Hello, I am Bae Ki-hyung, a lawyer at Cheongchul Law Firm.

On construction sites, the owner (the party ordering the work) guards against the risk that the contractor will abandon or delay the work or otherwise fail to perform the contract by requiring a 'performance bond' issued by institutions such as the Construction Guarantee Cooperative or Seoul Guarantee Insurance (SGI).

Yet when the work actually stops because of the contractor's cash shortage or defective construction and the owner claims the performance bond from the guarantor, the guarantor very often refuses payment, saying that "the construction contract was not lawfully terminated within the bond period, so no bond amount is payable." From the owner's perspective, even though it is obvious that the contractor ruined the project, it faces losing a bond worth hundreds of millions of won merely because its 'notice of termination' came late.

In this post, I explain, through Supreme Court precedent, whether a contractor's simple breach is enough to claim a performance bond, or whether 'termination' of the construction contract must come first.

Standard for Determining a 'Guarantee Event' Under a Performance Bond – Is Contract Termination a Requirement?

[Question] The contractor missed the completion deadline and left the site unattended, a clear breach of contract. Can the owner claim the performance bond from the guarantor without having expressly terminated the contract with the contractor?

[Answer] It depends on the specific terms of the construction contract and the bond conditions. As a rule, termination of the contract must often precede the claim within the bond period, but there are exceptions where termination is merely a procedural requirement, so that a termination made after the period has expired still allows a bond claim.

The Supreme Court holds that what specifically constitutes the 'guarantee event' for which the guarantor is liable must be determined by reading together the bond conditions incorporated into the contract by the parties' agreement and the terms of the principal contract (the construction contract). On that basis, the Supreme Court divides cases into two broad categories.

1. Where Termination Is an Essential 'Element of the Guarantee Event' (the Rule)

The most common construction contracts provide that "if the contract is terminated or rescinded on the ground of the contractor's breach, the contract bond is forfeited to the owner." On such clauses the Supreme Court has held that "the owner cannot forfeit the contract bond merely because the contractor failed to perform an obligation under the principal contract; only when the owner terminates or rescinds the principal contract on the ground of the contractor's breach as defined in that contract can the bond be forfeited" (Supreme Court Decision 2005Da32715, September 29, 2005). In other words, even if the contractor's breach occurred within the bond period, if the owner did not expressly give notice of termination 'within the bond period,' no guarantee event is deemed to have occurred and the bond cannot be claimed.

2. Where Termination Is Merely a 'Procedural Requirement' (the Exception)

However, there are cases where the end of the construction period under the principal contract and the end of the bond period under the bond fall on 'the same date.' In that case, the breach (delay in performance) arises only when the work is not completed by midnight on the completion deadline, so it is physically impossible in time for the owner to terminate the contract within the bond period. On this point the Supreme Court observed that "if the guarantee event were deemed to occur only upon actual termination of the principal contract, the construction contract could not be terminated by the end of the bond period, producing the unreasonable result that a guarantee event could never occur," and held that in such a case the guarantee event must be regarded as having already occurred not when the principal contract was actually terminated but 'when the non-performance giving rise to the ground for termination occurred (that is, when the construction deadline passed)' (Supreme Court Decision 2013Da99331, May 16, 2014). Accordingly, in such a case the guarantor cannot refuse payment even if the owner terminates the contract and claims the bond immediately after the bond period ends. Note, however, that in that case the bond conditions set a separate claim deadline requiring that 'the contract be terminated and the bond claimed within 15 days from the day after the bond period expires,' so you must also check whether the bond conditions actually applicable contain such a claim deadline.

Furthermore, where the surety insurance policy itself expressly states that "the insured event is the policyholder's non-performance of the principal contract without justifiable cause, and termination of the principal contract need not occur within the insurance period," the breach itself is recognized as an insured event occurring within the insurance period (Supreme Court Decision 2013Da27978, July 24, 2014). Even then, however, termination cannot be postponed indefinitely. In that decision the Supreme Court held that if the principal contract is not terminated within a reasonable period after the owner learns of the breach, the limitation period for the insurance claim already begins to run from the end of that reasonable period, and ruled that the insurance claim of an owner who terminated belatedly, some three years later, had been extinguished by prescription. So even with such a policy wording, it is safest to go through the termination procedure as soon as the breach is confirmed.

Key Point – Complete the Notice of Termination Before the Bond Period Expires

In practice, then, when the contractor delays the work or goes bankrupt, the owner must not simply wait or merely argue verbally with the site manager.

The first thing to check is 'the expiry date of the performance bond's bond period.' If the expiry date is approaching, promptly demand performance from the contractor by certified mail and complete an express 'notice of termination of the construction contract' before the bond period ends; this is the safest and most essential step to protect a bond worth hundreds of millions of won. If the bond period has already passed, you must closely analyze the wording of the contract and the bond conditions and establish, as a matter of law, that termination is merely a procedural requirement.

Disputes over performance bond claims are a highly specialized area where the law on termination of construction contracts intersects head-on with the demanding interpretation of insurance (guarantee) terms, so a concrete legal review is needed from the earliest stage of the incident.

Cheongchul Law Firm, drawing on its deep understanding of the complex contractual relationships on construction sites and the exemption defenses raised by guarantors, offers optimal solutions so that owners are not unfairly deprived of their bond and can secure their legitimate rights. If you are struggling with a contractor's bankruptcy or work stoppage, or a guarantor's refusal to pay, please consult the experts at Cheongchul Law Firm.

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Bae Ki-hyung has worked at the Defense Installations Agency and in the construction/real estate team of a major law firm, providing legal advice on the entire process of government contracts and construction projects, including large-scale construction works such as public works, defense facility projects, and SOC construction projects, and has extensive experience and proven ability in resolving related litigation. If you need assistance with public works, private construction projects, public procurement contracts, state property, local government property, or public property, please feel free to contact us at any time.

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Cheongchul Law Firm is composed exclusively of lawyers from Korea's top five major law firms, the prosecution, and in-house legal teams of large corporations, and responds to each matter not with a single lawyer but with a team of specialists in the relevant field. Cheongchul goes beyond resolving specific issues to provide comprehensive solutions for the business as a whole, delivering legal consulting focused ultimately on achieving what the client wants. If you need help achieving your goals, do not hesitate to contact Cheongchul.