The A312 Performance Bond is Not a Blank Check.

YOU represent a contractor working on a bonded construction project. It comes to your attention that the owner of the project has written letters over several weeks claiming that your contractor is falling behind, that your contractor (who the surety considers as their "Principal" under the Performance Bond) (1) does not have enough workers at the job, and that the work is substandard. The letters from the owner (who the surety considers as the "Obligee" under the Performance Bond) demand the principal to furnish more workmen, more supervisors, and a new schedule, and speed up the work.

The principal does not accelerate as the obligee demands, and the obligee advises that it will rely on the terms of the bonded contract and hire other contractors to supplement and complete the job. The obligee also alleges a default and terminates the principal. No demand is made upon the surety until approximately two months later, when the obligee has completed the principal's work.

At that time, the obligee simply makes a demand for payment from the surety. What should the surety do? The answer lies in an analysis of the terms of the Performance Bond, the contract which governs the surety's obligations to the obligee. In this case, the Performance Bond is the widely used American Institute of Architects A312 Performance Bond. (2)

1. A Review of the Material Sections of the AIA A312 Performance Bond

   A review of the A312 reveals that the surety's obligations are strictly conditioned, and the surety's rights are stated in detail by the express terms of the Bond. Unlike insurance policies, which are forms drafted and imposed by the insurer, the form of surety bond is typically a requirement imposed by the obligee, often in the very construction contract itself. Obligee's attorneys frequently either don't realize or intentionally try to fudge the fact that the form of the Bond was selected and mandated by their client and that the Bond form is essentially a contract of adhesion upon the surety and accordingly should be strictly construed against the obligee.

   Regarding terms and conditions, the A312 requires the following:

   2. If the Contractor performs the Construction Contract, the Surety and the Contractor shall have no obligation under this Bond, except when applicable to participate in a conference as provided in Section 3.

   3. If there is no Owner Default under the Construction Contract, the Surety's obligation under this Bond shall arise after:

      3.1 The Owner first provides notice to the Contractor and the Surety that the Owner is considering declaring a Contractor Default. Such notice shall indicate whether the Owner is requesting a conference among the Owner, Contractor and Surety to discuss the Contractor's performance. If the Owner does not request a conference, the Surety may, within five (5) business days after receipt of the Owner's notice, request such a conference. If the Surety timely requests a conference, the Owner shall attend. Unless, the Owner agrees otherwise, any conference requested under this Section 3.1 shall be held within ten (10) business days of the Surety's receipt of the Owner's notice. If the Owner, the Contractor and the Surety agree, the Contractor shall be allowed a reasonable time to perform the Construction Contract, but such an agreement shall not waive the Owner's right, if any, subsequently to declare a Contractor Default; and

      3.2 The Owner declares a Contractor Default, terminates the Construction Contract and notifies the Surety.

      3.3 The Owner has agreed to pay the Balance of the Contract Price in accordance with the terms of the Construction Contract to the Surety or to a contractor selected to perform the Construction Contract.

   4. Failure on the part of the Owner to comply with the notice requirement in Section 3.1 shall not constitute a failure to comply with a condition precedent to the Surety's obligations, or release the Surety from its obligations, except to the extent the Surety demonstrates actual prejudice.

   5. When the Owner has satisfied the conditions of Section 3, the Surety shall promptly and at the Surety's expense take one of the following actions:

      5.1 Arrange for the Contractor, with the consent of the Owner, to perform and complete the Construction Contract;

      5.2 Undertake to perform and complete the Construction Contract itself, through its agents or independent contractors;

      5.3 Obtain bids or negotiated proposals from qualified contractors acceptable to the Owner for a contract for performance and completion of the Construction Contract, arrange for a contract to be prepared for execution by the Owner and a contractor selected with the Owner's concurrence, to be secured with performance and payment bonds executed by a qualified surety equivalent to the bonds issued on the Construction Contract, and pay to the Owner the amount of damages as described in Section 7 in excess of the Balance of the Contract Price incurred by the Owner as a result of the Contractor Default; or

      5.4 Waive its right to perform and complete, arrange for completion, or obtain a new contractor and with reasonable promptness under the circumstances;

      5.4.1 After investigation, determine the amount for which it may be liable to the Owner...