The Financial Fallout from a Terminated Contract

terminated contractNo one wins — the principal, the obligee or the surety — when a principal is terminated on a bonded project. A termination will generally require the surety to step in and 1) find another contractor to complete the project, 2) complete the project itself or 3) offer a financial settlement to absolve itself of future liability on the project.

For this post, we’ll discuss the surety finding another contractor to complete the project or completing the project itself. When either of these happens, there is significant fallout that can financially impact the principal, the obligee and the surety. The principal will be required to reimburse the surety for any amounts paid, to a completion contractor or the obligee, and the surety’s costs and expenses related to termination.

This financial fallout can also extend to the obligee, should the costs to complete the project exceed the surety’s penal sum or maximum liability on the bond. Finally, the fallout will extend, generally, to the surety, at least initially, for amounts advanced to the completion contractor or obligee.

Given the amount of work available, principals in today’s market may be tempted to walk away from a bonded project that is experiencing difficulties. However, abandoning a bonded project is usually the last thing you want to do from a financial perspective. In almost all cases, the cost of finding a contractor to complete the principal’s work will greatly exceed the remaining contract balance. As noted above, the surety is entitled to recoup its costs and expenses from the principal.

A principal has an opportunity to control its own destiny and cap its expenses by staying on the bonded project and working with the obligee and surety to close out the project. When that doesn’t occur, let’s look at what a surety must do to complete a contract and how it adds to the cost.

Additional costs

Before work can resume on a terminated contract, the surety must determine the scope of the remaining work and, based on that scope, who may be able to bid the remaining work. The surety will likely need to conduct a site visit or retain a consultant to visit the site to determine the remaining scope and assess whether any remedial work is necessary. This will help the surety determine its options for closing out the bonded project. However, these preliminary steps cost money, which the surety will pass on to the principal.

If the surety decides rebidding the bonded project is appropriate, it faces significantly higher building material prices and labor costs than when the job was originally bid. If the principal hasn’t purchased all the materials or has not locked in prices with a material supplier, the additional costs for any completion contractor to purchase the materials will be an additional cost passed on to the principal.

Any bidding contractor, whether the principal has begun work on the bonded project or not, will almost always add a premium to their bid. They understand the role of the surety and its need to have someone step in to complete the bonded project. They know that it is already behind schedule from the termination, which can affect other trades on the project and potentially increase the surety’s costs. A surety, and thereafter a principal, can expect an increase of at least 30% to 50% from the original bid, even if a portion of the work has been completed. That number is likely to continue to climb, given inflation and current across-the-board increases in the construction industry.

Time

It takes time to put together a bid proposal, hire a completion contractor and get that completion contractor on the bonded project. It can be at least 60 to 90 days before work resumes. With contractors so busy these days, there may be a delay in getting them on site to resume work.

Meanwhile, the clock is ticking, and there may be resulting delay damages stemming from the termination. While the surety will act to bring someone on to the project as soon as possible, it won’t happen overnight. If there are contractual delay damages that the obligee assesses and will not waive, the principal can expect to be responsible. Moreover, if damages are not capped in the contract between the principal and obligee, the delay damages can escalate quickly.

If the obligee has general conditions, including extended overhead, attorney fees and management costs related to the termination and delay of the project, the obligee will expect the surety to pay these. The surety will pass along these costs to the principal.

Avoid termination

If you’re a principal, you want to to avoid termination. While you may stand to lose money on a difficult bonded project, almost certainly it will be less expensive than if you’re terminated. Should you receive a cure notice (opportunity to remedy a default), contact your surety, apprise them of the situation, and work with the surety and the obligee to resolve the default while you remain on the bonded project. Generally, you will still be better off than if the surety has to find someone to complete the bonded contract. Control your own destiny and fight to stay on the bonded project.

 

Arthur Sonneland

Arthur is a Claims Attorney with Old Republic Surety. He has a Bachelor of Arts in Democracy and Justice Studies (summa cum laude) from the University of Wisconsin-Green Bay and a Juris Doctor from Marquette University Law School. Prior to Old Republic Surety, Arthur held positions as Corporate Counsel for a major supplier to the construction industry as well as a Law Clerk.