By Kurt C. Faux, Esq.1 and Colin R. Chipman, Esq.

The downturn in the construction industry and the corresponding insolvency of many contractors has caused an ever increasing focus on the role of surety bonds. Despite the growing attention, the role of surety bonds is still often misunderstood by owners, contractors and subcontractors alike. As the title suggests, this article intends to provide an overview and introduction to the different types of construction bonds, which a Nevada construction law practitioner encounters most often.

INTRODUCTION

A surety is defined as someone who contracts to answer for the debt or default of another.2 A bond involves a tripartite relationship between a surety, a principal and an obligee. A construction bond is a guarantee, in which the surety guarantees that the contractor or subcontractor, called the “principal”, will perform the obligations stated in the bond. The obligee is the person or entity to whom the principal and the surety owe their obligation. The penal sum is the total amount the surety is obligated to pay, if the principal fails to meet its obligations.

Traditionally, the obligee (such as an owner) demands a bond from the contractor (principal) who then obtains a bond from the surety, typically through an agent. Before a surety provides a bond, it will almost always require indemnification from the principal and personal indemnification from individuals, including the principal‟s owners, spouses, business associates or interested parties. The indemnification agreement requires the indemnitors to protect the surety from any and all losses incurred as result of issuing the bonds, including reimbursement of bond loss payments, attorneys‟ fees, consultants‟ fee, and litigation costs.

A surety bond is not an insurance policy.3 Bonds are financial arrangements, similar to bank loans, which should not result in any loss to the surety, just as a bank does not expect a loss when it makes a loan. Insurance on the other hand, assumes a risk of loss based on ratings. Accordingly, the premiums for obtaining bonds are typically much less than those for insurance policies and a surety will often ask the principal to provide collateral security to the surety.

The Three Typical Construction Bonds

Bid Bonds

A bid bond secures a contractor‟s bid. These are typically required on public construction projects. If the principal is the successful bidder but refuses to sign the contract, the surety may be called upon to pay some or all of the penal sum of the bond to the obligee. If the principal is awarded the contract but then unjustly refuses to enter into the contract, the owner must necessarily pay more in contracting with the next lowest bidder. The bid bond is generally designed to protect the owner against this additional expense.4

Performance Bonds

A performance bond promises the obligee that the principal will perform the construc(Continued from page 1) tion contract. These bonds limit the surety‟s maximum exposure to the penal sum of the bond and often contain specific notice provisions for asserting a claim, limit the time period in which to commence a lawsuit against the surety, and typically incorporate the terms of the construction contract.5 The importance of such provisions cannot be underestimated, as these form the basis upon which the surety will determine how to proceed and/or the validity of a claim. For example, the American Institute of Architects performance bond form A312 (“AIA A312″), which is frequently used, states that the surety may, after proper notice of the principal‟s default:

4.1 Arrange for the Contractor, with consent of the Owner, to perform and complete the Construction Contract; or

4.2 Undertake to perform and complete the Construction Contract itself, through its agents or through independent contractors; or

4.3 Tender a new contractor, secure payment and performance and equivalent to the bonds issued on the Construction Contract, and pay to the Owner the amount of damages incurred by the Owner resulting from the contractor‟s default; or

4.4 Determine not to proceed with steps one through three, after an investigation, and tender to the Owner the amount for which it may be liable or deny liability in whole or in part and notify the Owner citing the reasons therefor.6

Payment Bonds

A payment bond, which often accompanies a performance bond, requires the surety to pay laborers, materialmen, suppliers, and subcontractors if the principal fails to pay them. These bonds also frequently contain conditions that must be met before a surety is required to pay under the payment bond, such as notice provisions. Additionally, sureties are entitled to assert all the defenses the principal has against any bond claimants. For example, if a principal refuses to pay a supplier for its failure to timely deliver a product or if the product fails to comply with contract specifications, then the surety may likewise not be responsible to pay such a claimant. If the bond is issued pursuant to a particular statute, the terms of that statute will be incorporated into the bond – even if the statute is not mentioned in the bond.7

BONDS FOR PUBLIC WORKS PROJECTS

Bonds are required on both State and Federal construction projects. The purpose of these bonds is to protect those who supply labor or materials as mechanic‟s liens, which can be recorded on private projects, are not available on public works.8 These bonds, however, protect only certain entities, have specific notice requirements, and contain short time frames within which to commence litigation. The federal statute requiring such bonds is referred to as the Miller Act. Similar state statutes are referred to as Little Miller Acts.

