Chapter 4 Bonds

• Library: Arkansas Construction Law Manual (2016 Ed.)

Bonds

David A. Grace^* © 2016

4.1 Scope of Chapter.......................................... 4-1

4.2 What is a Surety Bond?................................ 4-2

4.3 Distinction Between Payment Bonds and Performance Bonds 4-3

4.4 Construction Surety Bonds Required or Authorized by Arkansas Law 4-5

4.5 Payment Bond Claim Liability..................... 4-11

4.6 Performance Bond Claim Liability............... 4-22

4.7 Attorney’s Fees........................................... 4-31

4.8 Unfair Claims Settlement Practices and Bad Faith 4-33

4.9 Equitable Subrogation................................ 4-35

4.10 Exoneration and Indemnification............... 4-38

4.11 Conclusion................................................ 4-43

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4.1 Scope of Chapter

This chapter reviews Arkansas law regarding payment bond and performance bond liability and the indemnification and subrogation rights of a construction bond surety. Excluded from the review are lien bonds,¹ bid bonds,² and licensing bonds,³ as well as payment bond and performance bond liability under federal law and the law of other states.⁴

4.2 What is a Surety Bond?

To understand what a surety bond is, you should know what it is not. Despite the tendency of courts to refer to them otherwise, and even though many of them are executed and delivered by insurance companies, they are not insurance.⁵ Although sureties and guarantors share some analogous rights, liabilities, and defenses, and although a guarantor may be a surety, a surety bond is not a guaranty.⁶ The fact that a surety makes a promise to one to whom another is answerable distinguishes the surety bond from an indemnity contract, in which the indemnitor promises to save another from loss upon some obligation which the indemnitee has incurred.⁷

A suretyship is a contractual relation whereby the surety promises that it will do the thing which the principal has undertaken.⁸ As will be discussed infra, a surety’s undertaking is defined by statutory constraints, the terms of the principal’s contract, and the terms and conditions included in the surety’s bond.⁹

4.3 Distinction Between Payment Bonds and Performance Bonds

A construction bond surety undertakes two obligations of its principal, the performance of the work described in the principal’s contract with the obligee and the payment for labor and materials incident to the construction. Performance obligations due under a performance bond are commonly owed solely to the obligee, while payment bonds are intended to ensure that laborers and material suppliers will be paid in the event of a default.¹⁰

Arkansas courts also draw a distinction between “statutory” bonds and “common law” bonds for purposes of determining, inter alia, the applicable statute of limitations.¹¹

A statutory bond is a payment bond required by statute.¹² A common law bond is any other kind of construction bond, including a performance bond and a combined performance and payment bond.¹³

4.4 Construction Surety Bonds Required or Authorized by Arkansas Law

Laborer’s, mechanic’s, and materialmen’s liens cannot be filed or enforced against a public improvement.¹⁴ According to the Arkansas Supreme Court, payment bonds required by Arkansas statutes are intended as substitutes for lien rights,¹⁵ although this is not expressly stated in the statutes themselves.

All contracts exceeding $20,000.00 for the repair, alteration or erection of any public improvement must be secured “by a bond in a sum equal to the amount of the contract.”¹⁶ The bond must be in full compliance with other statutes related to bond requirements for the repair, alteration, or erection of public improvements.¹⁷ This requirement effectively incorporates section 22-9-401 of the Arkansas Code by reference into every construction bond for public improvements.¹⁸ In addition, section 18-44-506 of the Arkansas Code requires that the bond be conditioned that the contractor shall faithfully perform his or her contract.¹⁹

It is not always clear whether a project involves the construction of a public improvement. A bond is not required by statute when a public housing project is constructed before it is conveyed to a public housing authority.²⁰ On the other hand, the Arkansas Supreme Court held that construction of improvements with the proceeds of a public bond issue on land owned by a non-profit corporation and subsequently conveyed to the City of Texarkana was required to be secured by a “statutory bond.”²¹

“Before any work is performed under the contract, the bond shall be filed with the Clerk of the Circuit Court of the county in which the repairs, alteration or erection of any building, structure or improvements are made.”²² Failure to file the bond will not affect its “statutory” character.²³

