Bond. Performance Bond.
Performance bonds—insurance-like arrangements in which a surety (the bonding company) contractually agrees to pay for the performance of a principal (the contractor) to an obligee (the owner) in case the principal fails to perform the obligations of its contract—should be used more often in construction agreements to provide owners with a source of funds to cover defective work in a project.
Currently, owners typically require contractors to obtain insurance policies with the hope that such policies cover defects in the work they perform for the owner. Though owners are willing to spend a lot of money, time, and effort in obtaining these policies, insurers continue to make revisions to their policies to limit, and sometimes prevent, coverage for these defects.
.jpg)
Performance bonds may provide better protection to an owner. Typically, the bond provides funds to pay for repair of defective work that may not be covered by insurance as part of the bond’s guarantee of the faithful performance of the contract by the contractor.
Unlike insurance policies, performance bonds provide coverage only for the owner’s project—if an owner discovers a defect in the contractor’s work, the owner will not have to worry whether another owner’s claim against the contractor for another defective project will reduce the coverage available under the contractor’s bond. The performance bond’s recovery pool belongs to the owner for the specific project it is drafted to cover.
The Risk of Builders Risk
Contractors and owners obtain builders risk policies to protect themselves from risks associated with construction. But a lack of care in understanding and negotiating the provision of the construction agreement governing the builders-risk policy and the policy itself may lead the parties to expose themselves to needless and significant liability.
What owners and general contractors should do to protect themselves
If a construction contract requires the owner or the general contractor to obtain a builders risk policy—and it should—then that party should in fact obtain the policy. This may seem painfully obvious, but sometimes parties do not obtain required policies.
Courts have held, unsurprisingly, that a construction contract calling for a builders-risk policy means what it says. If the party whom the contract required to obtain a builders-risk policy does not obtain a policy, that party assumes the risk of loss that ought to have been covered by the policy. So, if a construction agreement requires, say, the owner to obtain a builders-risk policy, the owner should obtain the policy, and the other parties relying upon the policy should confirm the existence of the policy and its terms.
The Builders-Risk Policy Should Allow for the Construction Contract’s Mutual Waiver of Subrogation
Construction contracts frequently include a clause in which the owner and the contractor, both covered by the builders-risk policy, waive their right of subrogation against each other regarding any damages covered by that policy. The owner should not be able to sue the contractor for a loss if the owner has already obtained builders-risk insurance that would make him whole (or vice versa)—the mutual waiver of subrogation prevents the owner or the contractor from recovering twice.
However, if the builders-risk policy itself contains a provision preventing the parties from waiving subrogation, the execution of the construction contract may violate the policy conditions and might prevent recovery under the builders-risk policy.
As the owner and contractor negotiate the construction contract and the builders-risk insuring agreement, they need to pay attention to the provisions in each agreement governing subrogation. Broadly, they need to pay attention to the effect that each agreement has on the other, and should ensure that the builders-risk policy does not prevent the parties from waiving their subrogation rights. Moreover, they need to pay attention to the interaction between a builders-risk policy and any property insurance policy the owner may have (see below). The waiver of subrogation should apply to claims brought under the property policy for a few years after termination of the builders-risk policy.
The Construction Contract Should Specify When and under What Conditions the Owner Can Terminate the Builders-Risk Policy
Builders-risk policies are, as their name suggests, designed to cover risk arising from building. Once the structure is built, though, the builders-risk policy usually terminates. Builders-risk policies also typically terminate on the occurrence of a number of other conditions.
For example, the builders-risk policy may end when the equipment in a plant is first energized, on the theory that once you fire up the plant, it is no longer under construction but is operating as a business and therefore presents different insurable risks.
Once builder-risk insurance terminates, usually the owner’s property insurance kicks in. Property insurance, however, does not usually protect the contractor because the contractor is not a named insured under that policy, and it will not protect against all the events that a builders-risk policy would. If an insurable event occurs that would have been covered by the builders-risk policy after the policy has been terminated, there may be no coverage, possibly causing the parties to argue about whether the policy was properly terminated. If the owner terminates the builders-risk policy without telling the general contractor—and yes, this does happen—the parties will then argue whether the termination actually occurred.
Simply, unexpected termination of a builders-risk policy can ruin your day. The term of a builders-risk policy, then, is a critical point to negotiate and to stick to. Owners should not terminate a builders-risk policy early, and contractors should ask for a provision in the policy requiring the owner to give them notice before termination of the policy so that the contractor can arrange for adequate coverage elsewhere.
LEED Decertification
If you think LEED certification of a building is a one-time deal, think again.
USGBC’s latest version of LEED (version 3) establishes several new changes to LEED certification. Two of those changes are particularly significant. First, USGBC now requires building owners to submit operational performance data on a recurring basis as part of the LEED certification process. Building owners must provide the data for a period of at least five years. Second, and perhaps more important, LEED v.3 gives USGBC the right to decertify projects.
According to the USGBC, building owners can comply with this new data disclosure requirements in one of three ways:
1. Recertify the project on a two-year cycle using LEED for Existing Buildings: Operations & Maintenance;
2. Provide energy and water usage data on an on-going basis annually; or
3. Sign a release that authorizes USGBC to access the building’s energy and water usage data directly from the building’s utility provider.
As to decertification, LEED v.3 provides that certification "may be revoked" from any LEED project upon the USGBC's determination that a building does not comply with several minimum requirements, including environmental law and data disclosure requirements.
The impact of USGBC’s new enforcement right is unknown at this time. Indeed, USGBC has not yet decertified a project. However, one thing is clear: this new system of decertification may put your green investment at risk. Owners should have their attorneys draft contract provisions to protect against these risks during the design, construction, and post-construction stages of a project
