OUTCOME:
The trial court awarded $500,000 to the Bond Company and held the Producer liable for breach of contract and negligence. The court held that the Producer breached the agency agreement, even if the bonds were not properly “executed,” because a commitment was given on behalf of the Bond Company without authorization. Additionally, the court found that the Producer was negligent in delivering unauthorized bonds to the Principal. On appeal, the appellate court affirmed the trial court’s decision respecting breach of contract and did not address the negligence claim, as both claims led to the same amount of damages. The appellate court remanded the damages portion of the judgment and, on remand, the Producer was held liable for the entire $500,000.

ADVICE:
A surety bond producer may be liable to a bond company for accidentally delivering an unauthorized bond to a principal, even if the producer attempts to retrieve the unauthorized bond only hours after the mistaken delivery. It is recommended that producers have a system in place that requires the checking and double-checking of bonds before they are transmitted to principals, because after unauthorized bonds leave the hands of the producer, there is no guarantee that they will not be misused.

Scenario 2
Surety bond producer places a performance bond with a company that is insolvent or nearly-insolvent.

FACTS:
An obligee makes a claim against a Producer for negligence in procuring a bond from a company that became insolvent soon after issuing the bond. This example arose when a Subcontractor was required to procure a surety bond in order to perform certain concrete work for a General Contractor (the “GC”). The Subcontractor sought the aid of a Surety Bond Producer in procuring the bond. The Subcontractor was classified as a “substandard” business based on its financial health and other factors, so the Producer placed the Subcontractor’s bond with a Surety Bond Company with lenient underwriting standards and a questionable financial condition because it was known for issuing bonds to such substandard businesses. After procuring the surety bond for the Subcontractor, the Producer verbally represented to the GC that the surety bond confirmed that the Subcontractor was financially capable of meeting its obligations and possessed the requisite expert knowledge to complete its subcontract agreement with the GC. Thereafter, the GC sued the Subcontractor alleging failure to adequately perform its obligations under the contract. In the course of the lawsuit, the GC demanded that the Bond Company assure the Subcontractor’s performance under the bond. However, by that time, the Bond Company had filed for bankruptcy and/or was in receivership and could not fulfill its surety obligations. Thus, the GC sued the Producer for negligence in placing the Subcontractor’s risk with a Bond Company that was financially unstable and nearly insolvent.

OUTCOME:
The Producer was not negligent in placing the bond with a Bond Company that later entered into receivership because the Bond Company was a functioning, solvent entity at the time the bond was procured. However, the court held that when the producer knows, or through reasonably diligent investigation could know, that the bond company is insolvent, the producer may be liable for negligence. The court also cautioned that where a producer agrees to place a bond with a “good company” or to obtain a “good policy,” the producer may expose itself to liability for placing the bond with a soon-to-be insolvent company.

ADVICE:
A surety bond producer has no duty to predict the financial future of a bond company and is not expected to possess a “crystal ball” for bond company solvency. In other words, if a producer’s reasonably diligent investigation does not reveal that a company is currently insolvent, that producer should be confident that it will not face liability for negligently placing a bond. However, producers should avoid making unnecessary guarantees about the quality of the bond company or the bond because such guarantees may expose a producer to liability for placing a bond with a company that becomes insolvent shortly after the bond is procured.

These two scenarios exemplify the importance of risk management in a surety bond agent’s day-to-day operations. Quality control, day-to-day involvement of management, and ensuring the skills of your staff and the proper documentation of your files are paramount to successful business practice.

This article was written by Rockwood’s E&O claims administrators. For more information or a competitive E&O quote option, please contact Rockwood’s staff directly at: NASBPsales@rockwoodinsurance.com or 800-380-4642 today.

NASBP recently partnered with Rockwood Programs, Inc., Decus Insurance Brokers Limited, and ProSight Specialty Insurance to provide its bond producer members with preferred access to an “A” (Excellent) rated carrier offering an exclusive E&O insurance program. Coverage through this NASBP Program is specifically tailored to address the E&O insurance needs of surety bond agencies and producers and this NASBP E&O Program is exclusive to NASBP. NASBP members can learn more about it and complete an application at the Association’s web site at http://www.nasbp.org/eocoverage/EOProgram/.