DRAFTING THE BOND FORM, PARTICULARLY THE PERFORMANCE BOND FORM

imagesOftentimes, when it comes to payment and performance bonds (in particular), the bond forms are drafted by the obligee.  For example, an owner (as the obligee) may draft the bond forms that it wants its general contractor’s surety to execute.  And, a general contractor (as the obligee) may draft the bond forms that it wants its subcontractors’ sureties to execute.   As an obligee, it is always beneficial to draft the bond form (particularly the performance bond) that you want the surety to execute.  The bond is to benefit you—the obligee—so having a hand in creating conditions to trigger the application of the bond is important, specifically when it comes to triggering a performance bond upon the bond-principal’s default.

 

What if the surety executes a bond form prepared by the obligee and there is an ambiguity in the bond?  Should the ambiguity be interpreted against the obligee as the drafter of the bond?

 

This issue was addressed by the Fourth District Court of Appeal in The School Bd. Of Broward County v. Great American Ins. Co., 807 So.2d 750 (Fla. 4th DCA 2002) where the School Board owner prepared the performance bond form.  The surety argued there was an ambiguity with the bond form and wanted the ambiguity to be interpreted against the School Board as the drafter of the bond.  The court rejected this argument explaining:

 

Florida’s policy is to construe any ambiguity in a bond in favor of granting the broadest possible coverage to those intended to be benefitted by protection of the bond [e.g., the obligee]. This policy recognizes that the purpose of a bond is to protect a party to a contract; the burden is on the surety, who is in the business, to include the appropriate language in its bonds if it seeks to narrow its obligations after default.

The School Board of Broward County, 807 So.2d at 752 (internal citations and quotations omitted).

 

 

To reiterate, it is always beneficial as the obligee to prepare the bond forms (particularly the performance bond) that you want the surety to execute since the bond is designed to benefit you. Work with counsel to ensure the bond form provides you the broadest or best coverage based on the anticipated risks.    

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

 

DON’T MESS WITH THE GENERAL AGREEMENT OF INDEMNITY

untitledI have previously posted articles about the all mighty General Agreement of Indemnity (“Agreement of Indemnity”) that a surety requires a contractor bond-principal and designated guarantors to execute before issuing payment and performance bonds to the contractor. In cases forming the basis of the articles, the surety demands rights under the Agreement of Indemnity such as the right for collateral security to protect the surety from anticipated or pending claims and the contractor bond-principal refuses. In these cases, the surety files a lawsuit and moves for an injunction which, among other things, requires the principal to post the very collateral security it refused to post to begin with. As reflected in these cases, the surety gets the injunction granted because the Agreement of Indemnity is designed to protect the surety’s interests. In other words, don’t mess with the Agreement of Indemnity because the surety will typically get the recourse it pursues.

 

Recently, another opinion came out further supporting the rights of a surety under the Agreement of Indemnity and why it is beneficial to figure out an avenue to work with the surety instead of against it. In this case, Travelers Casualty and Surety Co. of America v. Design Build Engineers and Contractors Corp., 2014 WL 7274803 (M.D.Fla. 2014), the contractor bond-principal was working on two public projects. On one project, a dispute with a subcontractor resulted in a claim that the surety paid plus substantial attorney’s fees awarded to the subcontractor by the court. Although the contractor reimbursed its surety for the principal amount of the claim, it refused to reimburse the surety for the substantial attorneys’ fees awarded to the subcontractor. And, on the other project, the contractor was terminated resulting in pending performance bond and payment bond claims against the surety.

 

The contractor, in furtherance of trying to shield major property and assets, did some creative asset transfers forming holding companies, etc. This did not work.  The surety filed a lawsuit against the contractor and guarantors under the Agreement of Indemnity and moved for a preliminary injunction to require the contractor to post collateral security and to prevent the contractor from disposing of assets. Guess what? The surety prevailed on its motion for an injunction and the Middle District Court ordered that the contractor post the requested collateral that included properties the contractor tried to shield and prevented the contractor and certain holding companies it formed from disposing or encumbering of assets (inclusive of the real property is was ordered to post as collateral).

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

 

SURETY BONDING – THE NUTS & BOLTS

images-2Surety bonding is necessary in construction, particularly on federal and Florida public projects where the contractor is required to furnish a payment and performance bond.  Even certain owners of large-scale private projects want their contractor to obtain a payment and performance bond.  Understanding the nuts and bolts of surety bonding is valuable for the contractor that wants to increase job opportunities and/or increase their bonding capacity.

