Tag Archives: surety

A SURETY’S RIGHT TO DEMAND COLLATERAL SECURITY

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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.

 

 

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

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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.

 

 

 

 

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.