Does a performance bond require termination of the principal as a condition precedent to the surety’s obligations? Arch Insurance Co. v. The Graphic Builders LLC. United States District Court (Massachusetts) (2021), by Hugh Anderson

Summary: The Graphic Builders (TGB) was the general contractor on an apartment building construction project in Boston. TGB retained a subcontractor, RCM Modular, to fabricate, deliver, and assemble modular components of the apartment building. TGB required RCM to furnish a subcontractor’s performance bond covering RCM’s work. Arch Insurance issued the required bond. Based on excerpts, the bond was based on the standard bond published by AIA (AIA A312) and EJCDC (EJCDC® C-610, Performance Bond), adapted for use at the subcontractor level.

The subcontractor, RCM, delivered and began installing the modular units. TGB contended that the modules were defective, citing leaking windows and misalignment issues. TGB did not terminate the RCM subcontract, however, stating later that terminating would have been “the equivalent of shooting [itself] in the face” (an even more gruesome expression than shooting oneself in the foot). Instead, TGB unilaterally arranged for other subcontractors to remediate RCM’s defective work, and sent an invoice to RCM and Arch seeking reimbursement of $2.8 million in remedial costs incurred.

Representatives of TGB, Arch, and RCM eventually met in person to discuss the problems but did not reach a resolution. TGB followed up the meeting with a letter declaring RCM in default, but noted that TGB was not yet terminating the subcontract; this letter was followed by more notices of default, and an increased demand of $3 million. Arch rejected the general contractor’s demands and denied liability based on TGB’s failure to terminate the subcontract, which Arch asserted was a “condition precedent” to a recovery on the performance bond. Arch then filed a lawsuit in federal court, seeking a judicial declaration discharging Arch from liability because by not terminating RCM—a condition precedent to a claim under the bond—TGB had thereby rendered the bond null and void.

Decision: The federal district court’s decision explained that under Massachusetts law a “condition precedent” is an event which must occur before an obligation to perform under a contract. (A performance bond is a contract.) The specific performance bond issued by Arch stated that the obligations of the surety would arise only after several express conditions were met; the condition critical to the case is that TGB “declares a Contractor Default, terminates the Construction Contract, and notifies the surety.” The court found that it was undisputed that although TGB declared a Contractor Default, TGB never terminated the RCM subcontract. Accordingly, the court held that Arch was discharged from “any and all liability relating to [the Arch Performance Bond].”

In its decision the court also commented on what it called “an apparent last ditch effort [by TGB] to avoid summary judgment.” TGB had raised a new argument in its final submittal regarding summary judgment: that it had not been possible for TGB to terminate the subcontract, because RCM had substantially completed its work under the subcontract. The court made short shrift of this contention, pointing out that the subcontract did not contain any such limitation on termination, and pointing out that the argument could not hold up because TGB representatives had stated that they consciously chose not to terminate for other reasons, not because of any perceived obstacle posed by the purported “substantial completion.”

Comment: This decision closely adheres to the plain provisions of the standard performance bond. The structure and carefully composed wording of the standard bond do not leave much room for doubt about the need to terminate the contract in order to trigger the surety’s core obligations.

The stipulation that there must be a termination of the bonded contract is not an abstract formality—such a requirement assures that the safety net that is the performance bond is reserved for serious lapses in performance/completion. The performance bond is not a device for managing the day-to-day problems and frustrations that accompany most construction projects.

The Graphic Builders decision also addresses another issue: an accusation by the general contractor that during the lawsuit the surety engaged in unfair acts or practices by threatening to retaliate, and then actually retaliated by allegedly terminating the surety’s bonding relationship with a TGB parent company. The court held that the general contractor’s effort to pursue these “threadbare accusations” was “futile” because the allegations were merely conclusory and were unsupported by any factual allegations detailing the alleged retaliation.

The EJCDC standard bonds (C-610, Performance Bond, and C-615, Payment Bond) are drafted to meet the bond requirements of the prime (Owner-Contractor) contract (for example, the bond provisions of EJCDC® C-700 (2018), Standard General Conditions of the Construction Contract, Article 6). However, both these standard bonds contain a simple mechanism for adapting them to use at the subcontract level—presumably this mechanism was used to adapt the bond issued to TGB:

If this Bond is issued for an agreement between a contractor and subcontractor, the term Contractor in this Bond will be deemed to be Subcontractor and the term Owner will be deemed to be Contractor.