 

 

There are three main parties to the surety bond:

 

1. The surety– the entity (typically, a division of an insurance company) that issues the payment or performance bond for the contract price; the surety guarantees obligations on behalf of its principal, whether it is the performance of the contract (performance bond) or the payment to those entities working under the contractor providing labor, services, or materials (payment bond)

 

2. The principal – the entity (contractor) that procured the bond from the surety and who the surety is issuing the bond on behalf of; the principal along with personal and corporate guarantors will execute a General Agreement of Indemnity before the bond is issued outlining the rights and remedies of the principal/guarantors and the surety

 

3. The obligee – the entity (or entities) that can make a claim against the bond and who the bond is ultimately designed to benefit

 

Not every contactor can get a payment and performance bond.  This means that not every contractor can perform public work that requires a bid bond to be furnished with the bid/proposal and then a payment and performance bond upon the award of the contract.  This is because sureties undertake rigorous underwriting to best assess their risk before issuing bonds. And, many contractors, even if bonds are issued, will have a bonding capacity meaning the surety will not issue an unlimited dollar amount for the bond(s) issued or will not issue an unlimited number of project bonds at the same time. Rather, it will issue a bond or bonds totaling the bonding capacity of the contractor.

 

To obtain a bond, a contractor will go to a surety bond agent/broker, commonly referred to as the producer.  The producer represents select sureties.  Certain sureties cater to certain market niches or contractors and the producer tries to fit the contractor with the surety that best fits the needs, strengths, and qualifications of the contractor. The producer will work with the contractor to fill out required forms and review and collect the material and information that will be needed by the surety in the underwriting process. As a contractor, it is important to develop a strong relationship with a producer that understands your construction business and capabilities and can assist you with obtaining bonding capacity.

 

images-3In the underwriting process, the surety will want to determine the financial strength, creditworthiness, and condition of the contractor by analyzing extensive financial documentation along with the contractor’s operational ability to perform a contract based on the contractor’s history, equipment, personnel, etc.  Underwriting needs to obtain and assess financial and operational material to best assess the surety’s risk (based on the surety’s appetite or market) because if the surety has to pay out a claim on the bond it will absolutely be looking to recoup the costs it incurs from the bond principal as well as the guarantors that executed the General Agreement of Indemnity.  Among other things, the surety will run a credit check for the principal and likely the owners/guarantors; will analyze balance sheets, income statements, and other financial information to understand the contractor’s cash flow, working capital, net worth, and profitability history and forecasts; will want to know of judgments and lawsuits; will likely contact references; and will want to specifically understand past projects completed and current projects underway, including the project in which the bond is being requested, from an estimating and accounting standpoint, personnel and management standpoint, insurance standpoint, and possibly a scheduling standpoint.  The surety will do its homework because the very last thing a surety wants to do is pay a claim or expose itself to massive liability with a bond claim from a contractor that failed to pay its subcontractors or abandoned a job without any true recourse to recoup money expended.  The surety will consider the personal and corporate guarantors it requires from a contractual indemnity standpoint per the General Agreement of Indemnity and may require cash collateral or property collateral to be pledged for underwriting approval.   Again, developing the relationship with the producer that understands your business is crucial as the producer will understand the underwriting process and facilitate the transmission of information and material between the contractor and the surety.

 

 

The surety charges a premium for the issuance of the bond.  Payment and performance bonds are often single premium bonds.  Depending on the producer you ask, the premiums typically range from 1-3% of the bond amount.   Naturally, there are contractors that will have to pay in excess of 3% of the bond amount based on the associated credit risk with issuing the bond.

 

Once underwriting runs its course and the contractor is approved for the requested bonds, the producer typically signs the bonds on behalf of the surety.  The producer is given a power-of-attorney to sign bonds as an attorney-in-fact on behalf of the surety.