Federal – The Miller Act

The Miller Act requires a contractor, who is awarded a “contract of more than $100,000 … for construction, alteration or repair any public building or public work of the Federal Government” to post two bonds: a performance and labor and material payment bond.9

To prove a claim under the Miller Act payment bond, a claimant must show that:

a. It supplied material or labor in prosecution of the contract work;

b. Payment has not been provided;

c. There is a good faith belief that materials were intended for the contract work; and

d. Timely notice and filing requireContinued from page 7) Page 8 Construction Law Newsletter Volume 1, Issue 2, July 2010 ments are met.10

A proper beneficiary is one who has contracted expressly or impliedly with the prime contractor or directly with the subcontractor. Absent this contractual relationship a claimant is too “remote.”11

The Miller Act payment bond covers subcontract and supplier who have direct contract with the prime contractor. Subcontractors and material supplier who have contracts with a subcontractor are also covered. However, under the statutory scheme, those who supply labor and materials to suppliers, as opposed to subcontractors, are not proper beneficiaries.12 Therefore, whether one is a subcontractor or supplier is critical. The Miller Act does not define the term subcontractor, but the Supreme Court has held that a subcontractor is one who “performs for and takes from the prime contractor a specific part of the labor or material requirements of the original contract.”13 The actual function of the subcontractor – and the subcontractor‟s importance and substance in relationship with the prime contractor – not contract labels is outcome determinative.14

The Miller Act protects laborers (those who physically toil on the project) and suppliers of the bond principal. For an architect, engineer or other professional to recover, evidence must be provided that on-site supervisory or inspection services were performed.15 Attorneys‟ fees of a claimant are not recoverable absent a federal statute, or an enforceable contractual provision providing for the award of attorneys‟ fee.16

Those claimants not having a direct contractual relationship with the prime contractor must provide written notice to the prime contractor within 90 days from the date on which the claimant provided the last of the labor or material for which the claim was made.17 This notice must state with substantial accuracy the amount claimed and the cipal has against any bond claimants. For example, if a principal refuses to pay a supplier for its failure to timely deliver a product or if the product fails to comply with contract specifications, then the surety may likewise not be responsible to pay such a claimant. If the bond is issued pursuant to a particular statute, the terms of that statute will be incorporated into the bond – even if the statute is not mentioned in the bond.7 BONDS FOR PUBLIC WORKS PROJECTS Bonds are required on both State and Federal construction projects. The purpose of these bonds is to protect those who supply labor or materials as mechanic‟s liens, which can be recorded on private projects, are not available on public works.8 These bonds, however, protect only certain entities, have specific notice requirements, and contain short time frames within which to commence litigation. The federal statute requiring such bonds is referred to as the Miller Act. Similar state statutes are referred to as Little Miller Acts. Federal – The Miller Act The Miller Act requires a contractor, who is awarded a “contract of more than $100,000 … for construction, alteration or repair any public building or public work of the Federal Government” to post two bonds: a performance and labor and material payment bond.9 To prove a claim under the Miller Act payment bond, a claimant must show that: a. It supplied material or labor in prosecution of the contract work; b. Payment has not been provided; c. There is a good faith belief that materials were intended for the contract work; and d. Timely notice and filing requireContinued from page 7) Page 8 Construction Law Newsletter Volume 1, Issue 2, July 2010 ments are met.10 A proper beneficiary is one who has contracted expressly or impliedly with the prime contractor or directly with the subcontractor. Absent this contractual relationship a claimant is too “remote.”11 The Miller Act payment bond covers subcontract and supplier who have direct contract with the prime contractor. Subcontractors and material supplier who have contracts with a subcontractor are also covered. However, under the statutory scheme, those who supply labor and materials to suppliers, as opposed to subcontractors, are not proper beneficiaries.12 Therefore, whether one is a subcontractor or supplier is critical. The Miller Act does not define the term subcontractor, but the Supreme Court has held that a subcontractor is one who “performs for and takes from the prime contractor a specific part of the labor or material requirements of the original contract.”13 The actual function of the subcontractor – and the subcontractor‟s importance and substance in relationship with the prime contractor – not contract labels is outcome determinative.14 The Miller Act protects laborers (those who physically toil on the project) and suppliers of the bond principal. For an architect, engineer or other professional to recover, evidence must be provided that on-site supervisory or inspection services were performed.15 Attorneys‟ fees of a claimant are not recoverable absent a federal statute, or an enforceable contractual provision providing for the award of attorneys‟ fee.16 Those claimants not having a direct contractual relationship with the prime contractor must provide written notice to the prime contractor within 90 days from the date on which the claimant provided the last of the labor or material for which the claim was made.17 This notice must state with substantial accuracy the amount claimed and the name of the party for whom the services were performed or materials supplied. Notice must be sent by registered mail, postage prepaid, to the contractor at any place he maintains an office or conducts his business, or his residence.

