The COVID-19 Potential Impact on Contract Surety

March 25, 2020Legal Alerts

The COVID-19 Potential Impact on Contract Surety

The COVID-19 pandemic raises a series of unknowns for contractors, owners, subcontractors, suppliers, and sureties. Much is being written about whether construction is deemed an essential infrastructure exception to governors’ various executive stay-at-home orders. Surety practitioners are facing novel legal issues raised by the pandemic as they analyze parties’ rights and obligations under surety bonds and underlying construction contracts. As the legal industry and construction organizations work to understand the nuances of the governors’ executive orders, the health and safety of the labor force on jobsites is the absolute priority.

All construction projects must adhere to the Centers for Disease Control (CDC) safety protocols addressing COVID-19 health concerns. Social distancing and adequate spacing between laborers are difficult. Tight jobsite quarters, sharing of tools and equipment, and the requirement to routinely disinfect hands and surfaces raise concerns. Diligent contractors find their scope of work and specific trade can make it impossible or impractical to adhere to the CDC protocols.

Even when deemed an essential infrastructure exception to an executive stay-at-home order, construction on a particular job may still come to a halt. If a construction project is bonded, the surety may encounter its own challenges when faced with an interruption on a job due to the COVID-19 pandemic. The plain language of surety bonds often does not specifically address interruptions due to acts of God, disasters, national emergencies, etc. It is essential the parties understand the terms and provisions of the underlying construction contracts addressing force majeure, time extensions, damages, and the safety rights of the labor force. Construction industry contracts may address the parties’ rights upon the occurrence of an epidemic but not necessarily a pandemic occurring over a wider geographic area affecting more people.

Sureties will face new issues during this pandemic. Business relationships are a more significant factor than ever when working through best practices to address work stoppages under emergency situations. The surety’s bonded contractor/principal may be unable to keep its doors open if it is unable to remain on budget, or if the loss of work becomes too severe due to the pandemic. Construction financing can be withdrawn or modified, severely impacting the principal’s ability to perform or bid on future work. The principal and surety need to assess insurance coverage, the impact of work stoppages, inability to perform, and delays in completion requiring policy extensions and cost increases.

A surety faced with bond claims due to a declared default of its principal or interruption of performance due to the pandemic needs to address additional issues beyond the more traditional decisions made to assess the liability of its principal and the surety’s bonded obligations. Examples to consider include if this pandemic is an act of God or a national emergency. Is the surety’s principal entitled to time extensions or adjustments to its contract price due to the pandemic? Did the work stop due to a national or state executive order? Is the pandemic the sole cause of the stoppage, and there are no unrelated reasons why the principal is unable to proceed? Was workers’ safety at risk due to the pandemic?

It is essential for the surety to understand the multitude of pandemic-related challenges construction projects will encounter. The surety’s preparedness to deal with issues impacting its principals is key. 

Communication is essential. The parties should work collaboratively to reach a mutual understanding as to whether any work stoppages are temporary or will continue through the duration of the project. Issues should be addressed as early as possible regarding financial obligations to contractors for work in place, including overhead and profit, as well as the respective parties’ anticipated losses, costs, potential damages, and rights to time extensions.

The surety should continually communicate with its principal about the ability to remobilize as well as the principal’s financial capability to absorb associated costs due to work stoppages. The surety needs to evaluate the principal’s ability to absorb potential losses, costs, and damages due to the pandemic (e.g., loss of work on current and future jobs, inability to supply adequate manpower, obtaining materials and supplies, etc.). Confirming the principal’s capacity to withstand the pandemic will directly impact the surety’s ability to determine what obligations it has in response to anticipated performance and payment bond claims.

The challenges caused by the pandemic are unforeseeable but will have a significant impact on the construction industry. It may take years for the courts to determine how to address the fallout from failed construction projects. It remains imperative parties understand the terms of the bonds and the construction contracts when evaluating how to proceed legally and equitably during unchartered waters.

If you have any questions, please contact the authors or your Dinsmore attorney.