Legal Spotlight

  


General Indemnity Agreement: The Surety’s Right to Settle Claims, Effect of Prima Facie Evidence, and the Indemnitors’ Option to Post Collateral Provision

The effect of certain provisions in general agreements of indemnity (GIAs) on sureties’ rights and obligations—and on principals’ rights and obligations--is an evergreen topic for surety professionals. This article highlights three typical GIA provisions that impact the sureties’ and principals’ rights and obligations: the surety’s right-to-settle provision, the prima facie evidence provision, and the indemnitors’ option to post collateral provision.

The Surety’s Right to Settle Claims

When a surety settles a claim over the principal/indemnitors’ objections, the principal/indemnitors often assert that the surety acted as a volunteer and, therefore, is not entitled to indemnification. In such case the surety may very well face claims from its principal when it settles with an obligee or claimant. On the other hand, the surety may face claims, sometimes bad faith claims, from obligees or claimants by denying a demand on a performance or payment bond. As we know, sureties all-too-often find themselves with these competing demands to accept or deny claims.

Under common law a surety can recover from the principal the amount it paid under the bond only if it can prove it paid for an obligation that the principal was legally required to pay. If the surety can’t prove it paid an enforceable obligation, the courts consider the surety a volunteer, with no recovery rights against its principal and indemnitors. Certain provisions in GIAs function to resolve this dilemma by allowing the surety to resolve claims as it determines is proper. Such right-to-settle provisions allow the surety to avoid being deemed a volunteer and losing its recovery rights from the principal and indemnitors. A sample right-to-settle provision follows:
The Surety shall have the exclusive right for itself and for the Undersigned [the indemnitors] to decide and determine whether any claim, demand, suit, or judgment shall, on the basis of liability, expediency, or otherwise, be paid, settled, defended or appealed. . . . In the event of any payment by the Surety, the Undersigned agree that, in any accounting between the Surety and the Undersigned, the Surety shall be entitled to charge for any and all disbursements made by it in good faith in and about the matters contemplated by this Agreement under the belief that it is or was liable for the sum and amounts so disbursed, or that it was necessary or expedient to make such disbursements, whether or not such liability, necessity, or expediency existed.  

Courts will enforce right-to-settle provisions that give the surety the discretion to pay, settle, or defend claims. Note, however, that courts in most jurisdictions opine that the surety is entitled to indemnification only for payments made in good faith. The bottom line is that the right-to-settle provision gives the surety wide discretion to pay or settle bond claims without prejudicing its indemnification rights against the principal and indemnitors.

The Prima Facie Evidence Provision

In addition to the surety’s right to settle claims, courts will also enforce language that provides that vouchers or other evidence of payments will be prima facie evidence of the fact and the amount of the principal/indemnitors’ liability to the surety. A sample such provision follows:

The Surety’s determination shall be final, conclusive and binding upon the Undersigned. Vouchers, affidavits or other evidence of payment by the Surety of any loss, cost or expense shall be prima facie evidence of their propriety and the liability of the Undersigned to the Surety for such loss, cost or expense.  
 
Such language imposes on the principal/indemnitors the burden of proving the surety’s fraud or lack of good faith in settling claims and incurring expenses in order to avoid their indemnity obligations. Such a provision facilitates the handling of settlement by sureties and, theoretically, minimizes litigation with indemnitors.

Indemnitors’ Option to Post Collateral Provision

A provision in the GIA giving the principal and indemnitors the option to post collateral affords them the ability to require the surety to litigate or defend claims. Such a provision provides as follows:
The Surety shall have the right to adjust, settle or compromise any claim, demand, suit or judgment upon the Bonds, unless the Principal and the Indemnitors shall request the Surety to litigate such claim or demand, or to defend such suit, or to appeal from such judgment, and shall deposit with the Surety, at the time of such request, cash or collateral satisfactory to the Surety in kind and amount, to be used in paying any judgment or judgments rendered or that may be rendered, with interest, costs, expenses and attorneys’ fees, including those of the Surety.  
 
Pursuant to this provision of the GIA, principals and indemnitors can require the surety to litigate or defend claims by posting collateral in an amount that secures the surety against any loss. As set forth in the sample provision above, the typical deposit-of-collateral provision permits the surety to determine, in its sole discretion, if the nature and amount of the collateral is satisfactory. 
Courts generally find that the surety can settle claims over the principal’s objections and seek indemnification if the principal and indemnitors fail to deposit collateral pursuant to these provisions.

Please note that the option to post collateral provision is NOT the same as the collateral deposit provision in the GIA, which provides the surety with the right to demand and obtain collateral from the principal or indemnitors to cover potential liability. Under this provision, when a surety receives a demand on its bond, the principal and/or indemnitors must deposit with the surety, upon demand, funds or other collateral sufficient to secure the surety against the claim. 

The author of this article is Martha Perkins, General Counsel at NASBP. Martha Perkins can be reached at mperkins@nasbp.org 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.