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Publications
Killer Bond Forms and Contract Provisions--A Series
Construction Practices Newsletter
This is the seventh in an ongoing series setting forth examples of bond and contract provisions and providing commentary as to their meaning and impact. Unlimited Bond Liability
If Principal breaches the Contract (as determined in Obligee's sole discretion), Surety will, within seven days after written notice of breach, commence to complete the Contract. If, at its option, Obligee elects to complete, using contractors, subcontractors, or materials that Obligee, in its sole discretion, deems necessary, Surety will immediately pay Obligee's invoices without contest, waiving all defenses that either Surety or Principal may have under the Bond or the Contract.
By this provision, the surety must complete if the obligee requires it to complete but cannot insist upon completing if the obligee elects to complete—the worst of both possible scenarios from the surety's perspective. Further, if the obligee completes, the surety waives all defenses, including arguably that it is exonerated by virtue of the default of the obligee. It may also waive the defense of the bond amount cap. However, this provision has never been tested in the courts so it is unknown whether it would have that impact. California has a statutory provision in place, Civil Code section 2856, that allows sureties to waive virtually all rights otherwise granted because of its suretyship. What is interesting is that the waiver language in this provision does not apply if the surety completes. Accordingly, the surety could arguably complete under a reservation of rights and then pursue its excess costs against the obligee if it determines that the obligee was in default. It is unclear why the authors of this provision allowed the surety to assert its defenses and other rights when the surety completes other than in acknowledgment of the fact that the obligee can force the surety to complete. Bond Liability for Subdivision Bonds
In the event of the failure of Developer to complete the work covered by the performance bond and Obligee completes construction of the improvements, Developer and Surety under the performance bond shall be jointly and severally liable to Obligee for such costs of completion, including but not limited to, management and administrative costs, and engineering, legal and other costs incurred relating to the completion. Obligee shall bill Developer and Surety for such costs, which bill shall be paid within thirty (30) days after the billing date. Interest shall accrue on any late payment at the legal rate then prevailing.
Although this provision may seem onerous to sureties, arguably, each element of damages described in the provision would be included within a subdivision bond, i.e., costs of completion, management, administrative, engineering, legal, and other costs incurred in completing the improvements. The payment for such costs in 30 days is unusual but arguably not onerous when compared to the 40 plus 15 days in which a surety is to reject or deny a claim and make payment under California's Fair Claims Settlement Practices Regulations. (10 CCR section 2695.1, et seq.) Moreover, assuming the obligee has put the surety on notice of its intent to complete the improvements, the surety arguably had the opportunity to both complete the improvements itself or inspect what the obligee was doing so that it could pre-evaluate the obligee's costs before it received its bill for reimbursement. Attorney's Fees in Excess of Bond Penalty
Principal and Surety agree that if Obligee is required to engage the services of an attorney in connection with enforcement of this Bond, each shall pay Obligee's costs and reasonable attorney's fees incurred, with or without suit, in addition to the above penal sum.
The law generally provides that a surety's liability is capped at the penal sum, including attorney's fees incurred in enforcing the bond. (See, e.g., Hartford Acc. and Indem. Co. v Ind. Accident Comm., 216 Cal. 40 (1932); Lawrence Tractor Co. v Carlisle Ins. Co., 202 Cal.App.3d 949 (1988) (surety only liable for attorney fees beyond the penal sum of the bond if provided for by statute or if the bond provision regarding attorneys fees specifically obligated the surety to pay attorney fees in excess of the penal sum of the bond).) These provisions to the contrary, making a surety (and in this case, the bond principal) liable for attorney's fees in enforcing the bond in excess of the bond penalty are becoming quite prevalent. The theory is that the bond penalty corresponds with the contract price, which, in turn, theoretically corresponds to the cost to complete. If the attorney's fees that an obligee must expend to recover against a surety can reduce the penal sum, there is less money available for the obligee to complete the project or reimburse itself for the costs of completion. In California, this provision would automatically be mutual in the sense that if the bond principal and/or the surety prevailed in litigation that the obligee brought to enforce the bond, the principal and surety would be entitled to their attorney's fees and costs. (Civ. Code §1717.)
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