UTILITY CONSTRUCTION SURETY BONDS, PART 1--PERFORMANCE BONDS

It is common for water and wastewater utilities to require contractors engaged in construction of infrastructure projects to provide performance and payment surety bonds. Indeed, some states mandate that municipal-owned utilities obtain such bonds from their contractors. One example of such a mandate is the Illinois Public Construction Bond Act (30 ILCS 550/1, et seq). That statute states that performance and payment bonds must be obtained for all "public works" projects costing more than $5,000.

This posting will focus on performance bonds. The following post will discuss payment bonds.

Performance bonds involve a three party arrangement. In the utility situation, the contractor is the "principal"; the utility is the "beneficiary"; and the third party, of course, is the surety.

The purpose of a performance bond is to assure the completion of the project in accordance with the contract terms. Typically, in the event that a utility declares a contractor default, the surety becomes obligated to cause the contract to be performed and completed. If the surety fails to undertake its obligations with reasonable promptness, the utility is free to enforce available legal remedies. If the surety does comply with its obligations, it becomes subrogated to the utility's claims against the contractor.

So, what does a performance bond really do? In reality, for the utility as beneficiary the bond is not a guarantee that the contract will be completed. It often becomes simply a ticket of admission to the court house for the principal. That is, the beneficiary winds up suing the surety. A surety may decline to perform by raising defenses to its obligations such as a failure by the beneficiary to give proper notice or a breach of the construction contract by the beneficiary itself.

In accepting a performance bond provided by a contractor, a utility should be satisfied as to the financial standing of the surety and as to the various terms and conditions of the bond. A bond may be well written but of no value if the surety is insolvent.

Completion of a construction contract does not necessarily end the matter, although it may end the bond. The problem is that after completion defects in construction may develop or are discovered necessitating repairs and correction by the contractor. In turn, such repairs can be expected to cause extensions of the applicable warranty period. A utility should be aware of the need to extend bond protection either by terms set forth in the original performance bond or by a requirement for a new maintenance or performance bond covering such repair obligations and warranty extensions.