While contract provisions should transfer risk to the entity in the best position to bear or mitigate it, some onerous contract and bond provisions improperly allocate risk. This can lead to higher underwriting standards for contractors and higher construction costs for project owners to bear, as these improperly allocated risks are factored into bids and competition is reduced to fewer qualifying contractors.  

For the surety industry, onerous terms and conditions impact the top line as well as the bottom line. Refusing bonds means potential lost revenues or loss of the account itself to a competitor. Approving the bonds means accepting potentially higher losses due to the increased exposure and severity from onerous contract terms. For all these reasons, sureties are highly motivated to eliminate or mitigate these risks or, at the very least, contemplate them into their underwriting process.

Instrumental in helping the surety industry with the problems caused by onerous bonds and contract language are The Surety & Fidelity Association of America (SFAA), National Association of Surety Bond Producers and local surety associations across America. Together, they are keeping members informed about onerous contract matters affecting the industry and combating the potential effects of these excessively burdensome obligations by convincing public owners to make changes to their contract documents. 

Regional Challenges
The most common types of onerous contract bond issues guarantee long-term warranties, include ratings requirements and demand unreasonable claim response times. Onerous provisions also may vary in frequency from state to state. For example, in California and Pennsylvania, underwriters should watch for very short response times and uncapped consequential damages provisions within school project bond forms. In recent years, some Illinois obligees have required that eligible sureties possess an A+ rating on projects. 

Sometimes the language is more difficult to decipher, as evidenced recently by a City of Titusville, Fla., bond form that referenced an incorrect statute. In addressing the multiple problems with the obligee, the Florida Surety Association (FSA) wrote: “[T]he bond form references Florida Statute 224.05; however, there is no such statute. We believe the City means to reference 255.05, which addresses bonds for public projects.” Adding to the problems with this bond form, another paragraph identified language that “potentially expands the bond obligations to cover insurance perils.” And still another paragraph references uncapped consequential damages. A response from the city on this bond form is still pending.

Clearly, authors of public bond forms may not fully understand the consequences onerous forms have on the contracting procurement process. They often resist industry efforts to modify them and insist upon using them anyway. But changes do happen, particularly when negotiating long-term warranties.

In early 2014, the New England area experienced a high frequency of public school re-roofing projects in which the bid documents required five- to 10-year workmanship warranties. Writing to the obligee and architect, the Surety Association of Massachusetts successfully got owners to reduce contract warranty language down to a more palatable one- or two-year term. Also in early 2014, the FSA convinced the City of Coral Springs, Fla., to issue an addendum reducing the contractor’s warranty requirements from 10 years to one. And just this year, the Surety Association of Ohio was able to get a five-year warranty requirement removed entirely from a roofing installer’s contract, and five- and 10-year warranties reduced to standard one- or two-year periods on several other roofing contracts.

The South Florida market constantly challenges underwriters with onerous bonds. For years, Miami-Dade County has tied performance and payment bonds to a Florida statute that provides a four-year statute of limitations and a 10-year statute of repose for latent defects. There is good news and bad news on this. The good news is that the FSA, with the help of the SFAA and member companies, negotiated a new bond form deleting reference to the expansive latent defect statute and limiting the surety’s liability for all latent defect exposure to five years (as provided by law). The bad news is the county will still occasionally slip the old bond form into bid packets even though the negotiated form has become widely accepted within the industry. Members are advised to remain vigilant.

The SFAA was recently called upon to address another onerous bond form from Miami-Dade County. This time the obligee was the City of Doral. The Doral bond form incorporated consequential damages, expanded liability to include indemnification from negligence and introduced a joint obligee (the county) without reciprocal protection for the surety. Fortunately, in this instance, the city agreed to revise the onerous contract provisions by removing and clarifying the problematic language.

These are only a few examples of the many onerous bond provisions confronting sureties and contractors every day. Although detecting them all is difficult and fixing them is even harder, the consequences are potentially high if they are not dealt with effectively.

Contract bond provisions that are fair to all parties encourage open access to public construction projects, promote competition and benefit everyone. 

Richard Whitmire is contract underwriting officer for Liberty Mutual Insurance. For more information, email ichard.whitmire@libertymutual.com.