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Can a Surety Complete the Work with the Same Subcontractor that Was Terminated for Default

06/06/2015 | By: Randy J. Heller, Esq. | Summer 2015 Newsletter
Private developers often require contractors to obtain performance bonds, to make sure that the work will be completed. But developers should be aware that, under recent court precedent, if a developer terminates a contractor for its incompetence, the surety company may have the right to bring back the very same contractor to complete the job.

Not every private construction owner requires that its contractor obtain a performance bond. The cost of a bond is not insignificant and is inevitably passed along to the owner in the contractor's bid price. Requiring a subcontractor to obtain a performance bond is even more rare. But it is often viewed as a small price to pay to ensure that if something goes wrong, and the subcontractor is terminated for cause, there will be a surety company to arrange for (or at least pay for) the completion of the subcontractor's work.

But can the surety company step in and bring back the very same subcontractor which was terminated for its incompetence? That is the situation which provided the fact pattern for a recent case in the Supreme Court of New York County involving demolition work at the ill-fated Deutsche Bank Building in the aftermath of the September 11, 2001 terrorist attack in Lower Manhattan.

Following a fire in 2007, the contractor, Bovis, terminated the subcontractor, The John Galt Co. (Galt), for failing to maintain a fie standpipe, which left two firefighters dead. Following the "termination for cause," Bovis made demand upon the surety, Arch, to complete the work under its $25 million performance bond. Arch came forward and advised Bovis that it would be completing the work with the very same subcontractor, Galt, that Bovis had just thrown of the job!

Bovis advised Arch "in no uncertain terms" that it would not permit Galt back on the job. Bovis then retained a different subcontractor to complete the work and sued Arch for the costs. Arch argued that this constituted a breach under the bond, and rendered it no longer liable for any costs due to Bovis's refusal to let Arch use the replacement subcontractor of its choosing.

Bovis made two main arguments to justify its refusal to let Galt back on the job. First, it argued that Galt was not a "responsible" contractor. However, the Court stated that "when a surety elects to complete its principal's contract, the surety is primarily responsible for completion, and the contractor chosen by the surety to do the work becomes the surety's agent, not its subcontractor."

Next, Bovis argued that the subcontract gave it the right to approve or disapprove any subcontractors in its discretion. Again, the Court held that Galt would not have been acting as a subcontractor in working to complete the work; it would merely be acting as the surety's agent.

The Court concluded that unless the bond provides otherwise, a surety is free to choose its completion contractor, and the owner's or general contractor's interference with the surety's choice is a material breach rendering the bond null and void.

While we might all sympathize with Bovis's refusal to allow the defaulted subcontractor back onto the project site as a matter of principle, asserting that principle, without fist analyzing the language of the bond, proved very costly indeed.

About the author: Randy J. Heller, Esq. is a partner at Gallet Dreyer & Berkey LLP. His practice focuses on construction law and litigation, representing contractors and owners in construction related matters. Mr. Heller has been named a Super Lawyer by the New York Times magazine as one of the top attorneys in construction law in the New York metropolitan area, and by New York Magazine as one of the Best Lawyers of New York. Mr. Heller can be reached at rjh@gdblaw.com.