Performance Bond Claims Guide

What is a performance bond?

Construction bonds are a subset of surety bonds focused on underwriting construction projects. Meant as a guarantee of a large project’s quality, they offer financial security to invested parties that the project will be completed, paid for (to subcontractors), and live up to a certain established standard. In the interest of the public, the federal government requires (through the Miller act) that public projects have construction bonds taken out against them. These construction bonds include performance bonds, payment bonds, and bid bonds. This article focuses on performance bonds and the claim process against performance bonds.

Performance bonds are a type of surety focused on guaranteeing the performance of a project. It involves a service provider or contractor, the bond principal, who commits to finishing the outlined work according to an agreed-upon standard. A surety company (or sometimes an insurance company) then underwrites this work, offering the performance bond and the performance guarantee that the work will be completed to the predetermined quality. In the event that this does not happen, the surety offers financial compensation to those impacted, who are known as the bond obligee. The surety will then seek repayment from the bond principal. The obligee is a party directly impacted by the principal’s failure to complete the job.

What is a bond claim?

A bond claim is a legal action taken by an entity (known as the claimant) against a surety bond to receive financial compensation for losses or harms caused by the failures of the bonded party (the principal). 

If the principal fails to meet certain contract obligations, the bond obligee can initiate a claim process against the surety bond. The claimant needs to provide evidence of the principal's failure to perform and demonstrate the losses they have suffered as a result. If the claim is validated and is within the terms of the contract, the surety company is obligated to provide compensation up to a predetermined limit.

Claims claim serves as a mechanism to protect the interests of obligees, offering them financial remedy if the principal falls short of the predetermined expectations for a project. Claims against bonds depend on specific terms and conditions outlined in the initial bond agreement. For this reason, claimants must follow the specific claim procedure outlined in the bond to maximize the chances of a successful claim.

Who can file a claim against a performance bond?

A performance bond typically outlines the parties that can make a claim against the contract. This party, known as the bond obligee, is usually directly affected by the project's performance. Common types of bond obligees include:

Project Owners or Clients

These are obligees with direct investments in the work being fulfilled by the principal. They might file a performance bond claim if the contractor fails to meet the obligations outlined in the contract they entered into. This could be for many reasons: failing to complete the project, subpar work quality, or other breaches of contract.

Government Agencies

Government and Federal agencies that award contracts can file performance bond claims if the contractor does not fulfill the obligations discussed in the contract.

Subcontractors and Supplies

In some cases, subcontractors or other suppliers (such as material suppliers or work subcontractors) not party to the performance bond can file a performance bond claim. This might include cases where the general contractor (the principal to the bond) fails to pay them or if the subcontractor's work has been impacted by some failure on the principal's behalf. This is similar, but distinct, from a payment bond claim, which contractors are also usually expected to take out for larger government projects or within the construction industry.

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What causes performance bond claims?

Performance bond claims are typically triggered by specific situations where the principal fails to fulfill their contractual obligations. Some common causes of this include:z

  • Incomplete or Abandoned Work: If the work is delivered unfinished or the general contractor abandons the project without a valid reason, the obligee might file a claim to seek compensation for the unfinished work and to find a replacement contractor.
  • Work Quality: If the principal fails to meet the standards for work outlined in the contract, the obligee might file a claim to recover the cost of fixing or redoing work.
  • Delays: The obligee may file a claim against work that is delayed beyond an agreed-upon timeline. This might refer to milestones or deadlines outlined in the contract that the principal can no longer meet.
  • Bankruptcy or Insolvency: If the principal becomes bankrupt or insolvent before the completion of work, the obligee might file a claim to cover the costs of a new contractor.
  • Non-Compliance with Specifications or Regulation: If the work does not meet certain specifications outlined in the agreement or comply with established regulations (such as those concerned with safety or fire), an obligee might file to recover the cost of fixing the work to meet these standards.
  • Subcontractor Issues: A claim could be filed if the principals’ subcontractors fail to perform their duties and subsequently disrupt the project.
  • Financial Default: If the principal contractor faces financial difficulties and cannot pay subcontractors, suppliers, or other vendors, a claim might be filed to cover these unpaid amounts
  • Other Contractual Breaches: A claim might be pursued if the principal cannot fulfill other specific contractual obligations outlined in the performance bond. 

In all of these cases, the obligee must demonstrate that the principal hasn’t fulfilled one or more of the bond obligations and that this has impacted them. The bond process then seeks to mitigate the losses of these parties by compensating them up to the predetermined bond amount.

How to handle a performance bond claim

As the principal, navigating the bond claim process requires care and attention. While it might be stressful, it is important to consider your options and pick one that mitigates conflict and financial harm. If you are handling a performance bond claim, you might consider the following steps:

Step 1: Evaluate the Claim

Carefully evaluate the claim to understand the issue at hand. This might involve parsing through documentation provided by the claimant to understand the reasons for the filing.

Step 2: Seek Legal Counsel

Seek legal advice from those familiar with the performance bond claim process to understand your rights and obligations as outlined in the contract.

Step 3: Notify Involved Parties

Contact the Surety company that has underwritten your bond. Notify them of the claim and all supporting information related to the claim. This might include documentation, correspondence with the claimant, or other particulars.

Step 4: Initiative an Inquiry

Start an internal investigation to gather information pertinent to the claim being filed.  Validate the accuracy of the claim and identify deviations made from the outlined contract. Validate the claimant's contentions and assess the reported impact on the project, finances, or other circumstances.

Step 5: Craft a response to the Claim

Construct a formal response to the claimant, addressing the claim and expressing your perspective. Include any corroborative evidence or documents that fortify your stance.

Step 6: Negotiate to Reach Agreement

After sharing all the information with the involved parties, look to reach an agreement with the claimant. This might be through mediation or alternative dispute resolution. The methods for negotiation might already be outlined in the initial contract. This might involve specific guidelines for claim management that prescribe their own deadlines and other requisites.

Step 7: Formalize Settlement with Claimant

After negotiations, a settlement agreement will be reached with the claimant. Make sure all involved parties sign off on the final settlement.

Step 8: Reimburse the Surety

Since the bond was underwritten by the Surety, who has likely compensated the claimant, you must now work with the surety to reimburse them of this cost. The specific procedure to do so is likely outlined in the initial contract.

Usually, the initial bond form already outlines specific processes for each stage of the claim process. It is important to follow these guidelines to make sure that all parties can arrive at an amicable solution that safeguards the financial interests and reputations of those involved,