Who’s Responsible for the Protection of the Construction Site and Materials During the Surety’s Investigation into a Contractor’s Default? The Owner or the Surety?

Read the bond. Read the bond again. And once again, for good measure.  

But sometimes the performance bond alone does not give all the answers, particularly in the context of a contentious project default.

Picture an all-too familiar scenario: The Owner terminates the Contractor/Principal and ejects the Contractor from the Project site.  The properly notified Surety sets about gathering documentation, evaluating the state of the Project, and otherwise investigating before electing among the performance options afforded by the Bond.

But while the experienced Surety has acted under a full reservation of rights and begun its investigation promptly, the worksite is meanwhile left deserted. Construction has halted. The Owner clamors for performance from the Surety.  Subs have retrieved their tools and materials, but – – for the strength of our hypothetical – – let’s suppose some quantity of steel siding was not fully incorporated into the Project before termination. The siding now lies exposed to the elements, rusting.

Which entity bears responsibility for protecting Project site conditions, including proper care of stored and installed materials, during the pendency of the Surety’s investigation?  The Surety? The Owner? Surely not the terminated contractor?

The Bond itself may have little to say about the Surety’s rights and obligations during the investigation.  Generally, performance bonds only demand that the Surety make its performance election “with reasonable promptness.”  Courts, not common bond forms, have confirmed the Surety’s “right” to an investigation.  In recognition of the tripartite nature of suretyship, courts have deemed it commercially reasonable to allow the Surety time to investigate the circumstances surrounding a default and/or termination of a contractor before selecting from among the Bond’s performance options (e.g., takeover, tender, selection of a completion contractor).[1]

Meanwhile, the Construction Contract and/or General Conditions usually places the burden of securing the site and materials on the Contractor, the Surety’s principal – – at least from issuance of the notice to proceed through the date of final acceptance.  Arguably, this duty does not magically devolve to the Surety in the case of termination.  Unless the Surety affirmatively elects to assume the Contractor’s obligations under the Construction Contract through takeover, the Surety does not become liable for all of the Contractor’s duties under the general Construction Contract.  To require the Surety to shoulder its principal’s obligations during the investigation would defeat the investigation’s purpose: namely, to allow the Surety a window of time to evaluate whether it will choose takeover or some other performance option.

Case law from across the country does not seem to address the Surety’s obligations for site protection during the Surety investigation.  A leading treatise offers mixed guidance: “During its investigation, the surety may either attempt to secure the site, based upon an express and full reservation of rights, or it may require the owner/obligee to secure the site as part of its obligation to minimize or mitigate damages.”[2]  This advice is cryptic in that does not indicate whether the Surety must secure the site if it reserves rights, nor does it discuss the scope of the Owner’s duty to mitigate.

Most jurisdictions recognize at least an implied duty to mitigate damages.  The theory is that a party receiving a contractual benefit cannot stand idle, let its damages accrue, and then subsequently demand to be made whole.  “A surety’s liability under a performance bond may be wholly or partially discharged by an obligee’s failure to mitigate its damages. An obligee may not allow bonded contract work to knowingly deteriorate . . . thereby knowingly increasing the surety’s exposure, and yet seek to be made whole by the bond.”[3]  The mitigation principle of contract law suggests that the Owner has at least some responsibility to maintain the Project site until the Surety chooses among performance options under the Bond.  Indeed, a local Owner may be in a much better position to provide for security and care and storage of materials than the Surety – – which may be operating remotely and conducting its investigation via hired consultants.  But the extent of the Owner’s duty to mitigate – – that is a question for local counsel.

At the end of the day, practicality suggests the investigating Surety should communicate proactively with both Contractor-Principal and Owner-Obligee.  Ideally, the investigating Surety should state, in writing, whether or not the Surety will undertake any duties with respect to maintaining the Project site and stored/installed materials while investigating the merits of the default.  It may be advisable for the Surety to clearly indicate that the Surety (1) will not protect the site during the pendency of its investigation, (2) expects the Owner to protect the site and site materials during the investigation, and (3) will reimburse the Owner for the reasonable costs of protecting the site and the on-site materials if the Surety deems the termination proper.  This course may help forestall any unwanted claims that the Surety should have protected the site, while simultaneously guarding against the Owner’s possible argument that the Surety “took over” the Project by affirmatively securing the site and site materials.

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[1]     See Bd. Of Dirs. v. United Pac. Ins. Co., 884 P.2d 1134, 1136-38 (Haw. 1994); see also Farmer’s Union Cent. Exchange, Inc. v. Reliance Ins. Co., 67 F. Supp. 1534, 1542 (D.N.D. 1987) (recognizing that sureties have been credited a reasonable amount of time for investigating and selecting from performance options).

[2]     Marchelle M. Houston, Joseph Monaghan, and Armen Shahinian, Bond, Contractual, and Statutory Provisions and the General Agreement of Indemnity, in Bond Default Manual, 3d. ed., 17 (Duncan L. Clore, Richard E. Towle, Michael J. Sugar, eds. 2005).

[3]     Practical Gide to Construction Contract Surety Claims, 2d ed., § 8.07[H], 272 (W. Schwarzkopf, ed. 2006).