CHALLENGES OF A ROBUST CONSTRUCTION ENVIRONMENT
The Province of British Columbia is experiencing an unprecedented boom in construction projects. This increase in construction activity results from three sources:
(a) development activity due to ripening market conditions for housing products; and
(b) infrastructure projects related to the 2010 Olympic Games; and
(c) deferred capital works.
PROJECTED CAPITAL WORKS
- Transportation projects $2.9 billion
- 2010 Olympics $426.4 million
- Vancouver Port Authority Projects $792.9 million
- Advanced Education Projects $198.9 million
- Health Care Projects $800.4 million
- Other Capital Works $1.02 billion
The volume of projects and complexity of the work contemplated is placing significant strains on contractors and their sureties.
The demands on the contractor are obvious: the lack of an available and skilled labour force coupled with a shortage of the required construction materials. In relation to sureties, the challenges are less obvious but still present.
THE SURETY’S PERSPECTIVE
Like the contractor, the surety will want to ensure that the contractor has the ability to manage and finance the completion of a mega project. In no small measure, this will involve assessing the availability of skilled personnel and the required raw materials.
We have all heard stories on the lack of skilled labourers and we have all seen the price of construction materials such as copper rise to the point where supply is a real concern. However, the surety faces not only these “contractor” risks, but a host of additional risks that arise out of the challenges of placing bond coverage for large projects.
Once the surety is satisfied that a particular contractor is capable of performing the obligations arising under the contract, the underwriter has to assess the capacity of not only his own company to underwrite the risk but the availability and capacity of the re-insurance market.
WHY DOES RE-INSURANCE MATTER?
When sureties place bond coverage on a project, they “re-insure” that risk by placing a portion of the coverage with other insurers (re-insurers). Re-insurers are in the business of taking a portion of the bond risk for a portion of the bond premium.
The cost and availability of re-insurance is impacted by events that extend well beyond the borders of British Columbia. For example, the spate of hurricanes in the southern United States and the events of September 11 have resulted in a “hardening” of the re-insurance market. In addition, the rate of return which is available to underwriters in the re-insurance business on the global investment markets impacts their willingness to participate in certain risks. The re-insurance market is undergoing a recovery from the financial impact of the losses arising from the events of September 11. However, the market is impacted by lower overall rates of return on investments.
Re-insurance companies are not local. These companies are global and their appetite for incurring risks in the context of a large project in British Columbia is impacted by their global loss ratio.
OTHER FACTORS AFFECTING THE SURETY MARKET IN BRITISH COLUMBIA
There are two other factors that greatly affect the exposure of sureties in British Columbia today:
(a) extended contracts; and
(b) extended warranties.
Extended Contracts
In British Columbia, our government has now awarded contracts for work which was previously undertaken by the government itself. For example, road maintenance contracts are now being awarded based upon a ten year term. These contracts require the contractor to obtain and provide five year renewable surety bonds guaranteeing the performance of the work under the contract. In essence, these contracts expressly recognize that the term of the contract will be five years which represents a much greater exposure to the surety given that the contractor will have to be able to demonstrate that it is in a position to supply the contract with the necessary workforce and materials for an extended length of time.
Underwriters will have difficulty placing re-insurance for this type of extended period of time. In the context of the road maintenance contracts, certain underwriters have entered into agreements to share the risk on a local basis without placing the contract into the typical re-insurance market. By doing so, the risks of these contracts is spread among the local companies rather than out to the global market. This has been an innovative solution to what is a local trend requiring contractors to tender contracts for extended periods of time.
Extended Warranties
Many construction agreements now call for warranties beyond the standard one year warranty period which is contained within the CCDC contract.
Many specifications require extended warranties in relation to certain building components such as weather barriers.
The surety assumes the liability of performance in compliance with all warranties.
THE CLAIMANT’S PERSPECTIVE
We have addressed the concerns of the surety but what about the claimant? Sureties have been accused of being difficult and overly technical in the event of a claim. How does the claimant overcome the difficulties which arise?
