ConsensusDocs 200, the Standard Agreement and General Conditions Between Owner and Constructor, in Article 11 gives the owner the right to first give notice to cure a default and, if the default is not cured, to terminate for default. Article 10 gives the owner the option to require a performance bond with a penal sum equal to 100% of the contract price. If the parties are using CD 200 and the owner requires a performance bond, the bond will likely be the ConsensusDocs 260 Performance Bond. This article will discuss the interplay between CD 200’s default provisions and the requirements of the CD 260 performance bond–an interplay to which both owners and contractors should pay special heed.
First, from the owner’s perspective. Any owner that elects to require and pay for a performance bond should in any potential default situation look first to the notice requirements of the bond. CD 260 imposes four conditions that must be met to initiate an action on the bond. First, the owner must have performed its obligations pursuant to the contract. Second, upon making demand on the bond, the owner shall make any unpaid contract balance available to the surety for completion of the work. Third, the contractor must be in default pursuant to the contract. Fourth, the owner must declare the contractor to be in default. If an owner fails to follow these steps carefully, a surety may raise the defense of failure of condition precedent. At the same time, the owner must comply with the requirements of CD 200 Article 11 or it cannot meet the first condition to invoking the bond.
CD 200 Article 11 appears to require an owner to give the contractor notice two times before it can declare the contractor to be in default. I say "appears" because CD 200 does not specifically provide for a declaration of default. In ¶ 11.2, it states that a contractor who has failed to perform as described may be deemed in default. Subparagraph 11.2.1 requires an owner who deems the contractor to be in default to give the contractor written notice and allow the contractor seven days to cure the default. If the default is not cured, the owner must give a second notice allowing a further three days to cure. This second notice is to be given to the contractor and, if applicable, to the surety and may include that the owner intends to terminate for default absent appropriate corrective action. There is no provision for a simple declaration of default.
This disconnect in terminology is probably not significant. It would negate the purpose of ¶ 11.2.1’s notice provisions if the owner were able to declare default and invoke the performance bond while the contractor still had an opportunity to cure. For the same reason, the requirement to provide the surety with a copy of the second, three-day cure notice should be read as a supplemental notice requirement, not a declaration of default or an invocation of the bond. The crucial point for the owner comes at the close of the second cure period.
If the contractor fails to cure the default by the end of the second notice period, the owner may terminate the contract for default, but it is not obligated to do so. In fact, to do so would be self-defeating. Instead, it is at this point, having met its obligations under ¶ 11.2.1, that the owner should switch its attention from CD 200 to CD 260 and carefully follow steps two through four described above. If the contractor is truly in default, this should allow the owner to make a successful claim on its performance bond.
But what if the contractor is not in default? Certainly, not every contractor who receives a notice to cure will agree that it is in default. The contractor may feel that whatever problems the project is experiencing arise from the owner’s failure to recognize legitimate changes or other impediments entitling the contractor to additional time and money. In such a situation the contractor’s first reaction will probably be to dispute the declaration of default. This is entirely appropriate, but the contractor must remember to include the surety in its response. A truly savvy contractor will talk to its surety before it makes any response to an Article 11 cure notice. Why? Because ultimately the surety can do far more damage to the contractor than the owner.
To obtain a performance bond, most contractors must sign a general agreement of indemnity to indemnify the surety against any losses the surety incurs on the bond. Typically, these indemnity agreements give the surety wide discretion to deal with an owner declaration of default and give the contractor very little recourse to challenge the surety’s actions. For example, a contractor may be required to indemnify a surety for curing a default even if it is later determined that the contractor was not in default.
Because the surety has the ability to spend the contractor’s money without recourse, it is extremely important in any default situation for the contractor to provide the surety relevant information from the outset. A good way to start this process is to contact the surety’s claims handling representative and involve the surety’s representative in drafting the contractor’s response to the owner’s cure notice. The more information the contractor can provide the surety supporting its position, the better. Once the contractor has provided the surety relevant information, the provisions of both CD 200 Article 11 and CD 260 provide many potential defenses, as do Articles 4 and 8 of CD 200. In summary, for both owners and contractors the key to successfully dealing with a default situation is to be thoroughly familiar with the relevant contract documents and, even more importantly, to understand how the various parts of the contract, bond, and general indemnity agreement interact.
This article is by Charles W. Surasky, Senior Counsel at the Atlanta, GA office of the law firm of Smith, Currie & Hancock LLP. Surasky focuses his practice on cost-effective resolution of complex construction disputes. He has more than 38 years of experience in the trial and arbitration of both private and government construction contracts, along with extensive experience with mediation and other forms of alternative dispute resolution. He began working in the construction industry in 1969 as a millwright helper for Daniel International Construction Company. Smith, Currie & Hancock LLP is a national law firm that provides legal advice and strategic counsel to the construction industry and government contractors. Smith Currie publishes a newsletter for the industry, “Common Sense Contract Law,” which is available on its website, www.SmithCurrie.com. A version of this article was previously published in the "ConsensusDocs Construction Law Newsletter."
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