of time than any particular subcontractor. Where there is no statutory content in a public performance bond, one has to read the bond to see what the notice, venue and limitations periods are. (A typical performance bond form is attached hereto this paper as pages 15 and 16.)

(2) Things to keep in mind in dealing with a bonding company claim department

Why should one write the bonding company at all in the event of a claim (as opposed to simply turning the matter over to counsel or filing suit)?

Most responsible companies will try to settle as many payment and performance bond claims as possible at the claim level, if for no other reason than to save the expense of shipping the defense of a claim out to an attorney. Insurance companies tend to be very expense conscious, particularly during the past few years when there has been a lot of excess capacity (meaning, the sureties are not writing as many bonds as they would like to because of various factors including tougher competition.) Indeed, one of the primary methods that sureties use in evaluating the effectiveness of their claim representatives involves a determination of what percentage their expense dollars (monies paid to accountants, lawyers and technical consultants) bears to their loss dollars (monies actually paid to claimants). Also, for most sureties, “public bonds” represent more than 50% of their gross revenues. Since a municipality or state body can decide not to accept further bonds from Acme Bonding Company - based on poor performance on a claim, for example - sureties are or should be more sensitive to better service to public owners. This is all the more so with state agencies, as a particular surety’s right to sell bonds in a state is only with the permission of the Division of Insurance - another state agency. It can be a very effective technique in appropriate situations to threaten a surety with reporting a poor claims handling to the Division of Insurance for its own investigation. Our state Division of Insurance can and does keep track of these complaints and in particularly egregious situations can disenfranchise a surety from writing public bonds, which can cut a financial artery!

(3) Put your claim in writing; get it all in the first letter; third party verification; time lines for a decision; other timeless ‘do’s’ and ‘don’ts’!

Initially, one has to understand what an insurance company environment is like. Generally speaking, a surety company which has an office in Massachusetts probably has an involvement one way or another - whether in claims or in underwriting - with hundreds of principals. An insurance company which has only regional offices -- such as, for example, one office in New England -- probably deals at any one time with several thousand principals. An insurance company which has a single national claims office, which is not all that uncommon, could be involved with tens of thousands of principals, whether in claims or in underwriting. Moreover, each principal may have outstanding at any given time bonds on many different projects.

Much as an army travels on its stomach, an insurance company travels on its files. Keep your claim in written form! While it may be easier to just call the claims representative, confirm important phone calls in writing and have the more significant contacts appear in writing. In the law business, there is the expression that an oral contract is worth the paper it is not printed on! Put it in writing and keep it there.

Therefore, it is extremely important that your claim letter have certain things. For one thing, before sending the letter, attempt to find out what individual in the bonding company claims department will be handling your claim. (Having a Circular 570 can be useful in this regard in getting initial information as to a surety’s address and telephone number.) This can be as simple as calling up the claims department and asking who handles (or will handle) claim matters pertaining to Last Chance Construction Company. Although the claims manager may be startled to hear that there are claims against Last Chance Construction Company, identifying a specific person to whom to send your letter is critical. In every instance, your letter should be sent to a specific named individual. If you cannot identify which claims representative has the file or will have the file, then at least identify what individual is the bond claims manager for the particular branch you will be dealing with and address that letter to the bond claims manager. It is a good idea to send particularly the first correspondence certified mail, return receipt requested. Insurance companies, unfortunately, have the unhappy tendency of misplacing initial correspondence for new principals in claim. There is nothing intentional or evil about this. With new claims, because there is no file to file a piece of correspondence with and/or if the correspondence does not sufficiently identify the project and bond, correspondence can simply enter any one of numerous 'black holes' in an insurance company.

After addressing your letter to a specific named individual, in the "re" of your letter you should identify who the principal is. Against which of that insurance company's clients are you making a claim? Also, identify in the re the project you are making a claim relative to. If possible and if you have had the good fortune of obtaining a copy of the payment bond, attempt to identify the bond number. Many insurance companies use the bond number as the file number for claim files. Also, in the re of your letter, identify the claimant, which is your public owner's name.

