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.