July 26, 2018

SURETY BONDS

A. Overview of Suretyship
The suretyship is an ancient concept. “Whoever gives a guarantee is without sense; as surety he surrenders himself to another.” Proverbs 18:181. “Never be one to give guarantees, or pledge yourself as surety for another; for if you cannot pay, beware: your very bed will be taken from under you.” 2Proverbs 22:26-27.

Notwithstanding the biblical warnings, however, compensated sureties, also referred to as bonding companies, have a widespread and significant role in the construction industry. Bonds are classic third party beneficiary contracts because the two parties to the bond, the surety and the principal, are making a promise for the benefit of the obligee(s) (beneficiary). There many different types of construction bonds: license bonds; bid bonds; payment bonds (common law and statutory); conditional payment bonds (statutory involving only private projects); transfer bonds; performance bonds (common law and statutory); and maintenance bonds. This Part shall discuss primarily payment and performance bonds.

The classic insurance contract is based on actuarial analysis of risk and then the payment of a premium or premiums to the insurance company for assuming the risk less any applicable deductible. For example, the insurance company providing automobile insurance for a 24 year old male in Tampa can set a premium to assume the risk of personal injury or property damage based on a study of historical data of claims and losses.

The surety or bonding company, however, through its analysis of the nature of its risk, charges a premium or premiums, based in most instances on the strength of indemnity of its principal or principal’s owner(s). As a result, typically when a surety is presented with a claim on a bond it has issued, the surety tenders the claim to its principal, because the principal usually would be required to reimburse (indemnify) the surety when the surety makes a payment on the claim.

The party requiring or the reason for the bond can vary. If a public project is involved, then a payment bond and a performance bond may be required by statute. If there is a private project with a construction lender, then the lender may require that the owner’s contractor provide a payment bond or a performance bond, or both. Also, a more sophisticated owner, apart from what the construction lender requires, may require that the contractor be “bondable” (capable of providing a bond) as a method of prequalifying the contractor or may require a payment and performance bond to provide protection from claims by lienors other than the contractor and to provide added protection in the event of construction defects.

B. Tripartite Relationship

As noted above, the normal bond involves a tripartite relationship: (1) the principal; (2) the bonding company or surety; and (3) the obligee (beneficiary). There can be various permutations on this basic structure. For example, there can be one principal, one surety and dual or multiple obligees. In Florida, dual obligee bonds are seen most often when the construction lender is named as a beneficiary of the general contractor’s bond or when an owner is a beneficiary of a bond from a subcontractor to the general contractor. See also Current Builders of Fla., Inc. v. First Sealord Surety, Inc., 2008 WL 859341 (Fla. 4th DCA 2008) (contractor must proper declare subcontractor in default in order to trigger surety liability).

Typically the principal’s owner(s) provides a written indemnity agreement to the bonding company agreeing to defend or pay the defense costs of the bonding company and paying any claim against the surety or reimbursing any payment made by the surety. In addition, the surety is equitably subrogated to its principal’s right to payment where there has been a default. See In re Cone Constructors, Inc., 265 B.R. 302, 310 (Bank. M.D. Fla. 2001).

In addition, the surety typically places its bonds through an insurance or bonding agent. The agent often “represents” both the contractor and the surety. The agent will try to find a surety that can provide the bonds needed for an acceptable premium. Quite often the agent is actively involved in working with the contractor’s accounting firm to provide financial statements to the surety’s underwriters to review so that the contractor can become “bondable.”

The parties seeking the bond protection often require that the bonding company have a certain rating. Best’s Insurance Reports for example rates various sureties, as does the federal government. See .

C. Payment and Performance Bonds

The requirements for Payment and Performance Bonds may arise from either statute or contract, or both. Payment and Performance Bonds can be combined in one bond or provided as separate bonds.

The statutory bonds in Florida arise typically under the Federal Miller Act, Florida’s “Little” Miller Act dealing with public projects or for private projects the Construction Lien Law,3 Chapter 713. The Federal Miller Act, 40 U.S.C. Sec. 3131, requires a performance and payment bond for any construction or repair to any federal building in public work for contracts in excess of $100,000. On a comparative basis, there are relatively few federal construction projects as compared to state or local projects, so the reader should be aware that depending on how closely “contractually related” the contractor is to the claimant, then there may be notice requirements for a payment bond claim and that the action on the bond must be brought within one year of last providing labor or materials. Section 255.05; Federal Miller Act; 713.23; conditional payment bonds; common law bonds. 40 U.S.C. Sec. 3131(b)(4).

