Dealing with Surety Companies on Construction Contracts

(This document should be read in conjunction with Real Property Contracting (RPC) Best Practice Statement - "A Primer on Surety Bonds in Federal Construction Contracts"This link is available only to clients with access to Publiservice, the Government of Canada extranet.

There is a need for project managers to follow standard guidelines to ensure that the obligations of the Surety are exercised in those rare instances where Public Services and Procurement Canada (PSPC) declares the construction contractor to be in default of their contract, or bidding issues arise, or subcontractor claims are received.

Surety bonds furnished by the contractor provide protection to PSPC as Obligee and to the claimants in cases of default by contractors starting from the tendering process, through contract default, to payments of subcontractor claims. Construction contracts generally require default protection in the event that a contractor does not perform according to the contract. PSPC pays for this protection, as this cost is built into the contractor's bid. Surety companies that are members of the Surety Association of Canada usually provide this protection in the form of performance bonds and labour & material payment bonds, signed jointly by the principal (contractor) and the bonding company (Surety), referencing the contract between the Obligee (PWGSC/PSPC) and the contractor. Traditionally, bonds are issued in the amount of fifty percent (50%) each for performance and labour & material payment. There are four types of bonds presently utilized by PSPC, as follows:

  • Bid Bond (Format as prescribed by Treasury Board)
    The bid bond is provided by the Surety through the contractor to guarantee the sincerity of a contractor to enter a contract at its bid price. The provision of a bid bond does not, by itself, guarantee the performance of the contract by the contractor. It may be used to cover losses to PSPC for those cases where a contractor is the low bidder and withdraws its tender or refuses to provide contract security.
  • Performance Bond (Format as prescribed by Treasury Board)
    This bond is a bond given by the Surety to the contractor as the Principal naming PSPC as the Obligee to guarantee the performance (completion) of a contract in accordance with its terms and conditions.
  • Labour & Material Payment Bond (Format as prescribed by Treasury Board) This bond is given by the Surety to the contractor as the Principal naming PSPC as the Obligee and guarantees payment for labour furnished or materials supplied in connection with a contract awarded to that contractor. It provides protection to claimants as defined in the bond, typically subcontractors/suppliers/sub-sub-contractors who have not received payment for labour and material utilized in the execution of the contract. The notice of such claims must be received by the Surety and the contractor within ninety (90) days from the date the payment was due and may be in amounts up to the value of the bond.
  • Claimant's Payment Bond (Format as prescribed by Treasury Board) This bond is given by the Surety to the contractor and is used mainly as an alternative to withholding "earned but unpaid" monies from contractor's progress claim for those cases where PSPC has received notices of claims from claimants. A claimant's payment bond protects registered claimants by ensuring that funds are available to them in the event the contractor refuses or is unable to pay. Normally this form of bond is not required when a labour and material payment bond has been provided by the contractor.

Ensuring Surety Obligations are Exercised

In cases of default by a contractor, project managers must work in conjunction with RPC, Legal Services and the Surety to complete the project. Timing for the involvement of parties is at the discretion of the project manager but should begin if non-performance/ non-payment continues following an initial request for remedial action (warning letters, e-mails, facsimiles, etc.). Other factors to be considered are health and safety, economic and environmental consequences etc. of the non performance/non payment. In order to ensure that the Surety obligations are not compromised, PSPC must exercise the following obligations through the project manager:

  • obtain a copy of the bonds from RPC following the award of the construction contract to become aware of their content and bonding company contact information (name, address, phone numbers etc.) for communication purposes in the event of a default.
  • ensure that the labour & material payment bond is posted on the site by the contractor to conform with the General Conditions of the contract.
  • not provide approval to contractor requests for extensions of time, without the contractor providing written consent of the bonding company whose bond forms part of the contract security (as per GC 6.5 Delays and Extension of Time).
  • complete the Surety evaluation forms as requested by the Surety to alert them of potential problems so as to be part of the resolution process.
  • deal directly with the contractor to resolve non-performance/non-payment issues through use of letters of reprimand, holdbacks, mediation etc. (with copies to the supervisor to ensure his/her ongoing involvement).
  • provide Surety with copies of correspondence sent to the contractor re: outstanding issues (it is recommended that this action should commence the second time the contractor is notified to resolve the same issue).
  • direct the Surety to resolve difficult cases where PSPC negotiations have failed, or where claims arise involving project delays and/or delays in responding to warranty issues.
  • advise claimants that any legal action must take place within the two-year limitation period as stipulated within the standard performance bond.
  • use the Claimant's Payment Bond as applicable, when PSPC has received notices of claims under GC 5.13 from a claimant(s) as defined and intends to pay the claim(s) directly to the claimant(s).
  • use the Limited Indemnity Agreement as applicable, where a contractor has been declared in default of its contract, and the Surety has requested in writing that PSPC turn over to it the unpaid contract monies (does not include the contractual holdback) earned by the defaulting contractor up to the time of default. Use format as prescribed by RPC.

