GUEST COLUMN
The General Agreement of Indemnity (GAI):
A Surety’s Best Friend,
A Contractor’s Worst Enemy
Bonding challenges
Surety and bonding require-
ments and consequences un-
doubtedly create some of the
greatest business and legal lia-
bility for North Carolina contrac-
tors – and disputes relating to
the bonding process certainly
create plenty of work for special-
ist construction lawyers.

These two articles con-
tributed by Brett Becker (Nexsen
Pruet) and Luke Farley (Conner
Gwyn Schenck PLLC) address
some important but perhaps
misunderstood risks and issues.

We’ll continue to cover surety
challenges in future issues.

12 — Summer 2018 — The North Carolina Construction News
By Luke J. Farley, Sr.

Special to North Carolina Construction News
A general agreement of indemnity
(GAI) can be a surety’s best friend
when a contractor starts to show
signs of trouble on a project. For that
same contractor, though, a GAI can
be its worst enemy.

A general agreement of indemnity
is a three-way contract between the
surety, the bond principal (that is, the
contractor), and (usually) the individ-
ual owners of the contracting com-
pany and their spouses. Under the
GAI, the bond principal, the individual
owners, and the spouses—together
called “indemnitors”—agree to pay
back the surety for any costs incurred
as a result of issuing the bonds. Most
contractors with a bonding line have
probably signed a GAI at some point.

From “time immemorial” 1 sureties
have enjoyed a basic, common law
right to be reimbursed by their bond
principal. 2 A GAI expands those rights
in two major ways.

First, a GAI will make the individual
owners of the company and their
spouses liable to the surety when
they otherwise wouldn’t be. At com-
mon law, the surety could only seek
indemnification from its bond princi-
pal. 3 If the bond principal was a cor-
poration, the owners of the company
and their spouses were shielded
from liability. 4 The surety can get
around the corporate shield by requir-
ing the individual owners and their
spouses to agree to be directly liable
to the surety as a condition of issuing
the bond. If they don’t sign the GAI,
then they don’t get the bond. Having
both spouses sign a GAI has signifi-
cant consequences. If the surety later
files a lawsuit against them and wins,
the surety can potentially seize and
sell the family home to collect a judg-
ment. 5 If you and your spouse sign a
GAI, be sure you understand what
you’re putting on the line.

Second, the GAI gives the surety
powerful legal tools for dealing with
the risk created by an insolvent princi-
pal before the surety actually incurs li-
ability to a bond claimant. These
tools go beyond just indemnification
and allow the surety to be proactive
in mitigating risk. A recent case de-
cided by a federal court in Virginia
shows how a GAI can strengthen a
surety’s position when dealing with a
principal who finds itself on shaky fi-
nancial ground.

In the case of Allegheny Casualty
Co. v. River City Roofing, LLC 6 the
surety issued payment and perform-
ance bonds for three separate proj-
ects. The bond principal was a
roofing contractor. As is common
practice in the industry, the surety re-
quired both the bond principal and
several individuals (presumably the
owners of the roofing company and
their spouses) to sign a GAI.




After issuing the bonds, the surety
received two payment bond claims
from suppliers and a performance
bond claim. The surety paid roughly
60 percent of one of the payment
bond claims. To address the perform-
ance bond claim, the surety paid an
outside consultant about $13,000 to
investigate the project.

The surety eventually sued its prin-
cipal and the individual indemnitors
to enforce the terms of the GAI. In a
testament to the power of a well-
drafted GAI, the court found in favor
of the surety without the need for a
trial. The GAI contained three key provi-
sions often found in indemnity agree-
ments which are meant to protect
the surety from financial losses:
1. The indemnitors were required to
pay back the surety for all ex-
penses the surety incurred as a re-
sult of issuing the bonds or
enforcing the terms of the GAI.

2. If the surety paid a claim in “good
faith,” then the surety was “enti-
tled to charge” the indemnitors for
that payment “whether or not such
liability…existed.” 3. The indemnitors agreed to deposit
sufficient collateral with the surety
“as soon as liability exists or is as-
serted” against the surety, regard-
less of whether the surety had
made a payment on the indemni-
tors’ behalf.

