Newsletter
SUPREME COURT OPINIONS ON PAYMENTS FOR ENGINEERING WORKS
In two recent judgments, the Supreme Court de-livered important interpretations regarding the nature of performance bonds and retentions in construction contracts.
A Performance Bond Should Be Returned to the Contractor Subject to a Condition Precedent
If a public construction contract is awarded on the basis of the lowest-priced tender, and the procuring entity believes that the bid tendered by the lowest-bidding contractor is unreasonably low, the entity will require that the contractor deposit a bond in the amount by which it con-siders the bid to be under priced. The purpose of requiring such bond is to guarantee that the con-tractor will indeed fully perform its obligations under the contract. Therefore, most contracts stipulate that if the contractor breaches the con-tract in any way, the owner may draw compen-sation directly from the bond.
In an appeal heard by the Supreme Court, a contractor had deposited a differential bond. Subsequently, the procuring entity alleged that the contractor had arbitrarily suspended work on the project, and on that basis it terminated the contract, awarded it to another contractor, and confiscated the differential bond in compensa-tion for the losses it suffered. However, the original contractor claimed that work on the project had been suspended for reasons beyond its control, and that it was therefore unlawful for the owner to terminate the contract. But the owner had already awarded the contract to an-other contractor and the work had been com-pleted, so performance of the original contract was no longer possible. Therefore, the original contractor also terminated the contract and de-manded that the procuring entity return the dif-ferential bond.
In its 2005 judgment, the Supreme Court stated that the purpose of both a differential bond and a performance bond is to guarantee that contrac-tual obligations will be performed. Therefore, a contractor's right to demand return of such a bond should be subject to a condition precedent; in other words, when the contractually agreed time for the return of the bond is reached, if there is no reason to make the contractor liable, or if a balance remains after deducting due compensa-tion, the contractor has a right to demand the owner to return the bond or the balance thereof. In light of this judgment, in the future owners may not be able to, on the grounds of breach of contract, confiscate the entire amount of a dif-ferential bond or performance bond deposited by a contractor, but must consider the amount of loss actually suffered.
Retentions Should Be Paid to Contractor Subject to a Condition Subsequent
Most construction contracts provide that for each milestone payment, a certain proportion (usually 10%) should be retained by owner; the retentions are to be paid out net of any compensation or other fees when the work passes final inspection.
In an appeal before the Supreme Court, a creditor of a contractor had obtained an attachment order against the rights of the contractor over monies retained from milestone payments by the owner. However, the owner asserted that it had already deducted from the retentions compensation for its own losses for which the contractor was liable, and that after such deduction no balance re-mained, so there was no creditor's rights over the retentions. But the creditor asserted that the contractor's might to the retentions had come into existence at the times of the inspections of each stage of the project; the contractual provision that the retentions were to be paid out following the final inspection and acceptance of the work was merely a stipulation as to the time of pay-ment. Since the creditor had obtained its at-tachment order before the owner had made its deductions from the retentions, therefore, the creditor's attachment of the retentions should prevail over the deductions by the owner.
In its 2005 judgment, the Supreme Court stated that if a contract stipulates that in the event of defects in the work or non-fulfillment of other obligations by the contractor, the owner is enti-tled to directly deduct from retentions losses arising from such defects or non-fulfillment, the contractor's claim to the retentions should be regarded as a creditor's right subject to a condi-tion subsequent (a condition that invalidates the right if a certain event occurs). Therefore, if the circumstances contemplated by the contract arise, thus fulfilling the contractual condition, the claim on the amount deducted is automatically extinguished without the need for the owner to declare its intention to make a deduction. Thus if circumstances arise under which the contractor becomes liable to pay compensation, then the contractor's right with regard to the amount de-ductible from the retentions is automatically ex-tinguished by virtue of the condition subsequent being fulfilled, and it is not necessary for the owner to assert against the contractor its inten-tion to offset the retentions against its compen-sation entitlement; and even if a creditor of the contractor has obtained an attachment order against the contractor's claim to the retentions before the condition subsequent is fulfilled, this does not negate the effect of the fulfillment of the condition subsequent. In other words, the owner's rights still take precedence over those of the contractor's creditor.