The typical public bond claim in Florida involves either a state or local project. Under Section 255.05, Florida Statutes where a contract is for less than $100,000 no payment or performance bond is required. When the contract is between $100,000 and $200,000 the government entity may elect to exempt the contractor from providing a bond (or other acceptable security such as cash). When the contract is for $200,000 or more, then the contractor must provide a payment and performance bond. As discussed below, subcontractors, sub-subcontractors, materialmen, laborers and suppliers are required to provide certain notices to the contractor and surety to perfect Little Miller Act Claims.

Florida Construction Lien law in Chapter 713 provides for payment bonds (Section 713.23) and Conditional Payment Bonds (Section 713.245) for private non-public projects.4 The payment bond should be attached to the notice of commencement at the time of recording.5 Like the Florida Miller Act, claimants on Chapter 713 bonds are required to provide certain notices to the contractor and surety to perfect their claims.

D. Difference Between the Two

A payment bond protects the parties other than the entity posting the bond (typically) the contractor from the risk of not being paid if they properly perfect their rights and in turn protects the private owner6 from having any construction liens, other than that of the contractor, placed on the property. A performance bond protects the obligee (beneficiary) from defective or incomplete work.

E. Owner’s Rights

Typically the owner is the party requiring the payment or performance bond, or both. Under a Section 713.23 private “absolute” payment bond, the owner, assuming the bond has been properly attached and recorded with the notice of commencement, is exempt from all construction liens other than the contractor's. This significantly decreases the requirements for the owner to keep track of notices to owner form subcontractors, sub-subcontractors, suppliers and materialmen because they cannot lien the property or if they do, then the lien can be readily transferred to the payment bond attached to the notice of commencement by using the statutory form of notice of bond. Section 713.23(2). It likewise provides for a prevailing party attorney’s fees statute for lien as well as bond claims. Section 713.29. A Section 713. 245, Conditional Payment Bond, however, is a nightmare for the owner. It can result in the owner having a bond premium included in the price that is being paid to the contractor and liens being recorded: the worst of both worlds. The statute provides for a very convoluted process of notices for a claim on the conditional bond as well as recording claims of lien. It is very difficult to understand why an owner (or its lender) would accept a conditional payment bond. Conditional payment bonds were developed in response to the Florida Supreme Court’s decision in OBS Co. v. Pace Constr. Corp., 558 So. 2d 404 (Fla. 1990), which upheld a pay when paid clause giving the contractor a pyrrhic victory, but permitted the claimant to pursue the contractor’s surety. Ironically, a “conditional” payment bond surety may have its obligation converted into an absolute payment bond if the subcontract does not contain a valid pay when paid clause. See North America Specialty Ins. Co. v. Hughes Supply, Inc., 705 So. 2d 616 (Fla. 4th DCA 1998).

The performance bond provides more significant direct protection to an owner for its construction defect or failure to perform claims against the contractor. The owner, however, must comply with the contractual provisions7 because the surety has the benefit of all the defenses that its principal has under the contract. In addition, the owner may need to declare a default and actually terminate the contractor. See L&A Contracting Co. v. Southern Concrete Services, Inc., 17 F.3d 106 (5th Cir. 1994) (applying Florida law).

1 Oxford Study Bible.
2 Id.
3 As a word of caution, some public agencies, such as the Florida Department of Transportation have lobbied the Legislature to create an independent statutory bond system. See Section 337.18(2). For a discussion of FDOT bond claims see Rains, “Construction Law: Enforcing the Notice and Filing Times Requirements of “Florida’s Little Miller Act”-An Adventure in Statutory Construction,” 58 Fla. L. Rev. 425 (April 2006). In addition, by Local Act the dollar thresholds for when Florida Miller Act bonds are required may vary from county to county. See HB 1167 passed as 2005 Laws of Florida Chapter 323 which authorizes the City of Jacksonville, Duval County to waive the requirement for payment and performance bonds when the cost of a project is $500,000 or less.
4 In addition Section 713.24, Florida Statutes provides that a transfer bond may be posted to remove a lien from real property.
5 There is authority that the failure to attach the Section 713.23 bond does not make the bond a common law bond. Bridgeport, Inc. v. Tampa Roofing, 903 So. 2d 306 (Fla. 2d DCA 2005). See also Professional Plastering & Stucco, Inc. v. Bridgeport-Strasberg Joint Venture, 2006 Lexis Fla. App. 11801 (Fla. 5th DCA July 16, 2006).
6 There is no right to lien a public project in Florida. See Section 713.01(22) (The term “Owner” under Chapter 713 does not include any political subdivision). If a bond was required, however, and the public body fails to require the bond, then a claimant may have a claim based on the failure to provide the bond. See Palm Beach County v. Trinity Industries, Inc., 661 So. 2d 942 (Fla. 4th DCA 1995).
7 For example, many contracts require that the contractor obtain from its bonding company a consent of surety as a condition to final payment.