In the body of the letter, you want to educate a person who doesn't know anything about you or your unfulfilled relationship with the principal as to that relationship. You should send a copy of your contract with the principal. If you are making a performance bond claim, you need to identify that performance is not in accordance with the contract or with industry standards (or with both). Keep in mind that before the bonding company has an obligation to do anything in terms of taking over your project, the bond has to be triggered. “Triggering” a performance bond - in the easy cases - typically means that a principal has abandoned the job, has filed bankruptcy, is chronically or seriously in arrears in paying subcontractors or suppliers. In harder cases, the principal may still be on the job - but struggling, or worse - or may be disputing that the principal is in breach. Ultimately, before the performance bond has been “triggered”, the owner may have to declare the principal to be in breach of contract or even terminate the general contractor. For tactical reasons, you may not want to do this with the first bonding company contact. Those reasons could include the fact that once you contact the bonding company, performance may get better. Many complaints concerning performance are really only little brushfires and these tend to burn themselves out fairly quickly (unless we are talking about the canyons in Southern California which, like a young man’s heart in spring, are always perilously close to the flashpoint!) Also, and whether it gets better or not, hopefully there will be some further performance during the time period it takes the bonding company to investigate which - if the bonding company has its way - could be months. Therefore, it is critical to make the case in your first letter - as completely as you know how - that the principal is in a state of ‘default’, meaning that the principal is in breach of some material provision of the contract. This could be a contractual term (e.g. failure to complete on time) or this could be a technical term (the concrete does not meet the slump test; the building is not square or is at the wrong elevation). If there is a technical problem with the performance, it behooves the prudent owner to offer in the initial claim package to the surety a letter from an architect or engineer defining what the technical problem is and supporting the owner’s position. Typically, bond claims representatives are both non-lawyers (although there is a trend moving in that direction) and also non-technical. Very few claims reps will be technically-trained. Therefore, and since the panoply of technical areas that a surety may bond is quite broad, it would be wise to assume the claim rep reading your letter does not completely understand what you are talking about. Tactfully, one should explain the problem with references to plans and specifications and to other useful information - industry standards and norms, for example - to explain what the problem is. Obviously, the Owner’s design professional should make the case that the principal is not meeting one of these standards.

This type of letter can be very useful in the claims situation, as bonding companies are interested in third party verification. Much as in a divorce, often times the smoke obscures the fire and a surety is not necessarily persuaded when an owner - with a vested interest - says that a principal - with a vested interest - is in breach of some contract term or provision, particularly where if the owner is right, it is going to cost the bonding company some money. An independent evaluation - particularly not from the architect whose design concept may be at issue, if that is the case - helps persuade the surety that there may be a problem.

Send the bonding company a copy of its own performance - and, particularly, bid - bond! This may sound ridiculous but it really is not within an insurance company framework. Underwriters (those who write bonds) often do not communicate well with claims. Also, many companies use outside insurance agents, who are not employees, to write some or all of a company's surety bonds. While, generally, these agents are supposed to promptly report the execution of bonds to the insurance company, under various circumstances this reporting can be delayed. It always helps the claims person to give him or her a copy of the bond against which you are making claim. Bid bonds may not always be contemporaneously reported by the insurance agent. And while we are speaking of that fine fellow, do not deal in claims matters with insurance agents who are, after all, underwriters. Claims matters should always be dealt with claims people, who, invariably, will be home or regional office personnel - bonding company employees.

Also, since the claims person is going to attempt to verify every single thing that you say in your letter by writing to the principal, showing the principal as a carbon copy on your letter and sending the principal a carbon copy of your letter with enclosures accomplishes three goals. For one thing, you are going to save the insurance company a little time in that the surety company does not have to write to its principal: this is not necessary, as you have written the principal. Secondly, by writing the principal at an early stage of a claim, that principal, particularly a viable (still in business) principal, may realize that he has to deal with you and quickly. (It is quite common in the surety business that there are little “brushfires” with regard to payment and performance bonds; by having the surety involved - and writing its ominous letters to the principal and personal indemnitors - this may be all that is required to get your problems satisfactorily resolved.) Thirdly - perhaps, most important - everyone will realize that you know what you are doing. In that initial claims package, be sure to include every possible document that reasonably bears on the dispute. This could include correspondence, job meeting minutes, clerk of the work reports, architect letters and minutes, punch lists and pictures. And be sure to copy the principal with all of these documents.

