Once a surety accepts responsibility to complete a defaulted contractor’s work pursuant to its obligations under a performance bond, does the surety have an absolute right to use any completion contractor of its choice? What if the surety wants to use the defaulted contractor to complete the remaining scope of work? This very issue was recently analyzed by the Appellate Division, First Department.
Here, the general contractor filed a claim against the surety of two performance bonds issued to a project’s demolition subcontractor, promising to complete the work in the event that the subcontractor defaulted on its subcontracts with the general contractor.1 The general contractor terminated the subcontractor for several reasons, which the subcontractor hotly disputed. Generally, these reasons stemmed from the removal of a standpipe and the unavailability of the only source of water to put out a fire. The surety attempted to retain the defaulted subcontractor as its completion contractor, and the general contractor refused to allow the subcontractor to return to the jobsite. The general contractor demanded that the surety find a different contractor, and the surety refused. The general contractor then filed suit in Supreme Court for breach of the performance bond, demanding that the Court direct the surety to fulfill its obligations under the bond and complete the work using a contractor other than the defaulted subcontractor.
The trial court found that the general contractor, not the surety, had breached the performance bonds by refusing to allow the surety to choose its own completion contractor—even though the surety wanted to engage the defaulted subcontractor. The trial court specifically held that the general contractor deprived the surety of its ability to protect itself by retaining the completion contractor of its own choosing, as was specifically provided for in the bond. The court held that the general contractor’s action was a material breach of the bond. Therefore, the surety’s nonperformance was excused and, as a result, the surety was granted summary judgment against the general contractor. The general contractor appealed the trial court’s ruling, and ultimately prevailed on appeal.
The Appellate Division, First Department ruled that the trial court “erred in dismissing the claim asserted by  the general contractor on the construction project and obligee of the performance bonds and that [the] surety thereof, breached the bonds.” The Appellate Division held that “the bonds expressly required [the surety’s] replacement of [the subcontractor] to be in accordance with [the] subcontracts”. Crucially, those subcontracts incorporated by reference the prime contract between the general contractor and the owner, which required the prior written approval of both the general contractor and the owner for any replacement contractor—including the selection of the defaulted subcontractor to complete its own work after being terminated. Therefore, the general contractor was well within its rights to prohibit the surety from using the defaulted subcontractor as the completion contractor. As a result of this finding, the Appellate Division ordered that the general contractor, not the surety, be granted summary judgment based on the surety’s breach of the performance bonds.
It should be noted that the performance bonds at issue were the standard form at the time, AIA Document A311. This standard form has since been replaced by the AIA Document A312, which allows a surety to either arrange for the defaulted contractor to complete the contract, with consent of the owner, or obtain completion bids from qualified contractors “acceptable to the Owner”. Thus, the new form of bond itself now explicitly requires the consent of the obligee in choosing a completion contractor.
The moral of the story: when dealing with performance bond issues such as this one, a contractor must be aware of all of the bond’s pertinent provisions, including those incorporated by reference in any applicable contracts. As highlighted by the appellate court a party that is unaware of its rights and obligations may make decisions that result in costly and protracted litigation. Good legal counsel can help you in advising you as to the pertinent provisions of both bonds and contracts, and how to operate in accordance with those provisions.
1 The performance bonds are the standard form, AIA Document A311. The AIA has since replaced the A311 with the A312.