 

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

THE ALL MIGHTY GENERAL AGREEMENT OF INDEMNITY WITH THE SURETY

images-2Sureties do not issue bonds (e.g., payment or performance bonds) unless the principal and the principal’s personal guarantors execute a General Agreement of Indemnity (“Indemnity Agreement”).  The Indemnity Agreement routinely requires that the principal / guarantors: (1) defend and indemnify the surety for all losses, liability, claims, attorney’s fees, and expenses that the surety may incur and (2) post collateral security into a reserve account set up by the surety to cover any claim on the bond; the surety may seek an injunction to compel such collateral if the principal / guarantors refuse.  Yes, these are powerful provisions in favor of the surety if a claim is asserted against the principal’s bond (especially a performance bond claim) or if the surety, to offset liability or exposure, pays a claimant on behalf of the principal.  The leverage lies with the surety with respect to the provisions in the Indemnity Agreement and the worst thing a bond principal can do when a claim is asserted against the bond is to outright refuse to work with and cooperate with the surety (based on the powerful provisions in the Indemnity Agreement).

 

 

The opinion in Developers Surety and Indemnity Co. v. Hansel Innovations, Inc., 2014 WL 2968138 (M.D.Fla. 2014), exemplifies what can happen if a bond principal refuses to cooperate with a surety even if the principal has potentially meritorious arguments.  In this case, a surety issued a performance bond to a fire protection subcontractor.  During the course of construction (and, arguably due to the general contractor’s nonpayment), the subcontractor experienced cash flow problems.  The general contractor expressed concerns as to the subcontractor’s financial wherewithal to complete the contract work and made demand on the surety.  The subcontractor requested financial assistance from its performance bond surety and the surety agreed to pay the subcontractor and its vendors in excess of $100,000 provided the subcontractor execute a separate financing and collateral agreement (as the surety expected to recoup its “loan”).  Subsequently, the general contractor advised the surety and subcontractor of performance issues with the subcontractor’s work.  The subcontractor, however, refused to complete its work and address the performance issues unless the surety continued to fund the subcontractor’s work, released the guarantors from personal liability, and pursued claims against the general contractor.  Based on the subcontractor’s stance, the surety retained another subcontractor to complete the work and incurred additional costs.  The surety filed a lawsuit to, among other rights afforded under the Indemnity Agreement, require the subcontractor and guarantors to post $200,000 in collateral security into a reserve account.  The subcontractor and guarantor failed to post collateral upon demand.

 

 

The surety, as it customarily will do, moved for a preliminary injunction in accordance with the Indemnity Agreement for the court to order the subcontractor and guarantors to post collateral.   One of the requirements for a court to order a preliminary injunction is for the surety to establish that it is substantially likely to succeed on the merits.  This is not a challenging hurdle for a surety given the powerful provisions in the Indemnity Agreement. (Please see the following articles for more information on a surety’s right to demand collateral security and the requirements for a preliminary injunction in federal court: http://www.floridaconstructionlegalupdates.com/a-suretys-right-to-demand-collateral-security/ and http://www.floridaconstructionlegalupdates.com/a-suretys-right-to-demand-collateral-security/.)

 

 

The subcontractor argued that bad faith or unclean hands, evidenced by an improper motive, extinguished the surety’s substantial likelihood that it would succeed on its claim.  The subcontractor argued this because it did not want to post collateral.  In support of bad faith, the subcontractor contended that when the general contractor raised performance issues the subcontractor was 99% done with its work with the remaining work simply commissioning the fire sprinkler system and completing as-built drawings.  It further argued that the general contractor placed it in a dire financial position because the general contractor did not pay it for over one year and did not pay it for change order work that was performed at the general contractor’s direction.  (Not an uncommon subcontractor argument!)  The subcontractor also stated that it only signed the financing and collateral agreement because the surety assured it that the surety would assist the subcontractor in collection efforts against the general contractor if the subcontractor signed the agreement and continued with the work.  Then, the surety discontinued funding the subcontractor at the eleventh hour to help the subcontractor complete the work while contemporaneously failing to assist the subcontractor in collecting any money from the general contractor.  The Magistrate, though, was not persuaded by the subcontractor’s bad faith argument taking the position that it cannot be bad faith for the subcontractor to be induced into completing its work on a project it was hired to complete.

 

 

The subcontractor may have very strong arguments that it was truly placed in a cash flow crunch because the general contractor refused to pay for contract work plus additional work.  Thus, the subcontractor was forced to finance a job that it was never in a financial position to finance.  Then, when it agreed to complete its work with the surety’s assistance, it did so with the understanding that the surety would assist the subcontractor in recovering monies that the subcontractor should have been paid all along for contract and change order work that would also be used to reimburse the surety.  But, as shown in this case, truly establishing bad faith is very, very difficult and should not be sugarcoated with the sentiment that the provisions in the Indemnity Agreement do not have any teeth, because they do!

