Ch. 17 - Bonds

Question 1

Bond

Answer 1

(aka contract of suretyship) a special form of contract, whereby one party, the surety, guarantees the performance by another party, the principal, of certain obligations. Three-party agreements. Interpreted according to rules of contract law. Similar in some ways to insurance policy but NOT insurance; one difference is the surety requires the principal to indemnify the surety against any loss.

Question 2

Obligee

Answer 2

the party to whom the obligations are owed. If the principal fails to perform, the obligee can look to the surety instead of just the to the contractor, who may not have the money to satisfy a court judgement.

Question 3

Subrogation

Answer 3

Common law characteristic of a bond. Allows the party who pays for a loss suffered by another party to assume the rights of that other party for the purpose of recovering the loss from a third party. Allows the surety to assume rights of owner to sue any other party responsible to recover monies paid out, possibly from the principal.

Question 4

Bid bond

Answer 4

A guarantee by a surety, in favor of the project owner, that if the owner accepts a bid by the contractor in question and the contractor fails to enter into the contract that is the subject matter of the bid, the surety will pay the penalty specified by the bond. Used almost exclusively in construction industry. invitations of bid often require the bid be accompanied by a bid bond in the amount of 10% of the bid amount.

Question 5

Performance bond

Answer 5

a bond under which the surety guarantees a contractor’s performance of a construction contract with the owner. Face value usually equal to 50% of the construction contract value.

Question 6

Volunteer

Answer 6

a party who pays money to another without any legal obligation to do so. If a surety pays money as a volunteer, it would be unable to recover this amount from its indemnitors i.e. the principal.

Question 7

Payment bond

Answer 7

A guarantee of the performance of a payment obligation. Requested by a party to a contract whenever there is a concern that the other party may default on a payment obligation. Creates a trust relationship. can be one- or two-tier. Typically used when the owner requires one from the contractor or when a contractor requires on from its major subcontractors - reduces risk of liens against owner’s property. If financial strength of owner is in question, contractor can request the owner to provide payment bond.

Question 8

Labor and Material payment bond

Answer 8

used to protect owners and general contractors against liens by unpaid subcontractors, suppliers, and those working below them in the contractual chain. The owner is the obligee, but only as trustee for claimants as defined under the bond.

Question 9

Trust

Answer 9

a legal doctrine that separates the legal ownership of a right or of a property from the beneficial interest or ownership.

Question 10

Trustee

Answer 10

a person appointed under the terms of a trust who is given legal ownership of the trust property or rights but is required by law to act on behalf of and in the best interests of the trust beneficiaries.

Question 11

Trust beneficiary

Answer 11

a person for whose benefit the trust property or rights must be used.

Question 12

Lien bond

Answer 12

a payment bond used as security to facilitate the discharge of lien that has been filed against the land on which a project was constructed. The surety is required to pay a lien claimant if the lien is found to be valid and the principal doesnt pay the amount ordered by the court. Not put in place until after the lien has been filed.

Question 13

Surety

Answer 13

guarantees the performance of another party, often the contractor, for the benefit of a third party, usually the project owner. Can also guarantee performance of a different party’s obligations. The principal pays the surety a premium; in exchange, the surety accepts the obligation to guarantee the performance of the principal.

Question 14

primary obligations

Answer 14

the obligations owed by the principal to the obligee after first entering into a contract

Question 15

secondary obligations

Answer 15

the obligations owed by the principal to the surety after entering a contract and setting out primary obligations.

Question 16

Bond dependency

Answer 16

the obligations of the surety to the obligee are dependent on the obligations of the principal to the obligee. Therefore, any defense that a principal has to claim by an obligee is available to the surety as well.

Question 17

Once surety has been put on notice that its principal is in default for a performance bond, what 6 options does it have?

Answer 17

1) can require the principal to remedy the default by performing its obligations
2) can complete the contract itself in accordance with its terms and conditions
3) can solicit bids for completion of the work
4) can pay the obligee the amount of the bond
5) can assert a defence and refucse to do anything
6) can take “wait-and-see” approach to determine whether the principal was actually in default

Question 18

Surety may escape its obligation to pay (defense) if?

Answer 18

1) The obligee has not performed all of its obligations
2) The obligee failed to give the surety adequate notice of the claim against the principal
3) The risk the surety is exposed to changes, e.g., by the principal and obligee agreeing to increase the scope of work
4) The obligee overpaying the principal for work done; this also increases the risk the surety is exposed to

Surety can rely on any defense the principal would have against the obligee.