Guidelines for the Use of Bonds

Bid Bonds

The maximum liability of the Surety for a bid bond is $250,000, as stipulated in the General Instructions to Tenderers. Project managers should never waive the requirement for the provision of a performance bond by the successful tenderer simply because it has demonstrated financial and technical qualifications by its ability to obtain a bid bond.

When to forfeit a Bid Bond:

  • If the contractor fails to enter into a formal contract and provide the specified contract security, the amount of the bid bond may be forfeited up to the upset limit.
  • The amount assessed will be the lesser of the difference between the contractor's bid and the price for which the owner legally contracts with another to perform the work, or the stipulated amount of the bid bond.

When to not forfeit a Bid Bond:

  • When a tenderer advises that a demonstrable, genuine and substantial error has been made in its tender, the contracting authority will normally allow a withdrawal of the bid without penalty.
  • A substantial error is considered to be any error in excess of 10% of the tendered amount or $100,000 whichever is the lesser.

Performance bonds

Project managers should advise the Surety of all major changes in the scope of the work during the course of the contract and take the following actions as applicable.

Preliminary Actions:

  • provide the Surety with copies of the correspondence to the contractor alerting them to possible future problems and setting out the particulars of the dispute/problem.
  • direct the Surety to organize and attend a meeting or teleconference with appropriate representatives of PSPC, the Surety, and the contractor.
  • ensure the consultant is informed of any issues related to a counter-performance (either real or perceived) on the part of the contractor.
  • ensure that a 'Memorandum of Agreement' is signed by the three parties when agreements are reached.
    Note: the Surety may undertake its own investigation into the cause of the dispute/problem.

Declaration of Default or Six-day Notice:

  • sign and forward the six (6) day notice to the contractor with a copy to the Surety advising them of PSPC's intentions with respect to resolution of the default.
  • direct the Surety to fully investigate the situation and respond promptly.
  • determine the status of work completed up to that point in time when the work is taken out of the contractor's hands.
    Note: This is needed in order to determine the value of work satisfactorily completed by the contractor.

Remedial Action by PSPC to Preserve and Protect the Work:

  • ensure that PSPC takes remedial action to protect the bonded work and mitigate the damages, within the scope of the contract.
    Note: be aware that the Surety is responsible for costs associated with remedial actions.

Directing the Surety to complete the work:

  • direct the Surety to instruct the contractor to correct the default if the work is not taken out of the Contractor's hands.
  • direct the Surety to complete the work upon removal of the work from the contractor's hands.
    Note: occasionally, other options may be used, such as contract termination, etc. A termination does not involve a default by the contractor and does not involve the Surety.
  • approve the use of the contractor proposed by the Surety to complete the work and continue to administer the contract as if the Surety had simply replaced the original contractor.
    Note: PSPC will pay the unearned and unpaid contract balances to the Surety according to the payment terms.
  • ensure that performance bond monies are not used to offset payments under the labour & material payment bond.
    Note: subcontractor non-payment claims must be directed against the labour & material payment bond).
  • ensure the use of the Limited Indemnity Agreement as applicable, where a contractor has been declared in default of its contract, and upon written request from the Surety, PSPC intends to make payment to the Surety of the unpaid contract monies earned by the defaulting contractor up to the time of default.
  • advise the Surety that it must inform PSPC via a 'Notice of Withdrawal', if it becomes apparent during the completion of the work, that those costs will exceed the penal limit of the bond (in excess of the remaining contract balance combined with the amount of the bond); PSPC shall incur those costs.
  • hold the Surety liable for all excess costs, which would not have been incurred but for the default of the contractor, (including all PSPC's additional indirect costs for completion of the contract).
    Note: the Surety is not responsible for costs in excess of the amount of the bond.

Limitation period:

  • initiate any suit or action against the Surety within the two (2) year limitation period (from the date on which final payment under the contract is payable).

Liability not accepted by the Surety:

  • obtain from the Surety, in cases where the Surety denies liability, written notification stating its position and the reasons for that position.
  • take legal action through the courts as a last recourse.
  • consult with your supervisor, RPC and Legal Services in order to develop an implementation strategy to complete the project (i.e. cancel project, acquire new funding, call new tenders to complete the work, etc.).
    Note: General Conditions of the original contract also apply to the contract with the Surety.

It has been agreed that any earned but unpaid monies owed to the defaulting contractor will be released to the Surety upon receipt of a written request and a fully executed Limited Indemnification Agreement. The earned but unpaid referred to herein do not include the contractual holdback (5%) stipulated in the Terms of Payment. That is retained until the issuance of the Interim Certificate of Completion. It is also agreed that if there are lawful claims against these earned but unpaid monies in excess of the amount released to the Surety, it has the option of returning the amount to PSPC who will then be responsible for its distribution as may be directed by the courts, etc.