Understanding how the court inter-
preted the three key provisions of the
GAI shows why a GAI is such an im-
portant part of the surety-principal re-
lationship. The indemnitors first tried to de-
fend the lawsuit on the basis that the
surety shouldn’t have paid one of the
payment bond claims. Their argu-
ment was that the contractor had
two separate contracts on the project
and the surety only bonded one of
them. According to the indemnitors,
the unpaid supplier provided the ma-
terials under the non-bonded con-
tract. The court rejected this argument
and determined that the indemnitors
were liable to the surety for the full
amount it had paid the supplier. It
didn’t matter to the court whether the
supplier provided materials under the
bonded or non-bonded contract, be-
cause the reimbursement provisions
of the GAI didn’t depend on the
surety making payment under a
bonded contract. Instead, as long as
the surety made the payment in good
faith—even if it later turned out it
wasn’t necessary—the surety still
had a right to reimbursement. The
GAI granted the surety wide latitude
to settle claims as it saw fit and then
look to the indemnitors for reim-
bursement. The surety also sued to enforce re-
quirement that the indemnitors post
collateral “as soon as liability exists
or is asserted” against the surety.

This provision was meant to mitigate
the surety’s risk by having the indem-
nitors provide security for any debts
they may owe the surety as soon as
it became apparent that the surety
might have to pay a claim.

The indemnitors refused to put up
collateral on the basis that the surety
had already determined there was no
merit to the performance bond claim.

While the surety spent about $13,000
investigating the claim, it never made
a payment. If the surety hadn’t paid
the claim, why should the indemni-
tors have to post collateral? The court
rejected this argument based on the
plain language of the GAI which al-
lowed the surety to demand collat-
eral “as soon as liability exists or is
asserted.” The mere fact that bond
claims were made was enough to
allow the surety to seek collateral;
there was no need for the surety to
show those claims were valid.

As the Allegheny Casualty case
shows, a comprehensive, well-
drafted GAI can give the surety as
close to a slam dunk case as you’ll
find in the law. Sureties assume sub-
stantial risk when issuing bonds and
the GAI mitigates that risk by shifting
some of it back to the contractor, its
owners, and their spouses. Any one
signing a GAI should understand the
agreement has shifted much of the fi-
nancial risk for a contractor’s default
onto the indemnitors. While that’s a
scary prospect, it also creates a
strong incentive to keep the project
on track, pay your bills, and finish on
time. Luke J. Farley, Sr. is a construction
and surety lawyer in the Raleigh of-
fice of Conner Gwyn Schenck PLLC.

His practice focuses on contract
disputes, lien and bond claims,
and licensure of contractors and
engineers. He can be reached
at lfarley@cgsplic.com or by
phone at (919) 789-9242.

1 Smith v. Mitsubishi Motors Credit of Am., Inc., 247 Conn. 342, 348, 721 A.2d 1187, 1190 (1998).

2 City of Elgin v. Arch Ins. Co., 53 N.E.3d 31, 42 (Ill. App. Ct. 2016), appeal denied, 60 N.E.3d 871
(Ill. 2016); Capstone Bldg. Corp. v. Am. Motorists Ins. Co., 308 Conn. 760, 792, 67 A.3d 961, 985
(2013); Anderson v. Trueman, 100 Fla. 727, 730, 130 So. 12, 13–14 (1930); Non-Marine Underwrit-
ers at Lloyd's London v. Carrs Fork Coal Co., 421 S.W.2d 852, 853 (Ky. 1967); Hartford Acc. &
Indem. Co. v. Dahl, 202 Minn. 410, 413, 278 N.W. 591, 593 (1938).

3 See Restatement (Third) of Suretyship & Guaranty § 22 (1996).

4 Curci Investments, LLC v. Baldwin, 14 Cal. App. 5th 214, 220, 221 Cal. Rptr. 3d 847, 851 (Ct. App.

2017) (“Ordinarily a corporation is considered a separate legal entity, distinct from its stockhold-
ers, officers and directors, with separate and distinct liabilities and obligations. … The same is
true of a limited liability company (LLC) and its members and managers.”); cf. Fausse Riviere,
L.L.C. v. Snyder, 211 So. 3d 1188, 1192 (La. Ct. App. 2017).

5 Marquette Bank v. Heartland Bank & Tr. Co., 41 N.E.3d 1007, 1010 (Ill. App. Ct. 2015) (“The protec-
tion afforded by tenancy by the entirety ownership depends on whether the debt is individual or
joint. … A property held as tenants by the entirety may be sold the same as if title was held in
joint tenancy to enforce a joint debt.”); cf. Branch Banking & Tr. Co. v. ARK Dev./Oceanview, LLC,
150 So. 3d 817, 821 (Fla. Dist. Ct. App. 2014).

6 1:17-CV-01108 (IDD), 2018 WL 1785478 (E.D. Va. Apr. 13, 2018).

The North Carolina Construction News — Summer 2018 — 13