General Agreements of Indemnity For Commercial Surety Bonds
I have been fascinated by the multi-faceted, ever-changing arena of commercial surety bonds, with its broad array of risks and exposures, ever since I began my law career elbow deep in probate bonds, motor vehicle dealer bonds, public official bonds, notary bonds, myriad license and permit bonds, and judicial bonds. It seemed that, every time a new matter came my way, it concerned a new and different kind of commercial bond. And it was only after my initial introduction to commercial surety bonds that I then delved into the world of non-commercial surety bonds, a/k/a contract surety bonds.
As I soon learned, there are distinctive differences between commercial surety bonds and contract surety bonds. The most obvious difference is that contract bonds are generally for the duration of a construction contract, with an extension perhaps for a warranty period. Commercial bonds have longer durations than contract bonds and are generally continuous in nature. Such differences account for some different provisions in the GIAs for commercial bonds and contract bonds.
As the surety has a broad variety of risks under commercial bonds, sureties quite understandably try to control their risks with indemnity agreement provisions, to limit potential loss. While there are innumerable articles devoted to analyzing and explaining provisions of general agreements of indemnity (GIAs) for contract bonds, there are far fewer for GIAs for commercial bonds. This article is, therefore, intended to highlight a few key aspects of GIAs for commercial bonds and how they differ from contract bond GIAs.
It is as true for a GIA for a commercial bond as for a contract bond that the keystone language of the GIA is the indemnification provision, by which the indemnitors agree to indemnify or hold harmless the surety for all loss, costs, and expenses incurred by the surety as a result of having issued the bond.
With commercial bonds that are one-time agreements between the surety and the principal, the indemnity agreement is often included as part of the bond application that the principal completes for the business’s bond. And in some situations the surety may only require the principal’s signature on the agreement requiring the principal to indemnify the surety for any loss it may incur as a result of having issued the bond. In one indemnity agreement that is part of the bond application itself, the indemnification provision is to the point:
|I agree to pay to Surety upon demand:
a. The amount of any loss or expense, including attorney’s fees, for which Surety shall become liable by reason of such bond, whether or not Surety shall have paid such loss and expense at the time of demand.
b. All attorney’s fees and costs incurred by Surety in enforcing this agreement.
c. An amount sufficient to discharge any claim against Surety in enforcing this agreement.
On the other hand, with riskier and larger exposures, a commercial surety may require a separate, more “formal” GIA, with detailed provisions to limit the surety’s risk and set forth more duties and obligations of the principal and indemnitors. The indemnification provision of one such GIA follows:
|The Indemnitors will indemnify and save the Company harmless from and against every claim, demand, liability, cost, loss, charge, suit, judgment, award, fine, penalty, and expense which the Company may pay, suffer, or incur in consequence of have executed, delivered, or procured the execution of such bonds, or any renewals or continuations thereof or substitutes therefor, including, but not limited to, court costs, mediation and facilitation fees and expenses, fees and expenses of attorneys, accountants, inspectors, experts, and consultants, whether on salary, retainer or otherwise, and the expense of procuring, or attempting to procure, release from liability, or in bringing suit to enforce the obligation of any of the Indemnitors under this Agreement. In the event the Company deems it necessary to respond to, make an investigation of, or settle, defend, or compromise a claim, demand or suit, the Indemnitors acknowledge and agree that all expenses attendant to such response, investigation, settlement, defense, and compromise, whether incurred internally or otherwise, is included as an indemnified expense and shall be paid by Indemnitors to Company on demand. In the event of payments by the Company, the Indemnitors agree to accept a voucher, affidavit, or other evidence of such payments as prima facie evidence of the propriety thereof, and of the Indemnitors’ liability therefor to the Company.
The quite thorough language above is just the indemnification provision in the surety’s GIA for certain commercial bonds. Notably, the provision specifically includes any renewals, continuations, or substitutes.
Commercial bond GIAs often provide that the surety can demand collateral, typically in the form of cash, similar to the collateral deposit provision generally found in contract surety GIAs. An example of a collateral deposit provision in a commercial bond GIA provides as follows:
|Payment of loss or deposit of collateral shall be made the Company by the Indemnitors as soon as liability exists or is asserted against the Company, whether or not the Company shall have made any payment therefor. Such payment shall be equal to the larger of (a) the amount of any reserve set by the Company, or (b) such amount as the Company, in its sole judgment, shall deem sufficient to protect it from loss. The Company shall have the right to use the deposit, or any part thereof, in payment or settlement of any liability, loss or expense for which the Indemnitors would be obligated to indemnify the Company under the terms of this Agreement. If for any reason the Company shall deem it necessary to increase a reserve to cover any possible liability or loss, the Indemnitors will deposit with the Company, immediately upon demand, a sum of money equal to any increase thereof as collateral security to the Company for such liability or loss.