Suit to enforce bond rights must be commenced within one year after the day on which the last of the labor was performed or material was supplied by him. This suit must be brought in the United States District Court for any district in which the contract was to be performed, and executed, irrespective of the amount in controversy.18 Miller Act claims filed in state court will be dismissed for lack of subject matter jurisdiction of the state court.19

Nevada’s Little Miller Act

Nevada‟s Little Miller Act is found at Nevada Revised Statute 339.025. Its provisions are similar to the Federal Miller Act. However, a preliminary 30 day notice is also required (in addition to the 90 day post work notice) of a claimant who has a direct contractual relationship with a subcontractor but no contractual relationship with the contractor. Failure to give the 30 day notice may be fatal to a claim.20 An awareness that the claimant is on the project or supplying materials does not satisfy the written notice requirement, nor does a brochure which does not set forth the amount of the claim.21 Legal action must be commenced within one year of last supplying labor or materials.22 Certain subcontractors are also required to post bonds. NRS 339.025(2).

Highways and Roads

Nevada Revised Statute 408.363 sets forth the procedures for claiming against a bond furnished for the construction of highways and roads on Nevada Department of Transportation projects. To recover on such bonds, among other things, an action must be commenced within six months after the date of the Department‟s final acceptance of the project.23 Claimants are also required to file with the Department a claim in triplicate within 30 days from the date of final acceptance of the contract, executed and verified before a notary public and can contain a statement that the claimant has not been paid.24 One copy of the claim is to be filed in the Department and the remaining copies are to be forwarded to the contractor and the surety.25

PRIVATE PERFORMANCE AND PAYMENT BONDS

Bonds for private works may be mandated by statute or required by the owner or lender as part of the contract. Bonds required by an owner for private works are referred to as common law bonds and may take as many different forms as there are contracts.

Statutory Private Bonds

An example of a statutory private bond is the contractors license bond required by Nevada Revised Statute 624.270 and issued on forms mandated by the Contractors Board. A license bond must be obtained before the Nevada State Contractors Board will issue a license. The amount of the bond required may range from $1,000 to $500,000.26 The license bond requirement may be waived after a licensee has acted in the capacity of a contractor for five years. As set forth by NRS 624.273, the Nevada State Contractor Board license bond form identifies certain conditions to assert a claim and also identifies the bond beneficiaries.27 There is a two year statute of limitation.28 A claim of an employee of the contractor for labor is a preferred claim against a license bond.29 Claims, other than claims for labor, have equal priority. If the bond is insufficient to pay all claims, then claimants must be paid pro rata.30 The surety may deposit the bond sums with the court in the event of multiple, competing claims exceeding the penal sum of the bond in order to satisfy all bond claims. This process is referred to as interpleader. When this is done, the surety is entitled to deduct costs from the bond before depositing the funds with the court.31 The court will then, upon motion, determine the amount, if any, to be paid to each claimant. Pool contractors in Nevada are subject to additional bonding notification requirements.32 All pool contractors must include in written contracts with residential purchasers that a performance bond may be required of the pool contractor by the owner.33 Additional bonds may be required of a pool contractor before obtain its contractors license.34

Common Law Bonds

An owner may demand a performance and/or payment bond although not required by statute. Such a bond is a private contract. It must be carefully reviewed to determine the beneficiaries, the claim procedures and the scope of the surety‟s obligations. American Institute of Architects A312 performance bond is widely used performance bond form. This form contains important provisions regarding: the scope of the bond obligation; the conditions precedent before the surety‟s liability arises; the surety options in the event of the principal‟s default; the surety‟s liability limitations; and suit limitation period.35

