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 individual owners of the contracting company 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 common law, the surety could only seek indemnification from its bond principal.[3] If the bond principal was a corporation, the owners of the company and their spouses were shielded from liability.[4] The surety can get around the corporate shield by requiring 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 significant 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 judgment.[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 principal before the surety actually incurs liability to a bond claimant. These tools go beyond just indemnification and allow the surety to be proactive in mitigating risk. A recent case decided 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 financial ground.
In the case of Allegheny Casualty Co. v. River City Roofing, LLC [6] the surety issued payment and performance bonds for three separate projects. The bond principal was a roofing contractor. As is common practice in the industry, the surety required 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 performance bond claim, the surety paid an outside consultant about $13,000 to investigate the project.
The surety eventually sued its principal 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 provisions often found in indemnity agreements which are meant to protect the surety from financial losses:
- The indemnitors were required to pay back the surety for all expenses the surety incurred as a result of issuing the bonds or enforcing the terms of the GAI.
- If the surety paid a claim in “good faith,” then the surety was “entitled to charge” the indemnitors for that payment “whether or not such liability…existed.”
- The indemnitors agreed to deposit sufficient collateral with the surety “as soon as liability exists or is asserted” against the surety, regardless of whether the surety had made a payment on the indemnitors’ behalf.
Understanding how the court interpreted the three key provisions of the GAI shows why a GAI is such an important part of the surety-principal relationship.
The indemnitors first tried to defend the lawsuit on the basis that the surety shouldn’t have paid one of the payment bond claims. Their argument 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 materials under the non-bonded contract.
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, because 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 reimbursement.
The surety also sued to enforce requirement 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 indemnitors 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 indemnitors have to post collateral? The court rejected this argument based on the plain language of the GAI which allowed the surety to demand collateral “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 substantial 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 financial 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 office 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 Underwriters 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 stockholders, 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 protection 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).