 

 

Keep in mind that a performance bond guarantees performance under a contract.  Once a bond is furnished, it is rarely advisable to abandon a job or refuse to perform because it puts the surety in a compromising position where it will likely need to complete the subcontractor’s performance in order to mitigate its exposure and liability.  Here, the subcontractor’s surety was willing to finance the subcontractor’s work until the subcontractor was virtually complete.  All the subcontractor had to do was complete its work when it was 99% complete and work with and cooperate with the surety since the best course of action in the long run may have been for these entities to work together to recover monies that the general contractor owed the subcontractor and/or figure out how the subcontractor would reimburse the surety.  However, based on what the surety may have construed as an obstinate position by the subcontractor, the surety incurred additional expenses and elected to pursue its options against the subcontractor and guarantors under the all mighty Indemnity Agreement.

 

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

PRESERVING PERFORMANCE BOND CLAIMS

 

rPerformance bonds can be a valuable source of protection to owners that want their general contractors to provide a performance bond and, likewise, to general contractors that want certain subcontractors to provide a performance bond. The performance bond is designed to benefit the obligee in the event the contractor that issues the bond defaults under its contractual obligations. It is absolutely crucial that parties take the proper steps under the terms of the performance bonds to preserve their rights and arguments under the bond. To do this requires an unequivocal formal default of the contractor that issued the bond and that the party will be looking solely to the surety to complete the defaulted party’s contractual obligations. Otherwise, a court will rule in favor of the surety finding that the obligee of the bond did not comply with conditions precedent to preserve the performance bond claim and/or breached the terms of the bond by not allowing the surety to investigate and complete performance. This is exactly the situation in two federal district court summary judgment opinions relying on Florida law: North American Specialty Insurance Co. v. Ames Corp., 2010 WL 1027866 (S.D.Fla. 2010) and CC-Aventura, Inc. v. Weitz Co., 2008 WL 2699577 (S.D.Fla. 2008). Both of these cases illustrate the importance of formally and unequivocally declaring the party that issued the performance bond in default irrespective of whether the issue arises pre-completion or post-completion. Both cases also pertain to a subcontractor that provided a performance bond identifying the general contractor as the obligee (or beneficiary) of the bond.

 

I. North American Specialty Ins. Co. v. Ames Corp. (Pre-Completion)

 
In this case, a general contractor hired a roofer for a federal project. The roofer provided performance bonds identifying the general contractor as the obligee. The bonds provided as follows (which is common language in performance bonds):

 

“Whenever Principal shall be, and be declared by Obligee to be in default under the subcontract, the Obligee having performed Obligee’s obligations thereunder:

(1) Surety may promptly remedy the default …;

(2) Obligee after reasonable notice to Surety may, or Surety upon demand of Obligee may arrange for the performance of Principal’s obligation under the subcontract …;

(3) … If the Surety arranges completion or remedies the default, that portion of the balance of the subcontract price as may be required to complete the subcontract or remedy the default and to reimburse the Surety for its outlays shall be paid to the Surety at the times and in the manner as said sums would have been payable to Principal had there been no default under the subcontract.”

Ames Corp., 2010 WL at *1.

 

During construction, the general contractor notified the surety that the roofer was refusing to perform and that the general contractor will look to the surety for costs incurred above the roofer’s subcontract amount. A follow-up notice advised the surety that expenses were being incurred to finish the roofer’s subcontract amount and no one from the surety visited the jobsite. The surety then commenced an investigation while advising the general contractor that the “prior letters were not accompanied by supporting documentation and/or prior notice to the principal of default and/or potential default.” Ames Corp., 2010 WL at *3. A meeting was coordinated with the owner, the general contractor, the roofer, and the roofer’s surety at which time the surety represented it would need up to 5 months to assume responsibility and take action. After this meeting, the general contractor sent another letter to the surety and the roofer explaining that the roofing subcontract was not terminated or declared in default and that the surety needed to appreciate the short time allotted for completing the roofer’s contract. The surety responded that because the general contractor had not declared the roofer in default, the surety had no obligation to act under the performance bonds.

