This material is for information purposes and is not intended to provide legal advice in relation to any particular fact situation.  Readers who have concerns about any particular circumstance are encouraged to seek independent legal advice in that regard.

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July 16, 2018

 

New Bonding Requirements for Public Sector Contracts:
This One Is Important!

 

Pursuant to the Construction Act, all contractors (except architects and engineers) are required to provide performance and labour and material payment bonds under public sector contracts procured in Ontario after July 1, 2018, and where the contract price is $500,000.00 or more.  The impact of this is going to be substantial.

A “public sector contract” means a contract for an improvement where the owner is the Crown, a municipality or a broader public sector organization.  The definition of the latter is very broad and includes (subject to certain exclusions) every authority, board, commission, committee, corporation, council, foundation or organization that received public funds in the provincial government’s previous fiscal year.  This sounds confusing and it is.  There will inevitably be confusion over whether or not, and when, the new requirements apply – over whether or not there is a public sector contract and whether or not the contract was procured prior to July 1, 2018.  In each case, the tests set out under the Act can be difficult to follow and are at times ambiguous.  Care will have to be taken in addressing the issue.

The new requirements, which call for coverage limits of 50 per cent of the contract price (to a maximum of $50,000,000 on “P3” projects), will have a significant impact on trades and suppliers.  This is because, currently, there is no universal coverage under standard labour and material (or “L&M”) Bonds.  These only cover the first tier subtrades and suppliers of the principal under the bond.  Where the contractor is required to provide the bond, its subtrades and suppliers have coverage; where a subcontractor is required to provide the bond, its subtrades and suppliers have coverage.  This, however, will change under public sector contracts, where L&M bond protection will be extended to all subcontractors, workers and suppliers. 

The additional protections provide good news for subcontractors and suppliers who are further down in the pyramid and who would not traditionally have L&M bond coverage on publicly funded projects.  On the other hand, the need for universal coverage to the bottom of the pyramid will most likely result in more subcontractors being asked to provide L&M bonds of their own.  This may prove problematic for those who have not previously been asked for bonding and who may not have a bonding facility in place.

The changes will also have a significant impact on contractors.  First, the Act puts the onus on the contractor, and not the owner, to furnish the required bonding even if the owner has not expressly asked for it in a tender package.  Care will have to be taken to ensure the requirements are met and that the costs are included in the contract price.  Second, bonding costs will almost certainly increase.  While it is true that the bond limits will in most cases not change, sureties historically assess the likelihood of claims in determining a premium.  Under public sector contacts, the number of potential claims on an L&M Bond will increase, at times exponentially given the universal coverage requirements.  As a result, many contractors will have to increase the limits of their bonding facilities. In addition, the risk of increased claims creates higher indemnification risk.  This is because the principal under the bond, and its guarantors, are generally required to indemnify the surety for the surety’s costs of investigating, defending and paying out a claim.  This should prove particularly troubling on larger projects where the contractor will be asked to assume the risk that an (often unknown) subcontractor several rungs down in the pyramid won’t pay its subtrades or suppliers.  As above, contractors might manage this risk by requiring subcontractors to provide L&M bonding of their own, although this will increase subtrade prices.  (The Act recognizes that this approach will no doubt be taken in the P3 environment, and allows the bonding requirements to be altered slightly to accommodate the approach on P3 Projects).

For owners, public contract project costs will almost certainly increase.  This is because contractors and subcontractors generally pass their bonding premium costs on as part of their contract and subcontract prices – and these costs will be higher.  In addition, owners will no longer be able to decline bonding under public sector contracts as a way to reduce costs.

For sureties, there will no doubt be growing pains as their underwriters grapple with how to price the new bonding requirements.  In assessing the surety’s risk of potential claims, the underwriters have historically focused on the principal’s financial stability and ability to pay.  Now, they will also have to assess the risk that (often unknown) subcontractors and suppliers will not be able to pay.  Sureties may choose to manage the risk by increasing premiums or by requiring contractors to obtain L&M bonds from some or all of their subtrades.  How all of this will play out in terms of premium and project costs remains to be seen.