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Legal Notes: Examining the bounds of performance bonds

John Bleasby
Legal Notes: Examining the bounds of performance bonds

Surety bonds are an important part of almost every large construction project, helping owners complete projects according to the agreed contract terms should a contractor default.

As Gina Lockwood of Merchants Bonding Company explains, “Partnering with a surety with a common sense approach to bonding and claims resolution is the most cost effective and efficient way to mitigate the risks of your construction contract.”

However, questions have arisen regarding the limits of surety obligations.

Michael Swartz and Brian Kuchar of WeirFoulds LLP explain when it comes to the surety providing funds required to pay for the “costs of completion,” the surety and owner typically consult while soliciting bids to determine “the lowest responsible” bidder. 

However, the question Swartz and Kuchar ask is: What do the “costs of completion” include? Are these costs limited to just the cost of labour and material?

They point out that two court cases dating from more than 15 years ago have, until recently, left the matter unsettled.

A 2003 Ontario Court of Appeal decision involved contract terms requiring a split of any savings gained over the course of a condominium project — 75 per cent to the owner (Landmark) and 25 per cent to the contractor (Mollenhauer). When Mollenhauer ceased business, Landmark completed the work. They then made a claim against the performance bond not only for the construction costs but for the $600,000 savings they achieved. The surety refused, saying its obligations did not extend to any “collateral obligations.”

However, the Ontario Court of Appeal sided with Landmark, writing in part, “There is no basis in the language of the bond or in the circumstances surrounding its negotiation or completion to suggest that the cost-sharing provisions of the construction contract are not included as bonded losses.”

Contrast that ruling with a 2004 case in Saskatchewan. Once again, contract terms included “collateral monetary obligations” of $1,000 per day related to “liquidated damages for late completion of the contract.”

Swartz and Kuchar summarize the Saskatchewan Court of Appeal’s decision as follows.

“Where a surety is found liable for failing to respond to a performance bond claim, liability flows from the surety’s failure to respond to the bond claim as a whole; not a failure to adopt one option for completion over another…The court concluded that the surety’s obligation under the performance bond is to ‘complete the work’ rather than ‘perform all obligations under the contract.’”

The contradictory nature of these two rulings has left the limits of a surety’s obligation beyond the physical completion of work somewhat uncertain. That is until two recent Alberta disputes, in 2013 and 2017 respectively. Here, the courts favoured the whole contract obligation concept from the Landmark condominium case of 2003.  

The first case involving costs related to scheduled completion time. Justice Robert Graesser wrote, “I fail to see how a surety can arrange for completion of the contract in accordance with its terms and conditions unless it is responsible for any acceleration costs to meet the original schedule, and any delay damages the owner is entitled to if the schedule is not met. Otherwise, that would mean in cases where it is not possible, even by herculean acceleration efforts, to complete the work on schedule after the principal’s default, the blameless owner would be unable to deduct its legitimate delay damages from the amount otherwise owed to the defaulting principal.”

The second case also concerned delays, this time involving remedial work resulting in forgone rental income.

“Justice Nielsen noted that payment of lost income resulting from the correction of deficiencies was a contractual obligation of the contractor and was therefore part of the cost of completing the contract,” write Swartz and Kuchar.

Given the challenges of today’s construction environment, Swartz and Kuchar advise that owners and contractors become intimately familiar with their contractual obligations and notice requirements. Furthermore, they write that, “case law suggests that owners in Ontario have a reasonable prospect of collecting more than just their bricks-and-mortar costs from their sureties.”

John Bleasby is a Coldwater, Ont.-based freelance writer. Send comments and Legal Notes column ideas to editor@dailycommercialnews.com.

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