Always ask for a written response from the insurance company within a defined time period. For example, in most cases you should ask the surety company to acknowledge its receipt of your claim in writing within ten days. If you have provided the insurance company with the documents I have identified above, you should also ask the insurance company to indicate how it will handle your claim within thirty days.

Don't make two mistakes. Don't write to an insurance company and request action within 2 or 3 days: this is simply not possible. At the same time, don't be excessively polite in writing to the insurance company to give the insurance company the impression that there is no time urgency to your claim or that you don't really expect the insurance company to honor your claim. You have to give the insurance company a sufficient amount of time to investigate the claim; but, you do not want to give them an annuity to handle the claim for the next two years (the second year of which may be time-barred!)

In most performance bond situations which are not mere “brushfires”, sooner or later you are likely to meet the surety’s consultant. A “consultant” will be a non-surety employee, usually technically oriented. Here is a ‘don’t do’! Don’t allow the surety to hand you off to its consultant. Consultants are generally hourly workers who have a vested interest in racking up some hours. For hourly workers in this kind of situation, there is no inherent pressure to resolve the dispute quickly. And, sureties are used to dealing with files over long periods of time. Because of the nature of the surety product with its indemnity agreement, the concept of paying claims is harder for a surety to grasp than it is for an insurer on liability claims. Moreover, where consultants can earn a large portion of their fees in litigation, some times there may not be the incentive for a complete, clean resolution which is what you, the customer, are interested in. While not refusing to deal with the consultant - you may have no choice - be sure to copy communications to the surety company and periodically write to the surety company claim representative for status updates - even (especially) where your daily contact is with the consultant. This is important for a number of reasons. A principal reason is that if the surety drags its feet too long, an Owner may have a viable threat of a bad faith lawsuit against the surety or a colorable (meaning, containing possible or ostensible merit) claim which might be submitted to the Division of Insurance. One reason sureties use consultants is that they tend to insulate the surety from these problems. Don’t let them!

If the surety wants you to deal not only with its technical consultant but with its financial consultant - accountant or auditor - more likely than not, the principal is like the Boston Red Sox as defined recently in the Boston Globe: the walking dead! Sureties always want to wrap things in a nice complete package for ultimate indemnity proceedings, which means they may try to develop on multi-project defaults a complete picture of all aspects of a principal’s business - much of which in the final analysis is not really necessary - which is very time-consuming and not at all necessary to get your particular job done.

What kinds of resolution should an Owner be looking for? What are the typical methods of resolving performance bond claims? First and foremost, the principal should finish the job, if at all possible. If this is not possible, the following are the more common options.

The surety writes a check and gets a release. This is called “buying back” the bond. Ultimately, this is one of the surety’s favorite resolutions, as it is cleaner and minimizes further surety risk. Typically, the cost of completion is determined and the surety will make up the shortfall. The cost of completion may be determined by taking bids from several bidders, which is one method that sureties use to determine these costs. Another helpful hint. When completing a public job, try to use the original bidders who bid the job, as they are already familiar with the job and you have a benchmark price to compare the completion costs against. When a surety takes prices from new-to-the-project contractors, the prices often tend to be much higher. Another hint. If the surety is moving too slowly - or not at all - and the Owner simply has to get the job done, it will almost always be found by a reviewing court to have been reasonable for the Owner to have used one of the original bidders in completing the job and then chase the surety for the increased costs afterwards. An advantage to the Owner of this approach of buying back the bond is that it avoids litigation and tends to get the job done more quickly.

The surety gets someone to complete. This is fairly self-explanatory. The surety will tender a “completion contractor”, who then will either enter into a contract with the public owner directly or will complete for the surety under a “completion contract” with the surety completing for the Owner under a “Takeover Agreement”. (Both of these are fairly short contracts which may be necessary to get the job done. If the surety tenders the contractor and then wants to get out of the picture, it should have that contractor bonded to the Owner. Conventional wisdom - from an Owner’s standpoint - is to try to keep the original surety “on the hook”. An owner only wants one problem on this job and if problems develop with the completion contractor, it does not want to go through another claims scenario with another surety. By having the surety undertake completion but without a release, the surety has the same interest in getting the job done that the Owner has: a nice quick job with a minimum of headaches. Incidentally, by the author’s own experience working for sureties in arranging completion, the most important thing that I look for is a contractor who can get the job done quickly and without change orders. The price under these circumstances is a secondary consideration.

