Dealing with Contractor Termination

 OP NY NJ FOCUS 01By Jacqueline Greenberg Vogt

The owner of a troubled project has just terminated its general contractor and called upon the contractor's surety to complete the work. The surety responds affirmatively, but proposes that the owner and the surety enter into a takeover agreement. For the owner, entering into a takeover agreement with the surety will govern their relationship and provide a road map for the completion of the project.

The plain language of a performance bond requires the surety to take over a project and arrange for the completion of the work in the event of a contractor termination. The bond typically states that the surety's obligation under the bond arises when the owner notifies the contractor and the surety that the owner is considering declaring the contractor in default; the owner has actually declared the contractor in default and formally terminated the contractor, and the owner has agreed to pay the balance of the contract price to the surety.

There are a number of factors to consider before the owner enters into a takeover agreement. On the “pro” side, in the course of negotiating the takeover agreement, the owner can require the surety to confirm the contractor's default and affirm that the surety is bound by the contract documents. The agreement should include statements confirming that performance deficiencies existed and setting forth the specific reasons for the default and termination. Such provisions lay a good foundation for estopping the surety from being able to later claim that the contractor was improperly defaulted or terminated. 

Entering into a takeover agreement will require the owner and surety to examine and agree upon the remaining scope of work. The surety will typically hire a construction consultant to review the work in place, compare it to the specifications and identify the scope. The owner then has the opportunity to agree or disagree with the surety's evaluation of the remaining scope. This is an opportunity to identify and correct defective or non-conforming work in place before project completion.

The takeover agreement process also results in the owner and surety coming to an agreement on the remaining contract balance. As long as the owner commits to paying over the contract balances to the surety, the owner is assured of getting a completed job for the contractually agreed upon price.  

Other Benefits

The owner also benefits from a takeover agreement when a date for completion is agreed upon. By the time a contractor is terminated and the surety steps in, a project is likely to be delayed. A negotiated completion date in the takeover agreement requires the surety to commit to a schedule that gives the owner some idea of when to expect completion. Even if additional delay occurs, the owner is still better able to plan its use of the project.

In the takeover agreement negotiation, the owner can profit by obtaining new and additional undertakings that go beyond the promises made by the surety in the bond itself.  Indeed, this process provides the owner the opportunity to include language in which the surety concedes that the obligations under the bond are triggered, and that the surety is therefore obliged to complete the work.

Another example of additional benefit relates to liquidated damages (LDs). Liquidated damages are not specifically mentioned in the typical bond. In the course of negotiating a takeover agreement an owner can demand that the surety agree to be responsible for LDs. Although there are many scenarios under which a surety would never agree to pay LDs, if the contractor's performance was clearly deficient and the surety is concerned about its exposure to LDs, it might agree to be liable for a capped amount of LDs to limit that exposure.

The owner can also gain an advantage in negotiating changes to the dispute resolution procedure. For example, the parties can agree to an expedited process that can start and be completed quickly during the completion work, rather than go through the longer staged claims process typically utilized in the American Institute of Architects forms of contract. The parties can also make changes to other parts of the dispute resolution procedure such as venue or the number of required arbitrators.

The takeover agreement can be a means by which to identify claims that exist as of the termination. Language in the takeover document can be used to waive any claims that are not specifically identified. Also, the agreement can identify liens and require the surety to commit to obtaining lien releases prior to commencing completion work. The owner can also use the takeover agreement as a means for confirming and assigning liability to the surety for latent defects.

By the surety agreeing the complete the work in a takeover agreement, the surety may also be committing itself to pay for the completion work even if the cost to do so exceeds the penal sum of the bond. Finally, if the surety decides to use the terminated contractor as its completion contractor, the owner can demand that the surety take on the cost of a surety's representative to supervise the work of the contractor. This clearly benefits the owner.

There are a few downsides to entering into a takeover agreement. For instance, both the owner and surety usually seek to reserve all claims and defenses in the Agreement. This means that the impact of the additional obligations and promises made in the takeover agreement may be limited. Also, it takes time to negotiate a takeover agreement. This can cause further delays to the completion of the work. And, just as the owner may negotiate more favorable terms for itself than exist in the original contract, so may the surety. However, when all of the above considerations are factored in, it still makes sense for an owner to negotiate and enter into a takeover agreement with the contractor's surety.

Jacqueline Greenberg Vogt is of counsel at Greenberg Traurig LLP in Florham Park, New Jersey. She has 22 years of experience in construction law and concentrates on construction contracting and litigation. 

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