Discharge of Surety

Good news to a drafted serviceman used to be his forthcoming “discharge.” Similarly, good news to a construction bonding company is its discharge.

Discharge of a bonding (sometimes called surety ) company may occur when the principal on the bond (usually the general contractor) has fulfilled his obligations. Additionally, a bonding company may be discharged by occurrences during construction.

In this context “discharge” means that the bonding company is either fully or partially relieved of its obligations-depending on the circumstances prompting the discharge.

Two construction-phase events which may discharge a bonding company’s performance bond obligations are:

( 1 ) a material change in the contract between the owner and general contractor without consent of the bonding company, or (2) the owner’s failure to live up to the general construction contract requirements.

Since the bonding company only agrees to assure performance under the contract in effect when it posts the performance bond, a material change in the contract between the owner and contractor which increases the bonding company’s risk will usually result in a discharge.

For example, if the owner and contractor agree to add a fourth story onto the originally contemplated two-story building, thus doubling the construction cost, without the consent of the bonding company, the surety company would not ordinarily be held responsible for the full performance obligations of the contractor under the revised contract absent its consent.

Also, the bonding company’s performance bond obligations to the owner would be reduced if the owner does not comply with the underlying construction contract payment requirements. Either underpayment or overpayment to the contractor may relieve the bonding company of obligations.

It is easy to understand that a bonding company might be prejudiced by underpayment-if the general contractor is not paid on time his ability to perform may suffer.

Overpayment may have the same effect because performance bonds are usually issued together with labor and material payment bonds under which the bonding company undertakes to assure payment for labor and materials.

One very important assurance of payments for labor and materials (and of contractor performance as well) typically found in the construction contract is the retainage provisions. They require the owner to retain amounts from periodic payments due the contractor (commonly 10%) until final completion. The retainage fund thus becomes a vehicle to assure contractor performance and payments for labor and materials be cause the release (payment) of retainage usually requires the contractor’s assurance that his subcontractors and suppliers have been paid.

Naturally, if an owner decides to stop withholding retainage from his general contractor contrary to the contract terms, a prejudice to the surety may result if the contractor defaults in performance or does not make payments for labor and materials used on the job. Retainage monies would not be available to the bonding company to make up for the contractor’s defaults.

Therefore, to the extent that the bonding company has been adversely affected by such an overpayment, its bond obligations to the owner would be proportionately discharged-unless, of course, the bonding company had consented to the change in the terms of payment.

The lesson to be learned from the “discharge of surety” principle is that owners and other persons who may need to look to bonds for their protection must make sure that they, themselves, comply with the terms of their bonded contracts and that they agree to no revisions without consideration of their affect upon applicable surety bonds.

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