The AIA A312 performance bond provides the following conditions precedent:

3.1 The Owner has notified the Contractor and the Surety at its address described in Paragraph 10 below that the Owner is considering declaring a Contract Default and has requested and attempted to arrange a conference with the Contractor and the Surety to be held not later than fifteen days after receipt of such notice to discuss methods of performing the Construction Contract. If the Owner, the Contractor and the Surety agree, the Contractor shall be allowed a reasonable time to perPage 10 Construction Law Newsletter Volume 1, Issue 2, July 2010 form the Construction, but such an agreement shall not waive the Owner‟s right, if any subsequently to declare a Contractor‟s Default; and

3.2 The Owner had declared a Contractors Default and formally terminated the Contractor‟s right to complete the contract. Such Contractor Default shall not be declared earlier than twenty days after the Contractor and Surety have received notice as provided in Subparagraph 3.1; and

3.3 The Owner has agreed to pay the Balance of the Contract Price to the Surety in accordance with terms of the Construction Contract or to a contractor selected to perform the Construction Contract in accordance with the terms of the contract with the Owner.36 Courts around the country have consistently held that the foregoing notice requirements and other provisions of paragraph 3 of the AIA A312 performance bond are material and an obligee‟s failure to comply with them exonerates the surety’s obligation to perform under paragraph 4 of the performance bond.37

The AIA also publishes a companion payment bond – the AIA A312 payment bond. The bond contains terms that limit the surety‟s exposure and mandates specific notice procedures. For example, the AIA A312 payment bond provides the following:

4. The surety shall have no obligation to Claimants under this Bond until.

4.1 Claimants who are employed by or have a direct contract with the Contractor have given notice to the Surety, and sent a copy, or notice thereof, to the Owner, stating that a claim is being made under this Bond and, with substantial accuracy, the amount of the claim.

With regard to the notice, the AIA A312 payment bond provides:

5.1 Have furnished written notice to the Contractor and sent a copy, or notice thereof, to the Owner, within 90 days after having last performed labor or last furnished materials or equipment included in the claim stating, with substantial accuracy, the amount of the claim and the name of the party to whom the materials were furnished or supplied or for whom the labor was done or performed; and

5.2 Have either received a rejection in whole or in part from the Contractor, or not received within 30 days of furnishing the above notice any communication from the Contractor by which the Contractor has indicated the claim will be paid directly or indirectly; and

5.3 Not having been paid within the above 30 days, have sent a written notice to the Surety, and send a copy, or notice thereof, to the Owner, stating that a claim is being made under this Bond and enclosing a copy of the previous written notice furnished to the Contractor. The AIA A311 is another bond form that is used in private construction.

The AIA A311 Performance Bond form is similar to A312, in that the surety and the principal are jointly and severally liable for the performance of the contract, which is incorporated by reference. However, the AIA A311’s provisions regarding conditions precedent to the surety‟s liability and surety option are less detailed. The AIA A311 performance also has its companion payment bond form. This form, like the AIA 312 payment bond, contains terms limiting the surety‟s exposure and mandating specific notice procedures for claimants.

The Engineers Joint Contract Documents Committee and the Associated General Contractors of America also promulgate a common law payment bond with specific notice and claim requirements.38 A claimant without a direct relationship with the principal must provide written notice to two of the following: Principal, Obligee, or the Surety, within ninety days after the Claimant did or performed the last of the work or labor, or furnished the last of the materials for which the claim is made, stating with substantial accuracy the amount (Continued from page 10) claimed and the name of the party to whom the materials were furnished, or for whom the work was performed.39 Such notice must be served by mailing it by registered or certified mail.40

CONCLUSION

Whether the construction economy in Nevada regains its previous strength or continues in its current downturn, the role of construction bonds will continue to be of upmost importance. It is critical that contractors and subcontractors read the actual bond form that has been issued for their work and those bonds on which they may be potential claimants. This needs to be done before the possibility of a claim arises. Whether prosecuting a bond claim or defending and/or participating with a surety in the defense of a bond claim, knowledge of the terms and conditions of the specific bond at issue can prove to be a lynchpin or a fatal flaw to a successful claim or defense. As explained above, the typical construction bonds in Nevada contain different terms and condition, with which a potential claimant must comply if that claimant hopes that the surety will pay its claim. On the other hand, a failure to comply with the terms of the bond will most likely be fatal to any bond claim. In short: Read the Bond!