The surety does nothing and the Owner is left to its own devices. This situation, unfortunately, does happen every now and again but less so with responsible and effective sureties. This may be because of the fact that the surety is not convinced that the principal is seriously at fault with the Owner. This may be because the job is so open and in a state of confusion that it is impossible to get reasonable costs to complete. For example, on an electrical job there is a lot of conduit is showing but a potential completion contractor does not know whether or not there is any wire in it. Frankly, this result may obtain because of the inexperience of the surety’s claim representative or consultant. Surety performance situations often arise when a principal calls the surety on Wednesday and wants the surety to make payroll on Friday or six bonded jobs are going to die, the suppliers will sue and all the employees will walk off! When the surety gets this type of call, often a human response will interject itself: if I do not do anything because I do not know what to do, then I can not be criticized for making a bad choice. Therefore, and sadly, doing nothing becomes what a surety’s choice becomes by way of default.

The purpose of this paper is not to solve or anticipate all possible problems. Generally speaking - and based on nearly thirty years’ experience - there are some basic ideas to keep in mind. First and foremost, get the job done. The fact that the surety is not “stepping up to the plate” does not mean that it can escape liability for all times. Get the job done in a commercially reasonable way. Contact at least two or three bidders, possibly starting with the original bidders who already know something about the job. Have them bid to a written description of the work, if that is possible, and make sure they include 100% payment and performance bonds in their price quotations. Keep the defaulted principal’s surety informed of what you are doing all along the way in writing. (If you do, it will be harder for the surety to complain about what you did later - in court - if it did not complain when it had the opportunity to do so.)

Get the job done. After all, you need that school or that pipe installed in the ground. Also, everyone will be second-guessing you anyways down the road and it is important for you to “mitigate your damages”, meaning, to incur the smallest possible out-of-pocket loss. The same surety which did not take action on your performance bond claim might in court later criticize you for not taking action for the purpose of minimizing your damages.

(4) “Bad faith” claims and complaints to the Division of Insurance.

I will take the latter first. Since sureties can only write contract bonds under license by the Division of Insurance, threatening to go to the Division of Insurance with a complaint in the appropriate case might get the surety to move off the mark. Note two important ideas in that last sentence. The first is the idea of “threatening”. Twenty years in the law business has taught me that the threat of anything usually exceeds the value actually performing the activity. Moreover, if you actually make the complaint, the surety will have no wiggle room and might be more inclined to cast in concrete its position. By threatening this activity - and giving the mistaken/poorly motivated surety sufficient time to rectify its ways - you will get the benefit of an activity you never have to undertake.

There are two potential “bad faith” type claims. The first is under Chapter 93A, which is the state Consumer Protection Act, which applies equally to both consumers and to people in business. In fact, for a business to business C. 93A claim, each party must be engaged in “trade or commerce” in the Commonwealth, which is a hard showing for a governmental unit. There are a number of cases, however, which have allowed governmental entities including municipal corporations and the United States to make claim under Chapter 93A. Successful claimants under this statute may be entitled to double or triple actual damages and to an award of attorneys’ fees. Attorneys’ fees are not usually recoverable in an action against a performance bond under traditional common law principles. Apart from the “standing” issue (meaning, the ability of a governmental unit to assert such a claim) the courts of this Commonwealth are pretty aggressive about giving these types of awards.

Another kind of “bad faith” claim can be made. That is under Chapter 176D, which defines (and proscribes) certain unfair insurance claims settlement practices. There has been case law which has said that a violation of that statute is a violation of Chapter 93A, entitling a claimant to double or triple damages and attorneys’ fees. This has been cut back somewhat as to claims by businesses recently. Still, even the making of the claim is something that insurance companies take very seriously for a variety of reasons, including the fact that they may not be able to claim indemnity from their principals for the damages they suffer due to their own malfeasance (by improperly handling claims).

What are we talking about? The following are examples of unfair insurance claims settlement practices: failing to acknowledge and respond to communications promptly; failing to adopt reasonable procedures for the investigation of claims; compelling an insured (which can include bond obligees) to institute litigation to collect under a bond when liability is reasonably clear.

