It is common practice in the construction industry to use contract documents and performance bonds to allocate risk appropriately between owners and contractors. Owners often require that contractors provide a performance bond from a recognized surety as a condition to being awarded the construction contract. A performance bond provides the owner with a mechanism to mitigate the costs and risk of the contractor defaulting under the construction contract. If a contractor defaults on its obligations under the construction contract, and there is a performance bond, that bond entitles the owner to call on the surety to complete the contract.
Subject to the express terms of the performance bond, a surety generally has four options under the bond to respond to the owners demand. The surety can:
- remedy the default;
- complete the contract in accordance with its terms and conditions;
- obtain bids from other contractors for the completion of the contract, in accordance with its terms and conditions;
- make a cash payment to the owner and obtain a release.
Generally, option 3 is the one commonly pursued by the surety and owner. Once the surety and owners have obtained and reviewed the required bids, a decision is made as to the contractor that will complete the contract in accordance with its terms and conditions, and the surety's obligation is to make sufficient funds to pay the costs of completion (subject to the face value of the bond). But what are the surety's obligations given the phrase "complete the contract in accordance with its terms and conditions"?
There has been an extensive debate in Canadian Courts regarding the obligations of a surety when it comes to "completing the contract in accordance with its terms and conditions" and what those obligations actually include. One long line of cases, culminating with the 2004 Saskatchewan Court of Appeal decisionLac La Ronge Indian Band v. Dallas Contracting Ltd.1("Lac La Ronge"), adopted a narrow approach, holding that the surety is responsible only for completing the physical construction work (the "Bricks and Mortar Approach") and is not liable for payment of collateral monetary obligations (such as liquidated damages, delay damages/costs, loss of income) even if such monetary obligations are set out in and payable under the construction contract. In Lac La Ronge, the Court held that:
A surety's obligation on this point can be no greater than if it had completed the contract or had found a responsible bidder...
