SURETIES DO NOT ISSUE BONDS RISK-FREE TO THE BOND-PRINCIPAL

Posted on August 27, 2017August 27, 2017 by Edward Garber

If your construction company is bonded, then you have signed a General Agreement of Indemnity with your surety / bonding company. Stated another way, if a surety issued an obligee on behalf of your construction company, as the bond-principal, a payment or performance bond, then you have signed a General Agreement of Indemnity with your surety.

The General Agreement of Indemnity is NOT to be taken lightly. Without the General Agreement of Indemnity, the surety is NOT issuing the bonds you need to work on a certain project. A bond is not insurance and sureties do not issue the bonds under a risk-free premise. Oh no! If a surety has to pay-out claims under a bond, the surety will be looking to recoup that loss from the indemnitors that executed the General Agreement of Indemnity.

The General Agreement of Indemnity will generally require not only the construction company, but individuals (both husband and wife) and, potentially, other affiliated companies to indemnify the surety in the event a claim is made against a bond (the indemnitors). Thus, there will be multiple indemnitors the surety will look towards if they perceive risk under the bond. If you take the General Agreement of Indemnity lightly, then you could find yourself, for lack of a better expression, up “s#*#*t’s creek without a paddle!” This is no joke.

In a recent example, Great American Ins. Co. v. Brewer, 2017 WL 3537577 (M.D.Fla. 2017), a subcontractor furnished a general contractor with a performance bond. The subcontractor was defaulted and then terminated and a claim was made against the subcontractor’s performance bond. The surety, to mitigate its exposure, entered into a settlement agreement with the general contractor.

Before the surety entered into a settlement agreement with the general contractor, it demanded that the subcontractor (bond-principal) and other listed indemnitors post $1.5M in collateral pursuant to the General Agreement of Indemnity. The subcontractor (and the other indemnitors) refused. After the surety entered into the settlement agreement with the general contractor, it demanded that the subcontractor (and the other indemnitors) post approximately $2.8M in collateral representing amounts covered in the settlement and additional amounts constituting the surety’s exposure to the general contractor. The subcontractor (and other indemnitors) again refused.

The subcontractor’s refusal was predicated on the argument that it was improperly defaulted and terminated. And this argument is where the subcontractor’s problem lies. The subcontractor’s belief is largely irrelevant if the surety operates in good faith (and proving bad faith in this context is very, very challenging). But, in order to even argue that the surety did not act in good faith, the subcontractor (and its indemnitors) would need to post collateral per the terms of the General Agreement of Indemnity.

In Florida, a construction performance bond surety like Plaintiff is “entitled to reimbursement pursuant to an indemnity contract for any payments made by it in a good faith belief that it was required to pay, regardless of whether any liability actually existed.” Further, where—as here—an indemnity agreement gives the surety discretion to settle a claim brought under a bond, “the only defense to indemnity for [such a] settlement is bad faith on the part of the surety.”

A bad faith defense is not available to indemnities like Defendants who do not post collateral in accordance with a demand under an indemnification agreement. When a bad faith defense is available, it requires proof of “an improper motive or dishonest purpose on the part of the surety.” Standing alone, evidence of a surety’s “lack of diligence,” negligence, and even “gross negligence,” is not evidence of bad faith.

Great American Ins. Co, supra, at *7 (internal citations omitted).

Importantly, disagreeing with a surety’s investigation is not evidence of bad faith by the surety. Great American Ins. Co, supra, at *8. It requires, as stated, a truly improper motive or dishonest purpose — very, very difficult to prove.

General Agreements of Indemnity tend to have the same fundamental provisions. Before you refuse a demand made by your surety, consider the ramifications.

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

Posted on July 8, 2014July 8, 2014 by Edward Garber

Sureties 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: https://floridaconstru.wpengine.com/a-suretys-right-to-demand-collateral-security/ and https://floridaconstru.wpengine.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.

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

Posted on October 17, 2013October 17, 2013 by Edward Garber

I 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
https://floridaconstru.wpengine.com/a-suretys-right-to-demand-collateral-security/

A SURETY’S RIGHT TO DEMAND COLLATERAL SECURITY

Posted on September 17, 2013September 17, 2013 by Edward Garber

Before 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.

INDEMNITY AGREEMENTS BETWEEN A SURETY AND ITS BOND PRINCIPAL

Posted on May 15, 2012May 15, 2012 by Edward Garber

Sureties 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.