The Problem – claims rarely arise due to a single cause. Defaults are often due to a combination of factors.
UNDERSTANDING YOUR RIGHTS
A bond is a three party contract. The party who purchases the bond (in the context of a performance bond) is the party who is entitled to enforce its rights and obligations. For example, under a performance bond, the owner is typically the “obligee” and entitled to enforce the rights and obligations of the bond. However, in the context of a labour and material payment bond, the bond wording will dictate whether or not you are a proper claimant.
Make sure you fit within the criteria on allowing you to make a claim under the Bond.
COMMUNICATION
In representing bonding companies, I have noticed that owners who communicate early and frequently with a bonding company in relation to problems are the owners that tend to minimize the impact of poor performance of a contractor. In other words, do not wait for the day when the contractor has abandoned the work and the project is encumbered by a number of liens. The moment you can be certain that performance issues are present, ask to meet with the surety and discuss performance. In most cases, sureties will welcome an opportunity to meet with the obligee – after all, you are the customer. If the surety is not prepared to meet with you, then make sure you express your concerns to the surety in writing.
In many cases, the early involvement of the surety can address problems on a job. For example, the contractor may be experiencing cash flow difficulties and the spectre of a default will result in solutions which were not apparent before the involvement of the surety. The surety can speak frankly with the contractor about issues such as cash flow. The contractor may be reluctant to discuss those types of issues with an owner. Most importantly, the surety has the indemnities of the principals of the contractor and can express to the contractor the reasons a default would be undesirable.
Remember, under the case law, a surety isn’t required to respond “immediately”. A surety is entitled to a reasonable period of investigation and is entitled to “get both sides of the story”. Often, jobs do not go poorly due solely to the performance of the contractor. Inevitably, problem jobs are the result of a number of issues and it is in the interest of all to identify those issues and overcome them as soon as possible.
WHEN SHOULD A SURETY RESPOND?
A surety does not respond to every breach under the contract. This is a common misconception and it is important to recognize that a surety will only respond when there has been a “default”.
Typically, a third party will issue a “Notice of Sufficient Cause” which, if not dealt with in a timely manner by the contractor, will result in a default.
An owner should always be in contact with the surety if a Notice of Sufficient Cause is issued by the consultant. Contact at this point should be in writing and should be sent by courier or registered mail. If a default ultimately occurs then a formal notice of default should be sent to the surety by the owner. At this point, it is advisable to obtain legal advice to ensure that performance of the contract is properly tendered to the surety.
It is not open to the owner to complete the work and later request that the surety pay the costs of completion. This issue has been decided in a number of legal cases and the owner who “takes matters into his own hands” will find that his actions will have released the surety from its obligations.
Upon default, a surety may elect to follow a number of courses of action. However, it is up to the surety to make an election and any interference with that election by the owner will only impair the owner’s ability to proceed against the surety at a later date. Again, it is important to get legal advice at this point in time.
If the surety does not act, an action can be brought against the surety for failing to respond to its obligations under the bond. Performance bonds generally provide that an action shall be commenced within two years from the date on which final payment under the contract falls due. Further, as a practical matter, actions against sureties should always be commenced within a short period of time from the failure to respond.
RECENT DEVELOPMENT IN THE LAW OF SURETY
A Performance Bond Must be Delivered
Many construction agreements have as a precursor to the first payment under the contract the deliverance of bonds including a performance bond. If a bond is not delivered an owner may have difficulty proceeding against the surety.
In Paul D’Aoust Construction Ltd. v. Markel Insurance [2001], 3 S.C.R. 744 the performance bond in issue was signed by a broker on behalf of the surety and was given to the contractor following which the president and treasurer of the contractor signed the bond. However, the bond was placed in a file in the contractor’s office and was never properly delivered to the owner.
