Court Enforces Indemnity Agreement Provisions Against Bond Principal
Having practiced construction and surety law for, well, many years, I was and am still amazed at what a powerful document the General Indemnity Agreement (GIA) is for a surety that issues bonds and how courts will almost invariably enforce the provisions of the GIA as written. I also have been amazed in my law practice at how often bond principals did not understand their obligations under the GIA, or even if they did understand them, how often they tried to crawfish out of fulfilling those obligations under the GIA. Accordingly, bond producers and other surety professionals should encourage contractors to read and understand the provisions in a GIA.
I was reminded of the power of the GIA by a recent federal district court decision, Travelers Casualty and Surety Co. of America v. Dunmore, No. 2:07CV-02493, 2014 WL 6886004 (E.D. Cal. Dec. 3, 2014). This decision illustrates some basic tenets of surety law and the law of indemnity. The facts are not unusual. In 2005 Travelers Casualty and Surety Company of America (Travelers) and defendants Sidney B. Dunmore, an individual, and Sidney B. Dunmore, Trustee for Sid Dunmore Trust (Defendants), entered into a GIA, in partial consideration for Travelers issuing bonds on behalf of Dunmore Homes and its special purpose entity (SPE) affiliates and subsidiaries. Travelers issued 103 surety bonds (Bonds) for subdivision projects with Dunmore Homes SPEs as developers. When Dunmore Homes subsequently defaulted on certain performance and payment obligations under various contracts, obligees and claimants made claims against the Bonds.
Travelers sent a written demand to Defendants for defense, indemnity, collateral, and books and records, pursuant to Travelers’ rights and Defendants’ obligations under the GIA. When the Defendants refused Travelers’ request, Travelers filed suit against the Defendants.
Travelers thereafter filed a motion for summary judgment. The court construed the issues in the motion under California law and began its analysis discussing indemnity:
| “In interpreting an express indemnity agreement, the courts look first to the words of the contract to determine the intended scope of the indemnity agreement. A key factor in determining the scope of the agreement, [sic] is the specificity of the language.” . . . The terms “indemnity” and “hold harmless” generally obligate the indemnitor to reimburse the indemnitee for any damages the indemnitee becomes obligated to pay third persons. |
The court thereafter gives a good summary of surety law, set forth below (with case and statutory citations omitted):
| A surety or guarantor (there is no distinction between the two terms) is “one who promises to answer for the debt, default, or miscarriage of another . . . .” A performance bond is not an insurance policy. In contrast to an insurance contract, a performance bond creates a tripartite relationship between the surety, the principal, and the obligee. Whereas insurance protects the principal against risk, a performance bond protects the obligee against the principal’s default. In essence, a surety bond is essentially a line of credit to the bonded contractor. In suretyship, the risk of loss remains with the principal, while the surety merely lends its credit so as to guarantee payment or performance in the event that the principal defaults. Thus, if the surety is compelled to make payment for damages caused by the principal, it has the right to seek reimbursement from the principal. Moreover, if a surety satisfies the principal obligation, or any part thereof, whether with or without legal proceedings, the principal is bound to reimburse what the surety has disbursed, including necessary costs and expenses; but the surety has no claim for reimbursement against other persons, though they may have been benefitted by [its] act. |
The court then discussed the necessary elements, under California law, to establish a valid cause of action for breach of an indemnity agreement and found that each of these elements is established:
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The Defendants argued that summary judgment was not appropriate because Travelers did not “reasonably” inquire into the claims made against the Bonds before paying them (thereby breaching the implied covenant of good faith and fair dealing) and failed to mitigate damages. The court was “not impressed with this argument.” The court observed that “the implied covenant of good faith and fair dealing will not be read into a contract to prohibit a party from doing that which is expressly permitted by the agreement itself.”
The court then proceeded to cite a quotation from the GIA on Claim Settlement, which gives all claim resolution discretion to the surety:
| Company shall have the right in its sole discretion, to determine for itself and its indemnitors whether any claim, demand or suit brought against Company or any Indemnitor in connection with or relating to any Bond shall be paid, compromised, settled, tried, defended or appealed, and its determination shall be final, binding and conclusive upon the Indemnitors. Company shall be entitled to immediate reimbursement for any and all Loss incurred under the belief it was necessary or expedient to make such payments. |
The court found that the unambiguous language of the GIA permitted the surety to make payment “in its sole discretion.” The court went on the state that all parties to the GIA are “sophisticated business people, and the Court will not rewrite the parties’ contract after the fact to facilitate a different result.”
Thus, the court granted Travelers’ motion for summary judgment on its cause of action for breach of contract and granted Traveler’s motion for summary judgment as to Defendants’ counterclaim for breach of the implied covenant of good faith and fair dealing. The court continued the case for the sole purpose of determining the amount of damages owed to Travelers.
The Travelers v. Dunmore decision is a fine illustration of the power of a general indemnity agreement. A surety company that lends its financial backing so that a qualified contractor may obtain construction work expects that contractor to fulfill its obligations under the GIA. And a court will almost invariably enforce those obligations. Bond producers should do their utmost to encourage their contractors to read, re-read, and understand the provisions of any GIA they intend to sign.
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.
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