Wednesday, April 10, 2013

Do Payment and Performance Bonds Cover the Contract Amount with Change Orders?

Most public agencies, after awarding a construction contract, require the contractor to provide a Payment and Performance bond in the amount of 100% of the contract amount.  (I've written previously about the importance of obtaining separate Payment and Performance bonds, each in the amount of 100% of the contract amount.)

Do bonds cover increased contract amounts?  But what happens during the project if (when) there are change orders that increase the dollar amount of the contract?  Do the Payment and Performance bonds cover the increased contract amount?  It all depends on what the bid documents required and the actual language of the bonds.

3 options:  There are three broad options of how Payment and Performance bonds handle increases in the contract amount based on change orders:
  • Surety approval always required:  Sometimes, the language of the bonds will require that all increases in the contract amount be approved by the bonding company.  This may be documented by the surety in the form of a rider (amendment) to the bonds, a new bond for the full amount, or their signature on the actual change order.  This is a cumbersome process that slows down execution of change orders.
  • Surety approval sometimes required:  The language of some bonds will only require surety approval after a certain cumulative percentage of change orders has been reached.  For example, if the original contract was for $100,000, and the bonds required surety approval after a 10% increase in the contract amount, then bonding company approval would be required once the cumulative amount of the change orders reached $10,000, and all subsequent change orders would also require surety approval.  While this option is preferable to the option of requiring surety approval on all change orders, it is still a cumbersome process that may require bonding company approval on very small change orders that occur after the percentage threshold has been reached.  In other words, once $10,000 (in our example) in change orders was reached, even a small change order amount would also require surety approval.
  • Surety approval never required:  Under this option, which is the smoothest administrative process, the language of the bonds binds the bonding company to any and all increases in the contract amount from change orders without having to seek surety approval on the increased contract amount.  Here's some language from bonds that addresses this option:  
"The Surety for value received agrees that no change, extension of time, alteration or addition to the terms of the Contract, the specifications accompanying the Contract, or to the work to be performed under the Contract shall in any way affect its obligation on this bond, except as provided herein, and waives notice of any change, extension of time, alteration or addition to the terms of the Contract or the work performed.  The Surety agrees that modifications and changes to the terms and conditions of the Contract that increase the total amount to be paid the Principal shall automatically increase the obligation of the Surety on this bond and notice to Surety is not required for such increased obligation."
Agency requirements:  Here's a quick checklist for agencies (and contractors) to pay attention to regarding Payment and Performance bonds:
  • Bid document language:  What do the bid documents require regarding surety approval of change orders?  The best protection for a public agency is to require the bond amount to automatically increase with change orders.  Make sure this option is permitted by any grant funding source, and consult with your attorneys.
  • Agency bond forms:  In order to ensure that appropriate language is in the bonds not requiring surety approval on increases in the contract amount, it's a good idea for public agencies to have their own Payment and Performance bond forms.  Without agency required forms, an agency must then read each bond carefully to ensure it adequately protects the agency and appropriately addresses the question of whether surety approval is or is not required for changes in the contract amount.  
Standard bond forms:  In Washington state, the local APWA chapter (with legal advice and input) has developed separate Payment and Performance bonds that do not require surety approval when the contract amount increases.  Click here to go to their web page and look for the bullet labeled "P and P Bonds When Retainage Allowed."  There is also an option for bonds samples when retainage may not be withheld if the project is funded by the U.S. Department of Transportation, which is something I've written about previously.
Mike Purdy's Public Contracting Blog 
© 2013 by Michael E. Purdy Associates, LLC

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