The president of the contractor gave evidence that he did not intend to issue or deliver the bond and in fact he removed it from the offices of the construction company and took it to his home some time after execution. The surety, for its part, believed that the bond had been delivered but in fact it had not. The contractor ultimately defaulted on the contract and was terminated by the owner. The surety investigated and denied liability on the basis that it was not bound because the contractor had not delivered the bond.
The Ontario Court of Appeal and the Supreme Court of Canada agreed with the surety’s decision.
DO BONDS SECUREMORE THAN “BRICKS AND MORTAR”?
Contracts sometimes contain provisions requiring the payment of liquidated damages in the event of delay. Contracts often state that to the extent there are “collateral” damages incurred by the owner, the damage is recoverable against the contractor. Typically these “collateral” damages are items such as increased consultant fees or legal costs associated with dealing with unpaid trade contractors or material suppliers.
There has been some controversy in the law on whether or not these types of claims are recoverable against the surety.
The Whitby Decision
The Ontario Court of Appeal in Whitby Landmark Development Inc. v. Mollenhauer Construction Limited, [2003] O.J. No. 4000 found that a standard wording construction performance bond guaranteed an obligation to remit the contractor’s share of project cost savings – a non “brick and mortar” item – to the owner.
Early in the project, it became apparent that the work would cost less than the price stipulated in the contract. Pursuant to the contract, the owner would be entitled to a final accounting of these savings. As time passed, however, the contractor encountered financial difficulties and opted not to pay the balance of approximately $600,000.00 owing to the owner in relation to these savings. As a result, the owner took the position that the $600,000.00 was recoverable from the bonding company under the performance bond.
The Ontario Court of Appeal held that the wording of the bond was broad enough to include all issues relating to the underlying contract. This included the contractor’s obligation to issue the cost savings report and to provide compensation for the owner’s share of the savings.
In summary, the standard form bond wording, according to the Ontario Court of Appeal, is not limited to securing physical construction of the project or the “bricks and mortar” but will respond to claims for “collateral” obligations of the principal. In essence, the bonding company’s obligation to the owner is co-extensive with the contractor’s obligation.
The Lac La Ronge Decision
The second case on this issue was the decision of the Saskatchewan Court of Appeal in Lac La Ronge Indian Band v. Dallas Contracting Ltd., [2004] S.J. No. 531.
In Lac La Ronge, the bonding company provided a performance bond to secure the completion of a sewage lagoon for an Indian band in northern Saskatchewan. The contractor did not complete on time and eventually the owner tendered a new contract and sued the bonding company for completion of the work together with the payment of liquidated damages to cover the late completion of the contract and the payment of extra engineering and supervision costs. The trial judge awarded these costs to the Indian band but the Saskatchewan Court of Appeal overturned the lower court’s decision and stated that there was no authority in the contract to set off these funds against the funds owing to the surety upon default. Contrary to the reasoning in Whitby, the Saskatchewan court did not order the surety to pay more than the “bricks and mortar” costs.
Neither the Whitby nor the Lac La Ronge decisions have proceeded to the Supreme Court of Canada and therefore, at present, there is an inconsistency on the issue of the recoverability of “collateral” damages.
CONCLUSIONS
Like contractors, sureties are struggling with capacity as the volume of capital works projects reaches a level not previously seen in this province. In the past, when faced with these issues, sureties have been able to collaborate and devise strategies for developing the necessary capacity. However, the principal challenge will be for sureties to have sufficient comfort that the contractors have sufficiently skilled labour forces and the necessary materials to complete the projects.
In the event there are difficulties with performance, communication becomes critical and flexibility in identifying solutions to issues which would otherwise create a default is increasingly important.
In the event of a situation where default is unavoidable, seek early legal advice and attempt to open early dialogue with the surety. A construction lawyer who is a skilled negotiator will likely bring about a more cost-effective solution than a threatening stance. In either case, make sure that your rights are preserved such that a surety that is not acting appropriately can be forced to comply with its obligations under the bond.
Prepared by former Associate, Lyle E. Braaten
