Sometimes failing to arbitrate a dispute with a binding arbitration provision can be fatal to a claim under a construction contract, particularly if the limitation period to commence the arbitration has expired.  But, in the case of a project with a performance bond, things can sometimes become more complex.

Performance bonds are a common tool on major construction projects. They are three-party contracts:

  1. the obligee (the party to whom the obligation under the bond is owed; typically an owner, although can be a general contractor on large projects in which multiple levels of bonding are in place);
  2. the principal (the party performing the work under the bonded contract; typically a general contractor, although can be a subcontractor on large projects in which multiple levels of bonding are in place); and
  3. the surety (an insurance company).

If the bonded contract proceeds without issue between the obligee and the principal, then the surety plays no role in the project. However, if issues arise between the obligee and the principal and the principal is declared to be in default of the bonded contract, then the surety is required to step in and investigate.

The surety can either deny or allow the bond claim. If the claim is allowed, then the surety essentially steps into the shoes of the principal, and has the same defences available to it as against the obligee as did the principal under the bonded contract prior to its default.

A Surety Cannot Rely on the Expiration of a Claim against the Principal to Deny a Bond Claim

However, the Alberta Court of Appeal in HOOPP Realty Inc v Guarantee Company of North America, 2019 ABCA 443 held that the expiry of an obligee’s limitation period to sue the principal does not provide the same limitations defence to a surety in the face of a bond claim lawsuit.

In that case, Clark Builders (“Clark”) was the principal/general contractor, HOOPP Realty (“HOOPP”) was the obligee/owner, and The Guarantee Company (“GCNA”) was the surety. Clark was hired to construct a warehouse. HOOPP was unhappy with the warehouse floor. Clark replaced the floor at its own cost, but argued it was not required to do so under the bonded contract. The parties agreed the performance bond would extend to the floor replacement if Clark was in default of the bonded contract.

In litigation between HOOPP and Clark, the Court of Appeal held that the dispute was subject to a mandatory arbitration clause, and HOOPP could not maintain a Court action. Subsequently, the Court held that HOOPP was limitation-barred from commencing an arbitration against Clark, and as such, HOOPP could not maintain any claim, in Court or arbitration, against Clark.

HOOPP had commenced a separate, parallel action against GCNA under the bond, which it continued to pursue notwithstanding the dismissal of its claim against Clark. The issue then was whether GCNA was also immune from liability to HOOPP, given that HOOPP’s claim against Clark was limitation-barred.

The matter was heard via summary trial. The trial judge concluded that GCNA was not relieved of liability, as the expiry of a limitation period does not necessarily extinguish the underlying debt, but only bars the remedy against the defendant. In addition, the trial judge held that HOOPP had distinct claims against Clark and GCNA, even if those claims may overlap.

The Court of appeal upheld this decision. It noted that the general statement that a surety is entitled to any defence available to the principal is accurate when related to the principal’s liability under the bonded contract. However, when the issue is whether the surety is directly liable to the obligee, that is a separate issue.

The Court confirmed that the surety’s liability under the bond required that the principal had defaulted under the bonded contract. But in the facts at bar, where there was an alleged default by the principal, the obligee had a potential independent claim against both the principal and the surety. This was supported by the bond wording in this case, which provided that the surety and principal were jointly and severally liable under the bond.

In addition, the Court noted that an obligee is not required to exhaust all remedies against the principal in order to advance a claim against a surety. While HOOPP in this case had made an attempt to sue Clark, the Court noted that the outcome of the appeal would have been the same even if no such attempt had been made.

Finally, the Court rejected GCNA’s argument that by permitting HOOPP’s claim against GCNA to proceed, it was allowing HOOPP to indirectly pursue Clark. GCNA argued that if HOOPP made a successful claim against GCNA, GCNA would then have an indemnity claim against Clark; i.e. in the end, Clark would still be liable for HOOPP’s claim despite the expiration of HOOPP’s limitation period to sue Clark directly.  

The Court held that Clark, as principal, did not have the protection of a limitations defence until the limitation had expired against both it as principal and GCNA as surety. Similarly, GCNA, as surety, did not have the protection of a limitations defence until the limitation had expired against both it as surety and Clark as principal. In other words, if GCNA was held liable to HOOPP, GCNA could then pursue an indemnity claim against Clark.

While many of the Court’s comments were general principles applying to all performance bonds, in the end it was clear that the result on this appeal depended on the wording of the GCNA bond. In particular, the Court noted there was nothing in this bond requiring HOOPP to exhaust its remedies against Clark in order to maintain a bond claim against GCNA.

The Supreme Court of Canada has now refused leave to appeal for this matter, so it remains the law applicable in Alberta.  The case adds another level of complexity when trying to assess limitation periods in the context of projects with mandatory arbitration provisions coupled with separate performance bonds.

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