Because contractors often have limited liquid assets, insurance and bonding are often the best resources available to an owner to protect against contractor default or defective work. However, not all policies and bonds are created equal, and owners should make sure these resources provide the security the owner needs. Here are five questions an owner should ask.
Is your contractor self-performing the work?
A contractor may offer to self-perform a portion of the work as a way to save costs, on the theory that the contractor won’t charge a markup for its own work. Cost savings may be important to the success of a project, but they may come with a hidden cost. Because virtually all contractor general liability policies contain a “your work” exclusion, defects in self-performed work are very likely not covered by the contractor’s policy (however, this exclusion usually doesn’t apply to work performed by its subcontractors). An owner should assess whether the cost savings from self-performed work are worth the risk of insurance not covering this work.
Will your contractor have insurance after the work is complete?
Construction defects are, of course, often discovered after the work is complete, sometimes years after. The contractor, however, may not carry insurance that sufficiently covers damage that occurs after completion. This post-completion insurance is commonly called “completed operations” coverage. If an owner specifies insurance requirements for its project (for example, that the contractor and its subcontractors carry a minimum amount of coverage), it should ensure that those requirements continue after completion of the work. A conservative approach is to require that the completed operations coverage last until the expiration of the statute of repose (the date when the owner can no longer bring a claim against the contractor).
Does your contractor’s policy contain an exclusion that prevents coverage?
The details of a project may clash with exclusions in the contractor’s general liability policy. For example, the contractor’s policy may exclude residential or condominium projects. It’s possible that these exclusions can be removed through negotiation with the contractor’s insurer, or that there are alternative methods for insuring the project (for example, through an owner-controlled insurance program). The construction contract should make clear that exclusions that could reduce or kill coverage for the project are not allowed.
Are you relying on subcontractor default insurance?
Some contractors market their buying of subcontractor default insurance as a way to protect against subcontractor work failures, and will often ask that the owner pay for the premium for this insurance as a cost of the work. In practice, subcontractor default insurance can provide an indirect benefit to an owner, because it may cover the cost of subcontractor default in lieu of other insurance or bonding. It’s important to recognize, though, that the beneficiary of a subcontractor default policy is very likely the contractor – not the owner – and the contractor likely won’t be obligated to bring a claim on a subcontractor default policy on the owner’s behalf. An owner doesn’t want to be in the position of relying on subcontractor default insurance, only to have its contractor refuse to make a claim on the policy. An owner should think of subcontractor default insurance as a resource that may provide an indirect benefit, but not a core element of the owner’s risk protection.
Should you require a performance bond?
Because of the cost of bond premiums, performance bonds are less common in private projects than in public projects (where they are often statutorily required). A performance bond, however, can be an effective resource for contractor default, and, in comparison to an insurance policy, the bond should have fewer restrictions and exclusions on coverage. If a performance bond is required, care should be taken with its terms. For an owner, the best approach is to prepare the performance bond. At the very least, the owner should carefully review the bond form proposed by the contractor’s surety, as bond forms often contain coverage limits (for example, a limited period to make bond claims) or burdensome claims procedures. The performance bond should cover the contractor’s contractual duties not only during the project but after as well (for example, a contractor’s warranty or indemnity obligations). The owner should make sure it’s using a performance bond form that provides reasonable protections against contractor default.
"Five Questions an Owner Should Ask About Insurance and Bonds" was originally published on April 17, 2015 in the Daily Journal of Commerce.