005 - Dual or Multiple Obligees
Project lenders, and others, periodically seek to augment their loan security by requiring that they be added as an additional named obligee/beneficiary under a contractors’ Performance Bond. If the Surety company receives such a request to add another Obligee, it is normally their practice to insist that a Dual/Multiple Obligee Rider be executed by all parties. This rider provides additional obligees with the same rights as the primary obligee, provided that they agree to assume the obligee's obligations to the bonded principal under the contract.
Contract bonds are issued in the names of those entities who are party to a written contract with the owner, as the primary obligee, and the contractor, as principal. The surety guarantees to the obligee the due performance of the contract, by the principal, in accordance with the conditions of the contract. Periodically, a surety company will receive requests to add an additional obligee(s) to the bond even though such additional obligee(s) is not a party to the construction contract and does not have the legal responsibility to perform the primary obligee's obligations under the contract. The origin of these requests stems from the principle of "insurable interest" commonly found in mortgage endorsements on property insurance policies as well as endorsements for additional named insured(s) under general liability policies.
Surety companies have always been amenable to this type of request, provided that the risk could be clarified and potential new risks be mitigated by a rider which would effectively ensure that the performance bond did not become a pure completion obligation. This rider makes performance of the obligee's obligations under the contract a necessary condition in order for any additional obligee(s) to be entitled to pursue a claim under the performance bond, the same obligations required of the primary obligee. In other words, the added obligee gains the benefit of the guarantee by the Surety under their Performance Bond. However, with the rider, this benefit flows only under the strict condition that the obligations to the contractor, under the construction contract - such as payment of monies for work performed - have first been met by either the primary obligee, added obligee, or both. Accordingly, the Surety Association of Canada supports and recommends use of the attached format of Dual Obligee Rider in order to address these issues.
Who Requests It?
Project lenders most often request to be added as additional obligees in order to enhance their security position under a loan agreement with the project owner. Similarly, circumstances may arise when other interested parties, such as municipalities, also wish to obtain financial security in this fashion.
Why Do They Request It?
Whenever construction projects are heavily financed by lenders, especially if construction loans and subsequent long term financing are granted on a non-recourse basis against the project, the lenders will seek to ensure that the project is completed in a timely and satisfactory manner and is ready for its intended purpose. If the owner were to default under the loan agreement, the lenders could be faced with a loss of value on their loan security, or the necessity of contributing significant sums of money to salvage the project. Therefore, lenders often require the owner to assign its interest in the construction contract and, depending on the contract conditions, may also require the consent of the contractor and surety company.
There are other scenarios where sureties are asked to add additional obligees to the bond. Land developers are often required to post collateral security, or a subdivision bond, with a municipality to guarantee the completion of subdivision work. In order to reduce costs or due to financial constraints, the developer may wish to induce the municipality to accept a standard performance bond with the municipality included as a dual obligee.
In all instances, the Surety's need for a Dual Obligee Rider remains unchanged in spite of differing underlying circumstances prompting such request.
Dual Obligee Rider Recommendations
The Surety Association of Canada recommends that where additional obligees are to be added to a performance bond, the bond should be issued in a single obligee format containing just the parties to the construction contract. The additional obligees may then be added using Surety Association of Canada standard Dual Obligee Rider.
Note that the format of the Dual Obligee Rider includes the following elements:
- The surety's liability is limited to the penal sum of the bond and does not constitute an obligation to each obligee.
- The rider restricts the Surety's obligation to the secondary Obligees by affording them protection only if the primary Obligee's contractual obligations to the contractor have been completely fulfilled.
- The Dual Obligee Rider must be signed and sealed by the surety, principal, obligee and dual obligee for acknowledgment and then be attached to the bond making it an integral part of the surety's obligation.
This general overview should not be interpreted as all inclusive. The purpose of this position paper is to outline some of the major areas of concern for a surety company when confronted with a request to incorporate an additional obligee(s) into its performance bond coverage, and the recommended solution.
This paper is intended to serve as a general guideline to assist members and other readers in responding to the issues discussed. Nothing contained herein should be construed as legal advice and readers are cautioned to consult with legal counsel for such advice.