Defence & Indemnity - October 2017: V. SURETY AND BOND ISSUES

by Field Law
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V. SURETY AND BOND ISSUES
A. The Alberta Court of Queen’s Bench holds surety liable under a performance bond for consequential damages suffered by an obligee as result of defaulting contractor.
 
Vermilion & District Housing Foundation v Binder Construction Limited, 2017 ABQB 365, per Nielsen, J. [4242]
 
I. FACTS AND ISSUES
In 2004, Binder Construction Limited (“Binder”), as general contractor, entered into a construction contract (the “Bonded Contract”) with Vermilion & District Housing Foundation (“Vermilion”) for the construction of an addition to and the modernization of an existing senior’s lodge (the “Project”). Binder’s scope of work included the supply and installation of resilient sheet flooring (“RSF”) for the Project.

Binder obtained a performance bond (the “Performance Bond”) issued by The Guarantee Company of North America (“GCNA”). The Performance Bond named Binder as principal, Vermilion as obligee, and GCNA as surety.

Following completion of the Project, problems were encountered with the RSF which had been installed. In 2006, an inspection of the RSF determined that excessive moisture from either groundwater or a high water table and hydrostatic pressure appeared to have forced moisture through the floor slab which was then trapped under the RSF, causing the adhesive to break down and the RSF to bubble and ripple.

After Binder and GCNA failed to provide Vermilion with any solution, in 2009 Vermilion installed weeping tile and replaced the defective RSF. In having that work carried out, Vermilion incurred substantial costs. Vermilion also suffered a loss of income as residents had to vacate the premises while the flooring was replaced.  

Vermilion sued Binder, GCNA and others, advancing a number of claims including breach of the Bonded Contract and seeking recovery against GCNA pursuant to the Performance Bond. Vermilion sought to recover the costs incurred to install the weeping tile and to replace the RSF and recovery for its loss of income, however, the total amounts claimed were less than the penal sum of the Performance Bond.
II. HELD: Binder was held liable for 65% of Vermilion’s damages for its negligence and breach of the Bonded Contract and GCNA was held liable under the Performance Bond for the amounts awarded against Binder, including loss of income.

The Court held the work of Binder was deficient, it breached its obligations under the Bonded Contract, and was negligent. The Court apportioned Vermilion’s damages between Binder (65%) and the architect (35%). After some reductions in quantum, the Court awarded damages against Binder and the architect for the costs of the weeping tile, the cost of replacing the RSF, and the loss of income claimed. The Court held that GCNA’s liability was co-extensive with that of Binder under the Performance Bond, including for the loss of income awarded.
 
On the liability of GCNA, the Court reiterated that when interpreting a performance bond, the Court must consider “the terms of the underlying contractual relationship and the degree to which the obligations outlined therein are incorporated into the bond by reference: APM Construction Services Inc v Caribou Island Electric Ltd, 2013 NSCA 62 at para 62, 330 NSR (2d) 182.”

The Court noted there was conflicting case law on whether a surety could be liable for costs beyond the “bricks and mortar”, such as liquidated damages or collateral money obligations found in bonded contracts:

[296]      In Whitby Landmark Development Inc v Mollenhauer Construction Ltd (2003), 178 OAC 49, [2003] OJ No 4000 (CA), the Ontario Court of Appeal held that a surety is obliged to fulfill all of the defaulting contractor’s contractual obligations, including collateral financial obligations such as profit sharing.

[297]      However, in Lac La Ronge Indian Band v Dallas Contracting Ltd, 2004 SKCA 109, [2004] SJ No 531, the Saskatchewan Court of Appeal rejected the reasoning in Whitby Landmark Development Inc, holding that a surety’s obligation is limited to completing the actual physical construction in the event of the contractor’s default and does not extend to a financial guarantee of the payment of liquidated damages.

[298]      In MGN Constructors Inc v AXA Pacific Insurance Co, 2013 ABQB 216, 21 CCLI (5th) 10, Graesser J., in obiter favoured the reasoning in Whitby Landmark Development Inc and opined that a surety could not arrange for completion of the contract in accordance with its terms and conditions unless it was responsible for any acceleration cost to meet the original schedule and any delay damages the owner was entitled to if the schedule was not met.


The Court then looked at the Performance Bond which set out four options open to GCNA in the event of a valid claim. The Court found GCNA was notified in a timely fashion of Binder’s default, but noted neither Binder nor GCNA responded to the notice of default by Vermilion. The Court held that in failing to pursue options 1, 2, or 3, “GCNA elected, by default, to follow option 4; that is, to pay Vermilion the lesser of the Bond Amount or Vermilion’s costs of completion, less the balance of the contract price.”
 