 

Notwithstanding the general contractor never formally declaring the subcontractor in default, it supplemented the roofer’s scope of work. Both the roofer and the surety objected; the surety even advised that such efforts would be a material breach of the bonds. However, due to leaks with the roofing system (the manufacturer of the roofing system inspected the roof and found that there were installation defects), the general contractor incurred substantial costs to complete the roofer’s scope of work which exceeded the roofer’s subcontract balance. In addition, the general contractor incurred delay damages associated with completing the roofer’s scope of work.

 

The surety initiated this lawsuit based on the monetary demands from the general contractor. The surety moved for summary judgment based on the argument that a condition precedent to the bonds obligations was never triggered, that being that the general contractor never declared the roofer in default. The surety also argued that the general contractor breached the bonds by not allowing the surety the right to remedy any default and by not making available to the surety the unpaid subcontract balance in connection with the surety remedying the default.

 

Relying on Florida law, the Southern District found:

 

[A] surety’s liability on a bond is determined strictly from the terms and conditions of the bond agreement. The purpose of a performance bond is to guarantee completion of the contract upon default by the contractor.

***

A declaration of default sufficient to invoke the surety’s obligations under the bond must be made in clear, direct, and unequivocal language. The declaration must inform the surety that the principal has committed a material breach or series of material breaches of the subcontract, that the obligee regards the subcontract as terminated, and that the surety must immediately commence performing under the terms of the bond.

Ames Corp., 2010 WL at *6 (internal citations and quotations omitted).

 

Based on this law, the Southern District held that none of the letters the general contractor sent to the surety defaulted the roofer in clear, direct, and unequivocal language. While the letters urged the surety to become involved and threatened default, they did not formally and unequivocally default the roofer. Accordingly, the court granted summary judgment in favor of the surety.

 

Furthermore, the Southern District agreed with the surety that the general contractor breached the bond by completing / supplementing the subcontract without giving the surety the opportunity to remedy any default under the subcontract. As the court explained: “‘[O]nce Ames/Dawson [general contractor] engaged in the supplementation of work without allowing NAS [surety] to perform, its conduct constituted a material breach that voided the bond.” Ames Corp., 2010 WL at *9.

 

II. CC-Aventura, Inc. v. Weitz Co. (Post-Completion)

 

In this case, the general contractor was hired to construct a senior living facility. The general contractor hired a painter with a subcontract that contained an indemnification provision and a provision that required the painter to correct defective work. The painter provided a performance bond identifying the general contractor as the obligee.

 

pAfter completion of the project, the owner sued the general contractor for water intrusion and damage. The general contractor sued subcontractors including its painting subcontractor. The general contractor also asserted a claim against the painting subcontractor’s performance bond surety for breach of the bond. The surety moved for summary judgment arguing that the bond obligations were never triggered because the general contractor never formally declared the painting subcontractor in default.

 

The general contractor argued that it did provide default notices when it transmitted the owner’s expert and its expert reports regarding the paint that the painter applied. In the notices, the general contractor demanded that the surety correct the defects and that the painter’s failure to take corrective action will be a default under the subcontract.

 

The surety took the position that these types of notices were insufficient. The Southern District of Florida agreed and granted summary judgment in favor of the surety finding:

 

“Both of Weitz’s [general contractor] letters do state that Delta [subcontractor] is in ‘default’ of its Subcontract-and had Weitz maintained that position and indicated that Weitz now looked to American Casualty [surety] alone, both of its letters could reasonably be interpreted as declarations of default sufficient to trigger American Casualty’s liability on the Bond. However, in its December 30, 2005 letter Weitz also advised Delta to ‘please accept this letter as The Weitz Company’s final written demand that Delta Painting or its Surety take appropriate corrective action’….In its April 11, 2006 letter, Weitz reiterated that it had made ‘numerous demands upon both Delta and American to correct [the painting] deficiency.’ Weitz then stated its intention to perform the corrective work itself and announced that ‘Weitz will seek such costs and all other damages from Delta and American.’ If Weitz wanted to trigger American Casualty’s obligations on the Bond, it would have had to clearly and unambiguously notify American Casualty that it now looked to it to complete Subcontract obligations, in accordance with the Bond.”

CC-Aventura, 2008 WL at *4.