There are no consequences to the public entity (or its officers, directors or employees) if it fails or refuses to obtain the bond required by section 18-44-503 of the Arkansas Code,²⁴ nor can the contractor be held liable for fraud or negligence for failing to comply with the statute.²⁵ It is the duty of the supplier or subcontractor to determine whether the statutorily required bond has been filed and, if not filed, whether the bond has been executed and delivered.²⁶ The failure of the public entity to require the bond does not deprive a potential claimant against the bond of any right or privilege secured by the United States Constitution or federal law.²⁷ When an improvement constructed on public property leased to a private entity is not secured by the “statutory” bond, the leasehold, but not the publicly owned fee, may be encumbered by a mechanic’s, materialmen’s or laborer’s lien.²⁸

As noted, sections 18-44-501, et seq., of the Arkansas Code do not pertain to construction contracts with the Arkansas State Highway and Transportation Department.²⁹ For such contracts in excess of $1,000.00 there is a requirement for “a bond to be approved by a majority of the [highway] commission in an amount at least equal to the amount of the contract, conditioned as the commission may require,” which bond “shall also be liable for material, labor, supplies and expenses used in or incidental to the work, including that which may become due to subcontractors.” (emphasis supplied)³⁰ Among the “conditions” required is that there shall be a performance bond in a sum equal to the full amount of the contract and a payment bond in a sum equal to 80% of the full amount of the contract and that “the form of the bonds and the surety shall be acceptable to the department.”³¹ The performance bond form currently approved for use by the Arkansas Highway & Transportation Department expressly requires that the surety reimburse its obligee for overpayments to the principal and to indemnify the obligee against any loss or damage arising or occasioned by “deeds of negligence” of the principal.³²

A contract in excess of $1,000.00 to repair, alter or erect an improvement for a church, religious organization, charitable institution, or any agency thereof must be secured by a payment bond equal to the amount of the contract.³³ The bond must be filed in the office of the circuit clerk where the property is situated,³⁴ and the failure to file the bond will permit any person providing labor or furnishing material, except the principal contractor, to file a lien for the unpaid amount of the claim.³⁵

A general contractor may require its subcontractor to provide a payment and performance bond if the subcontractor is the low responsible bidder, the general contractor was required to list the subcontractor in its bid pursuant to section 22-9-204 of the Arkansas Code, and the work value of the subcontractor’s bid exceeds $50,000.00.³⁶ If the subcontractor refuses to produce the bond within five days after the general contractor’s bid is accepted, the subcontractor shall lose the bid and pay the general contractor a 10% penalty or the difference between the subcontractor’s bid and the next lowest responsible bid, whichever is less, plus the cost of recovery of the penalty, including attorney fees.³⁷

A bond for private construction is optional.³⁸ If a bond is executed and delivered, however, it will be construed in light of applicable statutes, including section 18-44-501 of the Arkansas Code, which provides that an “authorized” bond shall itself be in full compliance with all other statutes relating to bond requirements for the repair, alteration or erection of any improvement, public or private, “it being the intention [of the legislature] to provide a uniform bonding procedure in conjunction with such contracts.”³⁹

4.5 Payment Bond Claim Liability

As noted in Section 4.4, the minimum coverage of a payment bond, whether for public or private construction, is defined by section 22-9-401 of the Arkansas Code.⁴⁰ The issues involved in actually enforcing a claim against a payment bond are broader than what is suggested by the simple laundry list of potential claimants contained in the statute.

There is no statutory requirement that a potential claimant give notice of its claim to the surety or anyone else prior to filing suit against the payment bond. There is also no statutory prohibition against requiring notice as a condition to liability under the payment bond, nor has any Arkansas case addressed this issue directly. Many payment bond forms in common use in Arkansas for private construction, and, in some instances, for public works, include notice conditions. In all cases, it is advisable to review the payment bond carefully and comply with all conditions expressed therein, including requirements for notice.⁴¹

A payment bond claimant has a direct right of action against the payment bond surety, and the claimant’s debtor, including the bond principal, is not a necessary party in any action against the payment bond surety.⁴² Venue for a suit by a beneficiary of a payment bond against the payment bond surety is proper in the county in which the “loss occurred” or the county of the...