Takeover Agreements on Performance Bond Claims: What Are They and How Do They Work?

On many construction projects, the general contractor may be required to furnish a performance bond.  That performance bond guarantees the completion of the prime contract if the general contractor defaults.

A performance bond is a three-party contract between a surety (the party promising to be responsible if the principal fails to perform), the principal (the party who is performing the work—the general contractor), and the obligee (the party who is protected by the performance bond—the owner).

If the general contractor fails to perform its obligations under the prime contract, the performance bond surety may be required to take action in accordance with the performance bond. The performance bond typically provides the surety with several options to remedy the general contractor’s performance default.  One of those options may be “taking over” and completing the general contractor’s scope of work. If the performance bond surety elects to take over the general contractor’s scope of work, it is prudent for the owner and the surety to execute a “takeover agreement.”

What Happens If the General Contractor Fails to Perform?

If the general contractor fails to perform its scope of work, the owner should review the requirements of the performance bond. These requirements will typically include notice and procedural requirements in order for the surety to be required to take action.

For example, if the general contractor has provided an AIA (American Institute of Architects) A312 performance bond for the project, the surety’s obligations under that performance bond will not arise until:

1. the owner provides notice to the surety and the general contractor that the owner is considering declaring the general contractor in default, and possibly hold a conference between the owner, surety, and general contractor;
2. the owner declares the general contractor in default, terminates the prime contract with the general contractor, and notifies the surety; and
3. the owner has agreed to pay the balance of the contract price in accordance with the prime contract to the surety, or to a contractor selected to perform the prime contract.

When the owner has satisfied the requirements under the performance bond, the surety will be required to act in accordance with the performance bond. From there, the surety has options when faced with a general contractor default.

For example, the surety may:

1. arrange for the general contractor to perform and complete the work, with the owner’s permission;
2. undertake to perform and complete the prime contract itself, through its agents or independent contractors;
3. obtain a new contractor to perform the work by obtaining bids and executing a contract with a new general contractor; or
4. waive its rights and make payment to the owner.

Usually, owners, without any real construction management capabilities, prefer for the surety to elect to take over and complete the scope of work in the prime contract. Sureties may also prefer to take over and complete the prime contract because “[b]y completing the project itself, the surety obtains greater control than it would have had if it elected to require the obligee [the owner] to complete, because the surety can select the completing contractor or consultants to finish the project as well as control the costs of completion.” Seawatch at Marathon Condo. Ass’n, Inc. v. Guarantee Co. of N. Am., 286 So. 3d 823, 828 (Fla. 3d DCA 2019).

What is a Takeover Agreement and Why Is It Important?

A takeover agreement is an agreement between the prime contractor’s performance bond surety and the obligee [the owner], which is “the critical document for the completing surety and obligee in defining their future rights and obligations in establishing a clear understanding of the scope of remaining work to be completed.”  Id. (quoting Philip L. Bruner & Patrick J. O’Connor, Jr., 4A Bruner & O’Connor on Construction Law § 12:80 (2009)). The takeover agreement is important because it reiterates the surety’s obligations under the bond, and is the express contract between the surety and the obligee that provides the basis, if any, for a contract claim. XL Specialty Ins. Co. v. Commonwealth, Dep’t of Transp., 624 S.E.2d 658, 665 (2006).

A well drafted takeover agreement should include and specify the following:

• a clear scope of remaining work to be completed by the surety;
• the remaining contract balance;
• the completion date for the remaining scope of work;
• any amount of liquidated damages for delays in completing the work; and
• method of dispute resolution.

Although the surety may not agree, owners should avoid language that limits the surety’s liability to the penal sum of the performance bond [the dollar amount stated in the prime contractor’s performance bond].

What Happens If the Surety Takes Over the General Contractor’s Work?

If the surety takes over the general contractor’s work, the surety is permitted to hire the original general contractor to complete the work, unless the performance bond provides otherwise. See id. (holding that by the express terms of the performance bond, the surety is permitted to hire the original contractor).  The surety is also permitted to hire a different contractor to complete the general contractor’s scope of work.

Conclusion

If, after the general contractor defaults on a construction project, the surety elects to take over its work, it is important for the owner and the surety to execute a takeover agreement. The takeover agreement establishes a clear understanding of the scope of remaining work to be completed by the surety. Owners should keep the end of the project in mind and negotiate a takeover agreement with the surety that minimizes potential disputes and mitigates loss.