Again, the threat of this type of claim may exceed the benefit of actually asserting it. The last statistic the author has seen on how many civil cases of all kinds actually go to trial in Massachusetts to a verdict or judgment is only 4 to 8%. Where these type of cases - alleging bad faith - carry with them the possibility of extra-contractual damages (meaning damages that there is no bond or policy to pay them - a real insurance company “no-no”) and where discovery in these kinds of cases allows for the obtaining of the claim file and even the Holy Grail - the bond claims handling manual - these type of cases, which have any merit at all, have a way of being resolved and often fairly early on.

B. BID BOND CLAIMS

What is a bid bond? A bid bond is a bond which gives the owner some assurance that a successful bidder will enter into a contract and provide the one hundred percent payment and performance bonds required by various statutes. If the payment and performance bonds provide the main thrust, the bid bond is the booster rocket - to get the whole process off of the ground. Typically, the “penal sum” - the amount that the surety company will be liable for - is 5% of the value of the bid, which is supposed to include the value of all alternates, whether or not they are ultimately selected or not. (If the bid bond is not big enough to include the alternates, probably the bid itself should be rejected for having inadequate bond security.) The liability of the surety assumes that there is some spread between the low bidder who can not or will not enter into the contract and provide the payment and performance bonds and the next lowest eligible and responsible and responsive bidder. Up to the amount of this actual differential or 5% of the apparent low bid (whichever is lower) is paid to the owner from the bid bond.

I would like to make a couple of comments on bid bonds. First, by my own subjective experience with a number of sureties, it seems that not as many owners either make these claims or follow through with the surety to collect these monies. The only fundamental things that need to be demonstrated are that there was a bid and bid bond and the bidder refused to enter into a contract or provide payment or performance bonds impermissibly. Under C. 149, s. 44B, a subbidder or a general bidder can withdraw its bid and receive back its bid bond or other bid security if the bidder has made a “bona fide clerical or mechanical error of a substantial nature, or other unforeseen circumstances affecting the general bidder.” This language is construed very narrowly by the Courts which hold that the error has to be substantial and must be literally a mechanical, clerical type error such as an error in copying, transference, transcription, arithmetical computation and like mechanical tasks. These errors are the so-called “scrivener’s errors”. Perhaps curiously, although one can withdraw one’s bid under these careless circumstances, if someone boots the bid from a substantive standpoint - not taking off a piece of equipment or carefully enough reading the plans or specifications - there is no relied to the contractor (or his surety).

Without telling tales out of school - and I haven’t been in school for a looonng time - suffice it to say that contractors generally know which mistakes end with smiles and which ones end with frowns. The author’s subjective experience has been that most owners most of the time simply accept a two or three sentence letter from a bidder as to the claimed error and let matters go from there and return the bond security. While such behavior probably has a salutary effect on long term construction prices by keeping them lower (so as to not include monies in bids for possible non-compensable mistakes), it might be that if the Owner looked into the matter in greater depth, the mistake might actually be one which would be compensable under the bid bond.

Ultimately, all bid bonds should be returned to the bidders, successful and not. For the successful bidder, the payment and performance bonds and executed contract fulfill the condition of the bid bond. For the unsuccessful bidder, the condition of the bid bond is never triggered in the first instance. Once the lowest responsible and eligible bidder has entered into the final contract the bid bond secured, the bid bond like the butterfly’s empty and lonely cocoon has outlived its usefulness!

One final note on bid bonds. On filed subbids under C. 149, s. 44F the obligee of the bid bond is the public owner. Since the public owner is the named obligee, only the public owner has the right to make a claim on this bid bond.

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This article is not intended to be specific legal advice and should not be taken as such. Rather, it is intended for general educational purposes only. Questions of your rights and obligations under the law are best addressed to legal professionals.

Sauer & Associates sees as part of its mission the providing information and education to the contractors it daily serves, which will hopefully assist them in the conduct of their business. Articles are available on a number of construction subjects (e.g. rights under payment bonds, how to present payment bond claims, the mechanics’ lien law, how to file a demand for direct payment) on this website.

Copyright Jonathan Sauer 1999