Does the default termination of a general contractor automatically terminate the general contractor’s subcontracts? No authority supports this proposition, but many contractors and subcontractors continue to ask this question.
A bonding company that completes a project after a default termination arguably may enforce a subcontract—even if the subcontractor did not sign a ratification agreement with the bonding company—as long as the general contractor was not in material breach of the subcontract.
A bonding company can enforce a subcontract on three legal bases.
Equitable Subrogation
A bonding company may enforce the general contractor’s subcontract with a subcontractor pursuant to the right of equitable subrogation. In the 1947 case National Surety Corporation v. Allen-Codell Company, the owner terminated the general contractor after the general contractor abandoned the project. The bonding company completed the project and then sought to recover the costs to complete work the subcontractor failed to complete.
The court found: As a general proposition, a surety who, under the requirement of his bond, completes the contract of a defaulting contractor may be subrogated to all the rights and remedies of the defaulting contractor against a third person who, by a subcontract, was obligated and wrongfully failed to perform some part of the work which the surety was required to complete, although no relation of contract or of privity existed between the surety and the subcontractor.
The court stated that if a subcontractor fails to complete its scope of work, the bonding company that completes the work is entitled to the same rights and remedies as a general contractor completing the subcontractor’s work.
Assignment in the Indemnity Agreement
A bonding company also may enforce subcontracts pursuant to the assignment provisions in the standard indemnity agreement that bonding companies obtain from general contractors. Basic tenets of contract law allow a party to assign its rights to performance under a contract to another party. The bonding company is typically the assignee of the general contractor’s rights in all subcontracts.
Virtually all indemnity agreements contain an assignment provision, such as: In the event the contractor shall breach, or default or delay the performance of, any bonded contract, or fail promptly to discharge all obligations under any bond executed in connection therewith, the undersigned, and each of them, hereby assign unto the surety, as of the date thereof, their right, title and interest in and to all subcontracts relating to the work under such contract which have been or hereafter may be made, together with the materials embraced therein, and all surety bonds affecting the performance of, or the discharge of obligations incurred in connection with, such subcontracts, hereby agreeing that the surety may enforce the same in the name of the contractor or otherwise.
Based on the assignment in the indemnity agreement and on the owner’s default termination of the general contactor, a bonding company, as the general contractor’s assignee, may enforce a subcontract and recover any losses it suffered by virtue of the subcontractor’s failure to perform the subcontract.
Assignment in the General Contract
A bonding company also may enforce a subcontract pursuant to its rights as the owner’s subrogee or assignee, assuming the general contract provided for the general contractor’s assignment of all subcontracts to the owner, as follows: The owner shall, in its sole and exclusive discretion, have the option of requiring any subcontractor or materialsupplier to perform in accordance with its subcontract or purchase order with the contractor and assign the subcontract or such other person or entity selected by the owner to complete the work.
Accordingly, if a subcontractor refuses to complete its work under the subcontract, the bonding company arguably has the same right to proceed against the subcontractor as an owner completing the project itself.
A subcontractor must be aware of its obligation to complete its scope of work, whether it signed a ratification agreement or subcontract with the bonding company after the default termination of the general contractor. Failure to do so may result in paying the bonding company for the cost to complete the subcontract.
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Friday, September 3, 2010