 

 

As illustrated above, there are certainly procedural hurdles that are required to take place in order to properly default a contractor that provided a performance bond. Not doing so can be fatal to the performance bond claim. Default is always viewed as a last resort because parties do not want to be in material breach for incorrectly defaulting or terminating a party. However, by not defaulting a party, the performance bond’s obligations are not triggered. Due to these hurdles, general contractors are now obtaining subguard (subcontractor default insurance) instead of requiring individual subcontractors to provide performance bonds. This allows the general contractor to be more involved in the process since it is the one obtaining subguard and it eliminates subcontractors from having to obtain the bond (which could be problematic for certain subcontractors).

 

For more on performance bonds, please visit: http://www.floridaconstructionlegalupdates.com/statute-of-limitations-on-performance-bond-claims/

 

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

 

 

MORE ON A SURETY’S RIGHT TO DEMAND COLLATERAL SECURITY FROM THE CONTRACTOR BOND-PRINCIPAL AND BOND GUARANTORS

imagesI previously discussed a surety’s right to demand collateral security from its bond principal and personal guarantors by discussing the case Developers Surety and Indemnity Co. v. Bi-Tech Construction, Inc., 2013 WL 4563657 (S.D.Fla. 2013). (Please see below for the link where this blog article can be located.)

 

To add to this discussion, the Middle District of Florida in Travelers Cas. and Sur. Co. of America v. Industrial Commercial Structures, Inc., 2012 WL 4792906 (M.D.Fla. 2012), a case that preceded Bi-Tech Construction, dealt with a similar issue of a performance bond surety demanding the bond principal and guarantor to post / deposit collateral to offset the surety’s liability exposure. In this case, the surety issued a performance bond to the contractor in connection with a residential project. A dispute arose between the contractor and the owner and the contractor sued the owner for, among other claims, breach of contract and to foreclose a construction lien. The owner countersued the contractor and the performance bond surety (which is not uncommon in a payment dispute where the owner asserts construction defects or incomplete performance). The dispute was hotly contested.

 

During the dispute with the owner, the surety demanded that the contractor post collateral – it demanded that the contractor deposit money into a reserve account that would be used to offset the surety’s liability. When the contractor did not post / deposit the amount of money the surety wanted, the surety filed a lawsuit against the contractor (principal) and the contractor’s guarantors that executed the General Agreement of Indemnity (the agreement the surety requires to be executed before it issues bonds on the principal’s behalf). The surety moved for a preliminary injunction asking the Court to order the contractor to deposit the money into a reserve account. The surety also moved for an injunction demanding that the contractor not transfer or encumber assets, allow the surety to have a full accounting of the contractor and guarantor’s assets, and allow the surety access to the contractor and guarantor’s books and records.

 

The Middle District, analyzing the requirements for a preliminary injunction, agreed with the surety and ordered that the contractor post / deposit collateral into the reserve account. Of interest, the surety prior to the lawsuit demanded collateral of $1.5 million that it subsequently reduced to $300,000. Although the surety in its motion for preliminary injunction demanded that the contractor deposit the $1.5 million in collateral, the court ordered the contractor to deposit $300,000 to the reserve account. (There was some indication in the opinion that the contractor posted approximately $139,000 as collateral, but it is uncertain whether this was collateral provided in connection with the issuance of the bonds or the lawsuit with the owner.)

 

The MIddle District elaborated:

 

As one federal court of appeals has succinctly explained, ‘[a] collateral security provision [in an indemnity agreement] provides that once a surety…receives a demand on its bond, the indemnitor must provide the surety with funds which the surety is to hold in reserve. If the claim on the bond must be paid, then the surety will pay the loss from the indemnitor’s funds; otherwise, the surety must return the funds to the indemnitor.’ Moreover, ‘[s]ureties are ordinarily entitled to specific performance of collateral security clauses.’ This is because ‘[i]f a creditor is to have the security position for which he bargained, the promise to maintain the security must be specifically enforced.’ Industrial Commercial Structures, supra, at *2 (internal citations omitted).

 

However, the court did not order the contractor or guarantor to give a full accounting, provide the surety access to books and records, or prohibit the transferring of assets as the surety did not establish it would be irreparably harmed (a requirement for an injunction) if this relief was not granted. Also, the court, unlike the court in Bi-Tech Construction, required the surety to post a $100,000 bond for the injunction to cover damages in the event the injunction was wrongly ordered.