In addition, because of the significant risks involved in certain commercial bonds, sureties nearly always initially take collateral on certain types of bonds to secure potential exposure on the bonds. These include supersedeas and release/discharge bonds and premium and deductible bonds. An example of a collateral provision found in some commercial surety GIAs is as follows:
|Undersigned consents and agrees that any and all collateral deposited with Surety shall be available at the Surety’s sole discretion as collateral security on any or all bonds heretofore or hereafter executed for or at the request of all of the Undersigned. If Undersigned provides Surety with a letter of credit or similar instrument as collateral, Undersigned hereby agrees that Surety may draw on such collateral to enforce provisions of this Agreement, at any time, in whole or in part, for any reason, and to hold proceeds thereof as collateral to pay any obligations of the Undersigned arising hereunder. Any cash provided as collateral will be available, in the Surety’s sole discretion, to pay any of the obligations hereunder. Any cash security held by the Surety shall be deposited with a financial institution selected by the Surety in its sole discretion, in an account in the name of and exclusively controlled by the Surety.
For certain types of commercial bonds, such as judicial bonds and statutory and regulatory bonds, the surety wants assurances that the principal’s financial condition will allow it to meet its obligations to perform, because, if not, the surety must pay the obligation and seek exoneration or reimbursement from the principal or other indemnitors. Accordingly, sureties often include in the GIA a credit records access provision, an example of which follows:
|Indemnitors hereby expressly authorize the Surety to access credit records and to make such pertinent inquiries as may be necessary from third party sources for underwriting purposes, claims purposes and/or debt collection.
Provisions such as this one provide the surety with the continuous right to review and update the principal’s financial condition. Such a credit records access provision allows the surety to decide whether to cancel a commercial bond, as many commercial bonds are cancelable.
As noted above, commercial bonds often have a much longer duration than contract bonds. Consider fiduciary and probate bonds, which may last indefinitely, with the fiduciary having a duty to account throughout the course of the bond’s duration. Appeal and supersedeas bonds can continue in effect for years, before there is a claim on the bond. In addition, many commercial bonds are continuous, with automatic renewals in the bond or in the applicable statutes and regulations.
Unlike with contract bonds, sureties have the right to cancel certain commercial bonds, such as license and permit bonds. Many commercial GIAs specifically authorize the surety to cancel the commercial bonds. On the other hand, many are not cancelable, such as judicial, fiduciary, and appeal bonds.
Commercial bond GIAs typically lack certain provisions included in contract bond GIAs. For instance, contract bond GIAs frequently contain assignment and security interest provisions by which the principal and/or indemnitors assign or grant a security interest to the surety in the principal’s contract funds, equipment, inventory, and material to secure their obligations under the GIA. Commercial bond GIAs generally do not have such clauses because there are no contract funds, equipment, inventory, or materials due to the nature of the obligations secured under the commercial bond.
On the other hand, commercial bond GIAs contain provisions not generally found in contract bond GIAs. Sureties issuing commercial bonds often include provisions allowing them to decline execution of future bonds, including renewals of existing bonds. One such example follows:
|The Company is not required, by reason of any application for a bond or by reason of having issued a previous bond, or otherwise, to execute or procure the execution of or participate in the execution or renewal of any further bond or bonds. The Company, at its sole option and without assigning any reason therefor, may decline to execute or to participate in or procure the execution or renewal of any bond without impairing the validity of this Agreement or incurring any liability to Indemnitors.
What is the upshot of all this? As with GIAs for contract bonds, the express terms of GIAs for commercial bonds are typically viewed favorably by courts. The GIA is a powerful legal contract that provides a surety issuing bonds with many enforceable legal rights against the indemnitors that signed the GIA. As construction contractors are advised to read and understand the provisions of a GIA prior to executing the GIA, so any applicant for a commercial bond should do the same.
The author of this article is Martha Perkins, General Counsel at NASBP. Martha Perkins can be reached at email@example.com or 202.686-3700.
This article is provided to NASBP members, affiliates, and associates solely for educational and informational purposes. It is not to be considered the rendering of legal advice in specific cases or to create a lawyer-client relationship. Readers are responsible for obtaining legal advice from their own counsels, and should not act upon any information contained in this article without such advice.