Why underwriters need to know about indemnification risks posed by trusts

By Kathy Hoffman posted 04-30-2014 10:06 PM


The use of trusts is becoming more common in construction, so it’s crucial for surety underwriters to know whether a trustee is empowered to bind the trust within an indemnity agreement, John Coyne, vice president and regional underwriting officer at Travelers Bond and Financial Products, told attendees of NASBP’s Annual Meeting on Monday.

Underwriters should never just assume that a trustee is authorized to take such an action, said Coyne and Marc Brown, managing director and counsel of Travelers Bond and Financial Products.

Coyne and Brown provided an overview of the most common types of trusts and the pitfalls that can be associated with each one. They said that trusts are often created for legitimate purposes – simply estate and tax planning – but advised underwriters to watch for red flags.

Many assets including company stock, equipment, cash and securities “can be put in a trust, and you have to have an inventory of what’s in a trust,” Coyne said. That way, if a problem arises, an underwriter has a “baseline” for identifying any assets that are missing and addressing the problem, Coyne said.

For example, a surety could face difficulty accessing a defaulting road contractor’s equipment if the contractor has placed its equipment in a trust, Brown said.

Asset-protection trusts should be the biggest cause of concern, Brown said. In this scenario, the beneficiary is the settlor -- the person who established the trust -- and the purpose is to keep creditors away from the assets in the trust. Nine states and many foreign jurisdictions have legitimized such trusts, with foreign asset-protection trusts being the most difficult, time consuming and expensive in terms of pursuing assets, Brown said.

In securing trust indemnity and avoiding challenges to whether reimbursement can be enforced, it’s crucial for underwriters to ensure that the proper signatories have been identified, Brown and Coyne said.

If a trust is revocable, amendable and ambiguous regarding indemnification, the best course of action is to obtain a trust amendment, Brown said. In such a situation, an underwriter needs to determine who has the authority to sign the amendment to bind a trust’s assets and indemnify a surety, he said.

A less common scenario is the need to get a lawyer’s opinion letter on a trustee’s authority regarding indemnity obligations, he said. Coyne said that asking for such a letter is a tough request for an agent to make because of the legal expenses that would result for the client. And “pushback” also could result because a lawyer would have his or her “neck on the line” by giving a legal opinion on a trustee’s authority to obligate a trust’s assets for indemnification purposes, Brown said.

Legal challenges can arise if trustees “act outside the purpose of a trust,” Brown said. For example, lawsuits could emerge over family trusts in cases where relatives say the trust was designed to take care of them but the assets are used for surety indemnification or other purposes, Brown and Coyne said.

“The challenges can really come from anywhere, and you can’t provide for all of them. That’s really unrealistic,” Coyne said. “So you have to do what you think is best to secure the indemnity” and make it “impervious” to challenges.