1 Kurt Faux is the President of The Faux Law Group, a Las Vegas based law firm, which representing sureties, insurers, contractors
and others involved in the construction industry in Nevada, Utah and California. He is an acknowledged expert is
surety and mechanics lien law. Mr. Faux has written papers for numerous groups concerning surety bonds, Nevada construction
law, and legal ethics.
2 Stearns, The Law of Suretyship ‘ 1.1 (5th Ed. W.H. Anderson Co., 1951)
3 Insurance Co. of the West v. Gibson Title Co., Inc., 122 Nev. 455, 134 P.3d 698, 702 (2006); Great American Ins. Co. v.
General Builders, Inc., 113 Nev. 346, 355; 934 P.2d 257, 263 (1997)
4 See, e.g., American Fire and Electric v. City of North Las Vegas, 109 Nev. 357, 849 P.2d 352 (1993).
5 American Institute of Architects A201, General Conditions of the Contract for Construction; American Institute of Architects
AIA101, Standard Form of Agreement Between Owner and Contractor.
6 American Institute of Architects A312, performance and payment bond, 1984 edition.
7 Capriotti, Lemon & Assoc., Inc. V. Johnson Service Co., 84 Nev. 318, 440 P.2d 386 (1968).
8 United States for use of Wulff v. CMA, Inc., 890 F 2d 1070 (9th Cir. 1989).
9
40 U.S.C. ‘ 3131(b).
10 United States ex rel. Hawaiian Rock Products Corporation v. A.E. Lopez Enterprises, Ltd., 74 F 3d 972 (9th Cir. 1996)
11 Wulff v. CMA, Inc., 890 F.2d 1070 (9th Cir. 1989)
12 Clifford F. MacEvoy Co. V. United States, 322 U S 102 (1944) (suppliers to materialman denied relief).
13 Id. At 109.
14 F.D. Rich Co. V. United States for the Use of Indust. Lumber Co., 417 U.S. 116 (1974), Gulf States Enterprises v. R.R.
Tway, Inc., 938 F.2d 583, 587 (5th Cir. 1991)
15 United States v. W.H. Cates Constr. Co., Inc., 972 F.2d 987 (8th Cir. 1992) (recovery by project manager and estimator
performing on-site work allowed).
16 F.D. Rich, see note 13.
17 40 USC ‘ 133(b).
18 40 USC 3133(3)(B).
19 Airport Constr. & Materials, Inc. V. Bivens, 649 S.W.2d 830 (Ark 1983).
20 AMFAC Distrib. Corp. V. Housing Auth., 100 Nev. 573, 688 P.2d 318 (1984).
End Notes: Introduction to Large Bonds
Page 13 Construction Law Newsletter Volume 1, Issue 2, July 2010
21 Garff v. J.R. Bradley Co., 84 Nev. 79, 436 P.2d 428 (1968); Capriotti, 84 Nev. 318, 440 P.2d 386 (1968).
22 NRS 339 055(2)
23 NRS 408.363(2)
24 NRS 408.363(1)
25 Id.
26 NRS 624.270(4)
27 NRS 624.273(1)(a)-(d).
28 The Nevada State Contractors License Bond form provides that ANo action may be commenced on the bond… 2 years
after the commission of the act on which the action is based.@ See also NRS 624.273(2).
29 NRS 624.273(6)
30 NRS 624.273(7)
31 NRS 624.273(5)
32 See NRS 624.276
33 NRS 597.719(2); NAC 624.6964(7).
34 NRS 624.270(8)
35 AIA Document A312, performance bond (1984).
36 Id.
Page 14 Construction Law Newsletter Volume 1, Issue 2, July 2010
37 See, e.g., U.S. Fidelity and Guar. Co. v. Braspetro Oil Services Co., 369 F.3d 34, 51 (2nd Cir.2004) (stating that
AParagraph 3 of the [AIA A312] Bonds contained a number of conditions precedent to the Sureties’ obligations under the
Bonds.@); AgGrow Oils, L.L.C. v. National Union Fire Ins. Co. of Pittsburgh, 276 F.Supp.2d 999, 1017 (D.N.D.2003)
(A[T]he requirements of paragraph 3 are conditions precedent to the surety’s bond performance.@), aff’d, 420 F.3d 751
(8th Cir.2005); Bank of Brewton, Inc. v. Int’l Fid. Ins. Co., 827 So.2d 747, 754 (Ala.2002) (“The [owner] was required
by the performance bond to give proper notice, to call a meeting, to discuss the problems, and to attempt to resolve them;
