SURETY'S PERFORMANCE BOND OPTIONS

1. INTRODUCTION
2. INVESTIGATION
3. FINANCING THE PRINCIPAL
   1. Advantages
   2. Disadvantages
   3. Documenting the Financing Arrangement
4. THE TAKEOVER OPTION
   1. Advantages
   2. Disadvantages
   3. Negotiating and Documenting the Takeover
5. THE TENDER OPTION
   1. Advantages
   2. Disadvantages
   3. The Tender Agreement
6. COMPLETION BY THE OBLIGEE
   1. Advantages
   2. Disadvantages
   3. Documentation Requirements

Abstract

The purpose of this paper is to familiarize the reader with the traditional options considered to be available to a performance bond surety upon default of its principal. As such, this paper does not address the plethora of considerations in determining whether an obligee's declaration of default is proper, nor does it address the potential defenses available to the surety in defending a claim against its performance bond. Thus, this presentation describes the four traditional options available to a surety, provides a discussion of the advantages and disadvantages of each option, and outlines the documentation required in connection with implementation of any option. Nonetheless, it cannot be over-emphasized that an evaluation of the propriety of the declaration of a default, as well as an assessment of the prior conduct of the parties to the bonded contract and construction process, are essential to formulation of the lawyer's recommendations.

Therefore, with a properly declared default in place and very little defense potential, the surety's overall goal is to fulfill its obligation under the bond, while simultaneously minimizing the attendant loss and expense. Traditionally, the surety will select, on a project-per-project basis if possible, one of four options:

A. Provide assistance to the principal to assure the principal's completion of the projects. This practice is typically referred to as the "financing option" and may take different forms, i.e. providing funds to the principal for payroll, trade payables and other project expenses or by guaranteeing a bank loan for that purpose.

B. The surety undertakes to complete the bonded contract. This practice is typically referred to as the "takeover option" with the crucial distinction being an agreement between the surety and obligee providing for the surety's completion of the bonded contract.

C. In certain instances, the surety may fulfill its obligation to the obligee by making a replacement contractor available and offering to pay any difference between the replacement contract amount and the remaining bonded contract balance. This alternative, referred to as the "tender option" contemplates the execution of a new contract between the obligee and replacement contractor. Thus, the surety is not involved with completion of the bonded contract, excepting the associated cost.

D. The surety may elect not to participate in completion of the bonded contract nor arrange for a replacement contractor. This option, calling for completion of the bonded contract by the obligee, may involve a cash settlement between surety and obligee, a refusal of the surety to perform (often called the "do nothing option") based upon available defenses, or, in rare instances, the obligee may be able to and/or elect to complete the bonded contract with remaining funds.

Essentially, selection of one of the above options is a business decision requiring an understanding of the status of the bonded contract, the principal's affairs and capabilities, the legal choices available to the surety, and an assessment of the risk of loss to the surety in connection with each option.

Full Text

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