The Long & Winding Road Long-Term Construction Warranties II

The Long & Winding Road

Long-Term Construction Warranties

Part II – Bonding Concerns

Arizona Society of Civil Engineers Newsletter, June 2014

By Roger Owers, Ph.D., P.E., J.D.

Not only must owners of construction projects incur the costs for designing and building the project, they must also incur future costs of operating, maintaining, repairing, and replacing the project.  Though certainly expensive, the upfront design and construction costs are often a fraction of the future costs for operating and maintaining the project.

Therefore, it is natural for project owners to ask for long warranty periods during which the contractor will be responsible for maintaining the project. But contractors have financial concerns with the responsibilities of long warranty periods.  This was discussed in a previous article.

Sureties also have concerns.  In a recent white paper, The Surety & Fidelity Association of America identified several issues related to the bonding of long-term warranties.

First, long-term warranty bond requirements tie up the contractor’s bonding capacity.  An underwriting surety will need to understand the future and current obligations that the contractor has upon its manpower, equipment, and finances.  Long-term warranties increase the contractor’s obligations and thereby reduce the contractor’s bonding capacity.  This in turn limits how much additional work the contractor may take on.

Second, long-term warranty bonds create uncertainty in the mind of the surety.  The more certainty about the future of their contractors, the more likely a surety is to underwrite a bond.  The longer the term of the bond, the higher the uncertainty about the size, scope, and timing of the contractor’s obligations to maintain and repair the project.  Similarly, a contractor will not likely hold money in reserve for warranty work, so if warranty work is expected many years from the completion of the construction of the project, there is a strong possibility that the contractor may not have the resources to do the warranty work.  This could trigger the surety’s obligation to step in and complete the warranty work on behalf of the contractor.

Third, long-term warranty bonds reduce the pool of eligible contractors.  Only large, well-established contractors can most likely absorb the above risks related to decreased bonding capacity and the uncertainties that may arise from long-term warranty obligations.  Therefore, long-term warranties have a limiting effect on the amount of contractors who can build projects with such long-term warranties.

In the above-referenced paper, The Surety & Fidelity Association of America offers two recommendations.  First, they suggest a three-year warranty period as the optimal term to provide project owners with offsetting costs for maintaining their projects while also balancing the surety’s concerns with underwriting the bond.

Second, they suggest a warranty bond in the amount of 10% of the final contract price.  This warranty bond is to be provided at final acceptance of the project and is to be conditioned upon the release of the project’s performance bond.

In summary, while long-term warranties may appeal to the owner and the contractor, the long-term warranty must be carefully considered.  By undertaking long-term warranties, contractors may have financial surprises, sureties may not underwrite their contractor, and the owner may get stuck with a small pool of eligible contractors.

The white paper discussed in this article can be found at http://www.surety.org/resource/resmgr/govrel-pub/LongTermWarrantyStatement.pdf.

This article is intended for general information only.  It should not be construed as legal advice with respect to any particular situation.  Readers should not act upon information contained in this article without first consulting their lawyer.

Roger S. Owers is a commercial real estate professional with Keyser LLC and is a lawyer with the Kaibab Law Offices of Roger S. Owers LLC.  Roger holds a Ph.D. in civil engineering, is a registered professional civil engineer, holds a real estate license, and is a licensed attorney.  He can be reached via e-mail at rowers@kaibabllc.com or www.kaibabllc.com.  He can also be found on LinkedIn at http://www.linkedin.com/in/rogerowers/.

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