Labour and material payment bonds

Project managers have three primary roles in the resolution of non-payment issues: direct the contractor to resolve the issue, direct the Surety to resolve the issue in cases where the contractor fails to do so and direct the claimants to register their claims with the Surety.

Standard course of action:

  • ensure the contractor posts the labour & material payment bond on the job site
  • advise the contractor and the Surety of any alleged creditors.
  • advise subcontractors and suppliers of the existence of a labour & material payment bond and assist in expediting those claims that are covered under the provisions of the bond within the limitation period set out therein.
  • instruct claimants to register their claims with the Surety.
  • direct the Surety to investigate, litigate or otherwise satisfactorily resolve subcontractors' and suppliers' nonpayment claims in accordance with the bond within the limitation period.
  • direct the Surety to provide periodic status/changes updates.
    Note: the Surety is not liable for a sum greater than the amount of the bond.

Limitation period:

  • advise claimants who intend to take legal action that they must formally notify the Principal and the Surety within:
    • holdback monies: one hundred and twenty (120) days after the date that payment should have been paid in full.
    • monies other than holdback: one hundred and twenty (120) days after the date that the last of the services was completed/material supplied.
    Note: once their formal notice is provided, no suit or action may be commenced by any claimant after the expiration of one (1) year following the date that work ceased on the contract. The Surety is bound to pay all lawful claims where the general contractor refuses or is unable to make payments to subcontractors/suppliers/sub subcontractors (where applicable). In the very unlikely case where the Surety fails to resolve such claims, PSPC has the right to sue the Surety, however it would normally be the claimant who sues the Surety directly.

Claimant's Payment Bonds

Although used rarely, project managers should be aware that these bonds provide an alternative in the resolution of non-payment issues.

Claimant's Payment Bonds can be utilized:

  • when PSPC has received subcontractor/supplier claims, and intends to withhold monies from the contractor's progress payment for the purpose of resolving claims.
  • to ensure that funds are available to claimants in the event the contractor refuses or is unable to pay.

Advantages of Claimant Payment Bonds:

  • allows for prompt payment to claimants where disputes/defaults have occurred between PSPC and the contractor, and/or the work has been taken out of the contractor's hands.
  • provides an alternative to withholding “earned but unpaid” monies from the contractor's progress claims.
  • Permits the contractual authority to withhold payment as described in GC5 of the Standard Construction Contract.

Sample Claiment's Payment Bond

No.__

Bond Posted as Security Pursuant to the Contract Documents.

KNOW ALL PERSONS BY THESE PRESENTS, That __ as Principal, hereinafter called the Principal, and __ as Surety, hereinafter called the Surety, are, subject to the conditions hereinafter contained, held and firmly bound unto __ as Obligee, hereinafter called the Crown, in the amount of __ Dollars ($__), lawful money of Canada, for the payment of which sum, well and truly to be made, the Principal and the Surety bind themselves, their heirs, executors, administrators, successors and assigns, jointly and severally, or, where this bond is subject to the law of the Province of Quebec, as solidary debtors, and firmly by these presents.

SIGNED AND SEALED this __ day of __ 20 __

WHEREAS, the principal has entered into a Contract with the Crown, dated the __ day of __ 20 __ for __

AND WHEREAS, the Crown has notified the Principal in writing of its intention to withhold contract funds, pursuant to Clause GC5 of the Contract for the following claim(s) registered against the Contract:

Date of Notification
Claimant Amount

NOW, THEREFORE, THE CONDITION OF THIS OBLIGATION is such that this Bond stands in lieu of and as security for the release to the Principal of funds which otherwise would have been withheld by the Crown, by reason of Clause GC5 of the Contract on account of the aforementioned claim(s).

To the intent and condition that if the Principal shall pay or cause to be paid the said claim(s) as the Principal may be directed by the Crown to pay, which claim(s) otherwise the Crown would have been entitled to pay by reason of Clause GC5 of the Contract, then this obligation shall be void, otherwise it shall remain in full force and effect.

The Crown may sue on this Bond, have the right to prosecute the suit to final judgment for such sum or sums as may be due and have execution thereon; and such right of the Crown is assigned by virtue of Part VIII of the Financial Administration Act to each such aforementioned claimant.

Provided that, no suit or action shall be instituted by the Crown or its assignees herein against the Surety, unless the claimant(s) shall have commenced the proceedings to determine the right to payment pursuant to Clause GC5 of the Contract within one year from the date of notification.

Provided further that:

  1. the amount of this Bond shall be reduced by and to the extent of any payment or payments made in good faith hereunder;
  2. the Surety shall not be liable for a greater sum than the total amount specified in this Bond

IN WITNESS WHEREOF these presents have been executed by the Principal under its hands and seal and by the Surety by its seal and by the signature of its Attorney this __ day of __ 20__.

SIGNED, SEALED AND DELIVERED in the presence of:

Principal

Witness

Surety

Note: Affix Corporate seal if applicable