and then to declare a contractor default, formally terminating the contractor’s right to complete the contract at least 20
days after giving notice; and to agree to pay the balance of the contract to the surety or to a new contractor who would
complete the contract as originally agreed.”); LBL Skysystems (USA), Inc. v. APG-America, Inc., 2006 WL 2590497 at
23 (E.D.Pa. Sept. 6, 2006) (Athe language of Paragraph 3 of the Performance Bond . . . creates conditions precedent to
the duty of the surety@); Donald M. Durkin Contracting, Inc. v. City of Newark, 2006 WL 2724882 (D.Del. Sept. 22,
2006) (dismissal of owner‟s claim for failure to comply with paragraph 3 of the AIA 312 performance bond); Enterprise
Capital , Inc. v. San-Gra Corp. 284 F. Supp 2d 166, 177-179, 182-183 (D.Mass., 2003) (discharging the surety of liability
under an AIA A312 Performance Bond due to the obligee‟s failure to comply with the conditions of the bond.); Hudson
Development, LLC v. DiNunno, 8 A.D. 3d 77 (App. Div. 1st Dept‟t 2004) (“ [The obligee‟s] failure to comply with the
notice provisions of the performance bond issued by [the surety] precludes it from maintaining this action for damages
against the bond‟s surety.”); United States ex rel. Platinum Mechanical, LLC v. U.S. Surety Co., No. 07 Cv. 3318(CLB),
2007 WL 4547849, *3 (S.D.N.Y. Dec. 21, 2007) (granting summary judgment to surety where owner failed to provide
proper notice under AIA A312 performance bond that it was considering declaring contractor in default); and 120 Greenwich
Development Associates, LLC v. Reliance Ins. Co., No. 01 Civ. 8219(PKL), 2004 WL 1277998, *12 (S.D.N.Y.
June 4, 2004) (holding that the language of Paragraph 3 “creates unambiguous preconditions for triggering [the surety’s]
obligations under the Bond”). See also, Dragon Construction, Inc. v. Parkway Bank & Trust, 678 N.E.2d 55 (Ill. Ct. App.
1997)(finding “that the [obligee‟s] failure to provide adequate notice of [the principal‟s] termination and hiring of a successor
contractor before [the surety] received the late notice stripped [the surety] of its right to limit its liability and constituted
a material breach of contract which rendered the surety bond null and void.”); Seaboard Surety Co. v. Town of
Greenfield, 266 F.Supp.2d 189, 195-196 (D.Mass., 2003), aff‟d by Seaboard Surety Co. v. Town of Greenfield, 370 F.3d
215 (1st Cir. 2004) (holding that owner Aabsolutely deprived [the surety] of its rights under the Bond@ when it contracted
with a different contractor without first allowing the surety opportunity to fulfill its completion options.); Elm
Haven Construction Ltd., at 100-01 (improper notice and may serve as a complete dismissal of any claims against the
surety); L&A Contracting Company v. Southern Concrete Services, Inc., 17 F. 3d 106, 111, fn. 19 (5th Cir. 1994)
(“L&A‟s failure to declare Southern in default excuses F&D‟s failure to remedy Southern‟s breach. F&D did not breach
the terms of its bond and accordingly has no liability under the bond.”); Hunter Constr. Group, Inc. v. Nat‟l Wrecking
Corp., 542 F. Supp. 2d 87, 96 (D.D.C. 2008)(“Where the obligee fails to notify a surety of an obligor‟s default in a
timely fashion, so that the surety can exercise its options under the controlling performance bond, the obligee renders the
bond null and void.”).
38 See EJCDC C-615(A) Payment Bond.
39 Id.at paragraph 4.2
40 Id. at paragraph 5.

(Published originally in the Construction Law Newsletter Volume 1, Issue 2, July 2010)