Contracts and bonds 101

TC Media
Published on June 5, 2014

By Don Dicesare

With all of the fuss generated by the alleged release of Humber Valley Paving from its contractual obligations on a road construction contract on a portion of the Trans-Labrador Highway, I thought it would be appropriate to conduct a short course on contracts and bonds.

If you have nothing better to do than read this, and in the interests of your learning experience, there will be a short test when we’re finished. Just kidding!

Most government contracts of this nature go through a rigorous tender process before they are awarded.

The first step is usually the tender call or call for bids, usually by newspaper advertising and/or on the government website. The tender documents normally include an information package that outlines the conditions of the contract, engineering drawings, technical specifications, and a “schedule of quantities” that outlines the exact quantities of material to be supplied and placed, such as tonnes of granulars, tonnes of asphalt, metres of culverts, etc.

This schedule must be filled in with a “unit price” for each quantity item. This will become the basis of payment for the completed work. This bid must be accompanied by a “bid bond” in the amount of 10 per cent of the bid value. This bond is a document provided by an insurance company that guaranties that the bidder, if he happens to be the lowest bid, will accept the contract if offered to him.

If the low bidder refuses to accept the contract, the insurance company will forfeit the value of the bond to the government, who will use these funds to award the contract to the next bidder. The original low bidder may not be able to bid on other projects as insurance companies may then be reluctant to provide another bond.

If, on the other hand, the low bidder accepts the contract, he then must provide additional bonds to ensure that he completes the work, (the performance bond, to the value of 50 per cent of the contract) and another bond to ensure he pays for labour and materials, (the Labour and Material Payment Bond, to the value of 10 per cent of the contract).

These are merely documents of guarantee and not cash. If the contractor satisfactorily completes the work, these bonds, after a period of time, merely cease to exist and the project ends. If the contractor however, during the course of the work, feels he cannot complete the job, for whatever reason, a series of events begin to unfold.

The first step that most contractors would (or should) take is to convince the owner that he be released from his contractual obligations. That is not an easy task! Most current construction contracts will only allow termination, by either party, for very specific reasons. Extenuating circumstances, such as fires, civil disobedience and acts of God, would normally only allow the contractor, with the owner’s approval, to extend the construction period beyond the agreed completion date.

If, however, the contractor’s argument is compelling enough, there are mechanisms to allow the contract to end without a formal termination. The simple act of reducing the scope of the project by deleting some of the units, in a unit price contract, effectively can limit the contract to the value of completed work. The contract is not terminated, but considered complete. The contractor is paid only for work completed and can exit gracefully. This is well within the government’s power and authority to do.

This obviously can only work if there is an impending tender call that can be broadened to accommodate the uncompleted work. This new tender and contract can result in lower or higher unit prices than the original contract, but if the time period between the two tenders is not too great, the unit prices will generally be in the same range.

I have a feeling that this is what may have happened in the Humber Valley affair, but it has not been accurately articulated by those involved, nor has it been accurately investigated by the media, whose main aim is to sensationalize everything. Now let’s look for a moment at the alternative scenario of the government “pulling” the performance bond by contacting the bonding company and invoking the provisions of the bond.

At this point the bonding (insurance) company becomes the contractor. They do not simply hand over a big cheque. If you believe they will jump in and start work immediately, you may indeed be naive. They will investigate, procrastinate, agitate and irritate.

They will call in their engineers, their lawyers and some time in the future, the work will get done. In the meantime, the original contractor has been put out of business because he can no longer get bonding, other contracts he may have had with other entities have been cancelled, his employees have now lost their jobs, and creditors will not be paid.

The bonding company, once they have the work complete, will, in all probability, sue the government and the original contractor that they had bonded, to recover their costs.

I can speak with some authority on this subject because of my 50 years of handling contracts of this nature. The scenario described above is exactly what happened when I called in a bond for one of my municipal clients. Would I do it again? Only if it were the absolutely only option (and there are other options). Does anyone win in this scenario? No!

Is it worth the effort and aggravation? No!

So, did the government do the right thing in the Humber Valley case? I believe they did.

Time and the auditor general’s report will tell. I will hazard a guess the AG will find nothing illegal or untoward.

While this sort of contract closure may be rare, it is not especially unusual. It is a negotiated business transaction.

So, are you ready for the test?

Don DiCesare lives in Corner Brook and is a member of The Western Star's Community Editorial Board.