The Court held it would have been within the reasonable contemplation of both Vermilion and GCNA that if it was necessary to remedy defects in Binder’s work, then that remedial work might result in some loss of income to Vermilion: “…such losses would fall within the ‘cost to complete’ the work as set out in option 4 of the Performance Bond. Such costs fall within the indemnity obligations of Binder pursuant to the…” terms of the Bonded Contract.

The Court creatively sidestepped any difficulties posed by the schism found in the Whitby Landmark Development Inc and Lac la Ronge Indian Band decisions by distinguishing both:
 

[316]    Whitby Landmark Development Inc concerned a provision requiring the contractor to pay the owner savings realized in carrying out the contract. Lac la Ronge Indian Band involved a provision entitling the Band to deduct liquidated damages for delay in completion of a sewage lagoon from the amount otherwise payable to the contractor. As Vermilion’s loss of income in this case was directly related to the completion of the work, and was contemplated as such in the Construction Contract, I find this situation to be distinguishable from those in both Whitby Landmark Development Inc and Lac la Ronge Indian Band. Therefore, it is not necessary to comment further on the legal issues addressed in those cases.

    
III. COMMENTARY

 
This decision is of critical importance for the surety industry in Alberta (and other provinces) as it clearly expands the liability of a surety under a performance bond beyond the “bricks and mortar” costs of completing a defaulting contractor’s obligations. While distinguishing both Whitby Landmark Development Inc and Lac la Ronge Indian Band, this decision clearly takes an approach consistent with Whitby Landmark Development Inc in that it finds a surety’s liability is to fulfill all of the defaulting contractor’s contractual obligations.
 
The Court distinguished both the Whitby Landmark Development Inc and Lac la Ronge Indian Band through characterizing Vermilion’s loss of income claim as a “cost to complete”, with those words placed in quotation and coming directly from the wording of the Performance Bond. Without any explicit analysis, the Court clearly interpreted these words to mean the “cost to complete the obligations of the principal under the Bonded Contract”, as the Court expressly cited the indemnity obligations of Binder under the Bonded Contract for which it found the surety liable for.
 
The Court also held that the “loss of income in this case was directly related to the completion of the work”. While the loss of income may have been related to the completion of the remedial work and the time take to complete the same, the perhaps more proper question to ask was: whether this loss of income was directly related to the deficiencies in Binder’s initial work? In this author’s opinion, the answer to this question is no.
 
Damages for loss of income are by definition “consequential” damages, in that they are not the normal loss which every obligee in a like situation will suffer (i.e. the “bricks and mortar” costs), but special to the circumstances of a particular obligee. Consequential losses are anything beyond this normal measure, such as profits lost or expenses incurred through the breach, and are recoverable if not too remote: McGregor on Damages, 15th ed. (London: Sweet & Maxwell, 1988).
 
The indemnity provisions at issue here are common in construction contracts. Any surety who issues a performance bond must now recognize that upon completion of a given project, should any warranty or indemnity obligations arise and the contractor fail to respond, then the surety may well be liable for not only the “bricks and mortar” costs to repair the work, but also any damages arising from the interruption of the business or operation of a given facility or project. These types of damages could add up very quickly leaving a surety exposed to the full value of the penal sum of a performance bond or even worse faced with an argument that the penal sum should not protect the surety as a result of its failure to adequately respond to a given warranty or indemnity claim being made pursuant to a performance bond. 
 
Another important finding by the Court was with respect to the “default” selection of an option under the Performance Bond by GCNA. As mentioned above, both Binder and GCNA failed to provide any solution to Vermilion when the RSF issues arose. The Performance Bond gave GCNA four options in the event of Binder’s default. Those options were:

  1. To remedy the default;
  2. To complete the Bonded Contract in accordance with its terms and conditions;
  3. To obtain a bid for submission to Vermilion for completing the Bonded Contract in accordance with its terms and conditions; or
  4. To pay Vermilion the lesser of the penal sum of the Performance Bond or Vermilion’s proposed cost of completion, less the balance of the contract price.

GCNA did not elect which option it would pursue in response to Vermilion’s claim. However, the Court found that by failing to make any election, GCNA elected, by default, to follow option 4; that is, to pay Vermilion the lesser of the penal sum of the Performance Bond or Vermilion’s costs of completion, less the balance of the contract price.
 
This finding will be very helpful to sureties for if one were to fail to respond to a claim, this default option is likely the most favourable to a surety, as there is certainty about the limits of a surety’s liability under this option. This finding will prevent an obligee from arguing it should get to choose an option which it might find preferential (and possibly accompanied with an argument from that obligee that in the circumstances the penal sum of the Performance Bond should not apply). The Court has also confirmed, albeit indirectly, that when a surety fails to respond to a claim, its liability remains capped by the penal sum of a performance bond, as a result of the “default” election to pursue option 4.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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