 

Although the court in this case did not discuss the collateral security provisions, such provisions are virtually identical in most General Agreements of Indemnity. Even in a hotly contested dispute between the contractor and the owner (such as the situation in Industrial Commercial Structures), if a claim is asserted against the surety or it is sued, the surety can demand for the principal and guarantor to post collateral into a reserve account to offset the surety’s liability exposure. However, if the surety demands more, such as an accounting, access to books, etc., this case can support the argument that these remedies are not warranted because the surety has not established it will be irreparably harmed if this recourse is not ordered. Now, if the circumstances are different and the surety carries its burden of establishing irreparable harm, it is possible that this recourse will also be ordered; however, this additional recourse should ideally result in a higher injunction bond amount.

 

The objective is for the contractor (bond-principal) and guarantors to understand their rights and options in the event a claim or lawsuit is asserted against the bond.

 

To find out more about this issue and the requirements for a preliminary injunction, please see
http://www.floridaconstructionlegalupdates.com/a-suretys-right-to-demand-collateral-security/

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

 

A SURETY’S RIGHT TO DEMAND COLLATERAL SECURITY

power plantBefore payment and performance bonds are issued by a surety, the bond principal-contractor is required to execute an indemnity agreement with the surety that is often personally guaranteed. The indemnity agreement is naturally written in favor of and for the benefit of the surety that is issuing bonds that are typically in the amount of the contracts that are awarded to the contractor. Contractors that execute indemnity agreements need to understand what the surety’s rights and remedies are in the event performance and/or payment bond claims are made that raise a concern to the surety. Not understanding these rights could put the contractor in a losing situation with the surety.

 
The recent Southern District of Florida opinion in Developers Surety and Indemnity Co. v. Bi-Tech Construction, Inc., 2013 WL 4563657 (S.D.Fla. 2013), exemplifies a surety’s options against its bond principal-contractor. In this case, the contractor was awarded a contract by a public owner to install a new generator system. The contractor was required to obtain public performance and payment bonds. Shortly after construction commenced, a payment dispute arose between the contractor and the public owner. The public owner refused to pay the first full payment application amount because it originally over-estimated the amount of trenching that the contract would require. The contractor contended that it bid its work on its own assessment of the trenching and needed to be paid in full to cover project costs. The contractor further argued that it could not complete the project without full payment; the public entity therefore elected to terminate the contractor from the project.

 
The public owner and the contractor’s surety entered into discussions as the public owner must have submitted a performance bond claim to the surety. They agreed that the public owner would pay the contractor in full and the contractor would be reinstated to complete the work. The surety then issued the contractor a memorandum of understanding that outlined the terms of its agreement with the public owner and needed the contractor to sign off on the memorandum of understanding. The contractor, however, refused because it objected to certain provisions in the memorandum of understanding that would have, among other things, required the public owner’s payments to the contractor to be held in a third party trust account until the surety authorized the disbursement of the funds.

 
Meanwhile, subcontractors to the contractor remained unpaid. The electrical subcontractor was owed approximately $172,000 and filed a suit against the contractor’s payment bond. Additionally, another subcontractor was owed approximately $8,000. The surety decided to create a reserve account and deposited $205,000 into that account. The surety demanded that the contractor also deposit $205,000 into the reserve account as collateral security. The contractor refused prompting the surety to file suit against the contractor.

 

 

While the surety’s lawsuit against the contractor was pending, the surety immediately moved for a preliminary injunction asking the Court to order the contractor to provide the surety $205,000 as collateral security to be deposited into the reserve account.
“In order to obtain a preliminary injunction, the plaintiff [surety] must establish [the following elements:] (1) a substantial likelihood that it will prevail on the merits of the underlying cause of action; (2) a substantial threat that it will suffer irreparable injury if the injunction is not granted; (3) that the threatened injury to the plaintiff outweighs the threatened harm the injunction may have on the defendant; and (4) that the public interest will not be adversely affected by granting the preliminary injunction.” Bi-Tech, 2013 WL at *3. If the Court decides that an injunction is appropriate, it has the discretion to determine the amount of the bond the plaintiff (in this case, the surety) will have to post as security to cover damages in the event the injunction is wrongfully issued. Id. at *5 quoting Fed.R.Civ.P. 65.
The Court, in determining whether the elements for injunctive relief were satisfied, analyzed the terms of the indemnity agreement. (The Court would also do this when determining whether the contractor breached the terms of the indemnity agreement.) The indemnity agreement contained few applicable provisions:

 

 

“-Indemnitor [contractor and guarantors]…shall indemnify and hold harmless Surety from and against any and all liability…which Surety may sustain or incur by reason of or in consequence of the execution and delivery by Surety of any Bond on behalf of Principal [contractor].
-Indemnitor shall, immediately upon demand and whether or not Surety shall have made any payment therefor, deposit with Surety a sum of money equal to such reserve account and any increase thereof as collateral security on such Bond…If Indemnitor shall fail, neglect or refuse to deposit with Surety the collateral demanded by Surety, Surety may seek a mandatory injunction to compel the deposit of such collateral together with any other remedy at law or in equity the Surety may have.
-Principal and Indemnitor…agree to hold all money and all other proceeds for the Obligation, however received, in trust for the benefit of Surety and to use such money and other proceeds for the purposes of performing the Obligation and for discharging the obligations under the Bond, and for no other purpose until the liability of the Surety under the Bond is completely exonerated.”
Bi-Tech Construction, 2013 WL at *1.

 

 

 

Based on these provisions, the Court maintained that the surety has the contractual right to create the reserve account and demand for the contractor to post collateral security in the reserve account equal to the amount deposited by the surety. This contractual right exists irrespective of whether the contractor disputes the legitimacy of claims made against the surety’s bond. Once the Court recognized this contractual right, it recognized that the surety could suffer irreparable injury because it would be unsecured against claims (hence, the reason why the indemnity agreement allows the surety to request collateral security). Finally, finding that an injunction was appropriate, the Court did not require the surety to post a bond.

 

 

Indemnity agreements with sureties contain very similar provisions as the ones referenced above. The provisions applicable for purposes of the preliminary injunction are contained in many indemnity agreements which, among other things, give the surety the right to request collateral security. It is important to understand rights and remedies in connection with the indemnity agreement to hopefully avoid any situation or dispute where the surety pursues recourse against the bond principal-contractor and the guarantors that executed the indemnity agreement.

 

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

 

INDEMNITY AGREEMENTS BETWEEN A SURETY AND ITS BOND PRINCIPAL

UnknownSureties that issue contractors payment and/or performance bonds obtain indemnity agreements with the contractor, or bond principal, prior to issuing such bonds. These indemnity agreements, besides requiring the bond-principal contractor to indemnify, defend, and hold harmless the surety in the event a claim is submitted on the bonds, are designed to fully protect the surety in the event the contractor fails to do so.

 

There are situations where a surety needs to protect its own interests and comply with the terms of the bond and pay a claim on a performance or payment bond (such as if the contractor gets into financial trouble, walks off a project, is not paying subcontractors, etc.). If the surety pays a claim, they typically assert a claim against the bond-principal contractor for breach of the indemnity agreement along with any person that personally guaranteed the agreement (which is often the case). The indemnity agreement will include a provision that provides that the bond-principal assigns certain collateral to the surety in the event the principal is in default of the agreement. Among those rights that are collaterally assigned to the surety would be all of the principal’s contract rights and causes of action for accounts receivable.

 

The case of Guarantee Co. of North America v. Mercon Construction Co., 2012 WL 1232104 (M.D.Fla 2012), exemplifies a surety’s rights under the indemnity agreement. This case involved a situation where a surety paid a performance bond claim on behalf of its principal contractor and sued the contractor, as well as others, under the indemnity agreement. The surety also exercised its right under the indemnity agreement and settled a claim the contractor had against another payment bond (issued by a different surety). In other words, the surety’s position was that the claim for an account receivable under the other payment bond was collaterally assigned to the surety due to the contractor’s default. The contractor asserted a counterclaim arguing, among other things, that the surety did not have the authority to settle its account receivable payment bond claim. The Middle District disagreed and dismissed the contractor’s counterclaim with prejudice!

 

If a bonded contractor is involved in a situation where its surety either paid a claim or will pay a claim, it is important for the contractor to consult an attorney to understand the surety’s rights under the indemnity agreement. Again, surety’s oftentimes have the indemnity agreement personally guaranteed so that the obligations under the agreement could not only impact the bond-principal contractor but also the guarantors to the agreement.

 

 

 

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.