New Year, New Performance Bond: The AIA A312-1984 Performance Bond Expires Dec. 31, 2011

As 2011 draws to a close and the holiday season is in full swing, it’s good to take time away to spend with loved ones, reflect on the year’s accomplishments, and – for those in the construction industry – undertake the heartwarming task of reviewing your company’s performance bond forms in anticipation of a bright and busy new year. This time of joyful reflection is even more rewarding when the coming new year will bring with it some major changes to the standard performance bond form issued by the American Institute of Architects.

On Dec. 31, 2011, the standard A312 performance bond form published by the AIA in 1984 will officially become a thing of the past. A312 has been used as an industry standard bond form since its release more than 25 years ago, with no changes made until the revised form A312 was published in June 2010. With the official retirement of the 1984 version, some reflection on the differences between the old and new forms is justified.

The 2010 revisions to A312 made several important changes, primarily focusing on (1) streamlining the process by which defaults can be raised and cured and (2) clarifying the Surety’s exposure.

1. Default Process Streamlined

Under the revised 2010 version of A312, the process by which an Owner (or other obligee) can declare a non-performing Contractor (or other principal) in default has been significantly streamlined. Section 3.1 no longer requires the Owner to “attempt[] to arrange a conference with the Contractor and Surety” before declaring the Contractor in default, as was required by the 1984 version of A312. Instead, the Owner may simply notify the Contractor and Surety that it is “considering declaring a Contractor Default.” In connection with this notice, the Owner may request a conference among itself, the Contractor and the Surety, but—unlike in the 1984 version—it is not required to do so. After receipt of the Owner’s notice, the Surety has the option of requesting a conference among the parties, thereby effectively shifting the burden of conferring with the parties to the Surety instead of the Owner. Critically, however, the revised A312 has added a new Section 4, which expressly provides that none of the notice provisions set forth in Section 3.1 are conditions precedent to the Surety’s performance, except to the extent that the Surety can demonstrate “actual prejudice.”

In addition to the scaled-down conference requirements of Section 3.1, Section 3.2 now requires only that the Owner “declares a Contractor Default, terminates the Construction Contract and notifies the Surety[.]” Section 3.3 remains largely the same, requiring that the Owner agree to pay the Contract Balance to the Surety or its replacement contractor. The changes to Sections 3.1, 3.2 and 4 greatly diminish the impediments presented to an Owner seeking the intervention of the Surety.

These changes have the practical effect of reducing the Owner’s waiting period for declaring a Contractor default from at least 20 business days (if not much more) to as few as five business days. Similarly, pursuant to the new Section 6, if the Surety fails to act in response to the Contractor’s initial letter with “reasonable promptness,” it shall be deemed in default seven days after receipt of an additional notice from the Owner. This seven day waiting period is a substantial reduction from the previous version of A312, which required a 15-day period before the Surety could be deemed in default.

2. Surety’s Exposure Clarified.

In addition to streamlining the default process, revisions to former Section 6 of A312 and the addition of a new Section 8 seek to define more clearly the scope of the Surety’s responsibilities, depending upon which remedy the Surety elects to provide the Owner in the event of a Contractor default. These more nuanced provisions of the revised A312 should help prevent a situation in which the Surety assumes responsibility for completing a project, exhausts the penal sum of the bond before construction is completed and subsequently walks off the job site.

If the Surety elects to take over the work of the Contractor and perform in its place (either by self-performing or hiring a replacement contractor of its own choosing), then the Surety’s obligations to the Owner are limited only by the obligations of the original Contractor under the Contract, which could present significant exposure to a Surety over and above the penal sum on the bond. If, on the other hand, the Surety elects to (1) arrange for the original Contractor to complete the Contract, subject to the Owner’s consent, or (2) arrange for a substitute contractor to contract directly with the Owner, then the Surety’s exposure is limited to the obligations of the Contractor under the original Contract or the penal sum of the bond – whichever is less. Finally, if the Surety waives its right to perform on behalf of the Contractor or simply determines that the Contractor is not in default, the Surety’s exposure is capped at the amount of the penal sum of the bond.

In sum, these changes to A312 counsel in favor of closely reviewing any performance bonds used on a given project to ensure that both Contractor and Surety performance is properly secured. Like all performance bonds, whether standardized or not, the terms of A312 define performance required by the parties. Whether or not a business relies on the AIA bond forms, another vendor, or its own internal forms, it is critical to understand and appreciate the legal force and effect of the forms selected.