The General Agreement of Indemnity: Nine Selected Provisions to Discuss with Your Contractor

A general agreement of indemnity (GIA) is standard document in the construction and surety industries. A surety company that issues a bond to a contractor or subcontractor almost invariably requires that its principal, and usually the individuals who control the company, and often affiliated companies, to execute a GIA. While a contractor/subcontractor bond principal has common law duties to indemnify and exonerate the surety against any loss sustained as a result of having issued a bond, a surety will not just rely on those common law rights. The GIA expands the surety’s common law rights. The required GIA provides the surety with a contractual right of recovery and specific remedies against the principal and the other named indemnitors.

A surety bond is not insurance; rather, it is like an extension of credit. A surety, by issuing a bond, provides its credit to the principal in order for the principal to contract with the obligee/owner. Because the surety extends its bonding credit on behalf of its principal, the surety underwriter evaluates the principal’s financial capacity and ability to perform the contract. The surety, however, does not expect to incur a loss as a result of having issued the bond and extended its bonding credit. Through the protections afforded the surety in the GIA, in addition to the surety’s common law rights, the principal and third-party indemnitors, both individuals and business entities, are required, among many other things, to reimburse the surety if the surety incurs a loss as a result of having issued bonds on behalf of the principal.

The GIA is a powerful instrument enhancing the surety’s goal to avoid losses in resolving claims and seeking salvage. Courts will generally enforce the provisions of a GIA, as written. Contractors, subcontractors, and others executing such agreements should understand that the GIA provides the surety extending credit with favorable rights and remedies in the event of loss and provides the principal for whom the credit is extended, and the indemnitors, with responsibilities and obligations.

The specific terms of the GIA will vary among surety companies, and the contractual obligations of the principal and indemnitors to the surety are set forth in each GIA. But most GIAs contain certain typical clauses. This article is a general discussion and explanation of some of the common provisions in GIAs about which bond producers and their contractors should be familiar. This article is not–and is not intended to be–a comprehensive analysis of the GIA and all the fact patterns that could occur and all the legal intricacies that could be argued.

1. Surety’s Right of Indemnification

   The keystone language of any GIA is the indemnification provision, which varies from form to form. In the typical provision the indemnitors agree to indemnify the surety for all costs and expenses incurred by reason of having executed the bonds:

   The Indemnitors will exonerate, hold harmless, and indemnify the Surety from and against any and all liability, loss, costs, damages, fees of attorneys and consultants, and other expenses, including interest, which the Surety may sustain or incur by reason of, or in consequence of, the execution of such bonds and any renewal, continuation or successor thereof, including but not limited to, sums paid or liability incurred in settlement of, and expenses paid or incurred in connection with claims, suits, or judgments under such bonds . . .

   This example is a broad form of indemnity language, which covers all types of anticipated costs. This contractual language allows the surety to recover from the indemnitors all losses, including attorneys’ and consultants’ fees, incurred as a result of having issued a bond.

2. Surety’s Right to Enforce the GIA

   The typical GIA provides sureties with a contractual right to sue the principal and indemnitors for their failure to comply with any of the obligations stated in the GIA. An example of such enforcement language is the following:

   The Principal and Indemnitors shall indemnify the Surety from and against all loss, including attorneys’ fees, expenses and costs by reason of the failure of the Principal and Indemnitors to perform or comply with the covenants and conditions of this Indemnity Agreement.

   Such obligations include, among others, the duty to deliver collateral to the surety, the duty to hold contract funds in trust, and the duty to make books and records available to the surety. Upon the principal’s breach of these or other obligations stated in the GIA, sureties have recovered their attorneys’ fees, expenses, and other losses arising from the breach.

   Courts will look to the language of the GIA to determine whether attorneys’ fees are recoverable in such enforcement proceedings. As set forth in the sample language above, attorneys’ fees incurred by the surety in enforcing its rights would be recoverable by the surety. This attorneys’ fees language in the GIA allows a contractual end-run around the American Rule, which provides that, unless there is an agreement otherwise, each litigating party pays for its own attorneys’ fees.

3. Surety’s Right to Settle Claims

   A typical provision in a GIA provides that the surety has the sole and exclusive right to decide whether any claims against the bond should be paid, settled, or defended. The principal and indemnitors agree that the surety’s decisions on such matters will be final and binding on them. An example of such language is the following:

   The Surety shall have the exclusive right for itself and for the Undersigned 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 sums and amounts so disbursed, or that it was necessary or expedient to make such disbursements, whether or not such liability, necessity or expediency existed.

   This right-to-settle provision is included in GIAs so that the surety can avoid a contention by the principal and indemnitors that the surety acted as a volunteer and thereby forfeited its right to indemnification by settling a claim over the principal’s or indemnitors’ objections. Absent the surety’s fraud or lack of good faith, courts have held that the surety’s decision to settle a claim is within the surety’s sole discretion and is binding on the principal and indemnitors.

4. Indemnitors’ Option to Post Collateral

   A right-to-settle provision can provide the indemnitors with the option of posting collateral with the surety to protect the surety from claims and requiring the surety to litigate or defend the claims. A sample option-to-post-collateral provision 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.

   Courts have found that the surety is entitled to settle claims, even if the principal objects, and seek indemnification if the principal and indemnitors fail to deposit collateral as provided in the GIA. Under such provisions the surety generally has sole discretion in determining whether the type and amount of collateral are satisfactory.

5. Surety’s Right to Demand Collateral

   GIAs often contain a provision that allows a surety to demand that the principal and indemnitors deposit cash or collateral with the surety to cover potential liability. A sample collateral-deposit provision follows:

   Immediately upon demand, the Undersigned will deposit with Surety, as collateral security, money or other collateral satisfactory to Surety, equal to (1) the liability of Surety, if established; (2) the liability asserted against Surety; or (3) the reserve established by Surety, or any increase thereof, to cover any liability for any loss or expense for which the Undersigned may be obligated to indemnify Surety under the terms of this Agreement. Surety shall have the right to use the collateral, or any part thereof, in payment or settlement of any liability, loss or expense for which the Undersigned is or would be obligated to indemnify Surety under the terms of this Agreement.

   This provision requires that, upon demand by the surety, the principal and indemnitors deposit cash or collateral with the surety to protect it from liability for claims and expenses. The GIA provides that the surety has the right to use this collateral to pay any and all liability under its bonds. The principal and indemnitors’ failure to meet a surety’s collateral demand is a breach of the GIA.

6. Surety’s Right to Assignment

   The assignment provision in the GIA provides the surety certain rights in the principal’s contract, equipment, and materials. A GIA might permit assignment of the following:

   All rights in, or growing in any manner out of, any contract in which the Principal and Indemnitors or any of them have an interest, whether bonded or unbonded, and any extensions, modifications, changes, alterations or additions thereto, including, but not limited to, any and all sums due or that may become due under any contract and proceeds of any insurance policies payable to Principal or any of the Indemnitors . . . .

   All subcontracts and purchase orders let or to be let by the Principal or any Indemnitors and any and all rights, actions, or causes of action, claims and demands of whatsoever kind which the Principal or any of the Indemnitors may have or acquire with respect to any contract or any subcontract or purchase order or any bonds given to the Principal or any Indemnitor by any subcontractor or vendor in connection with any contract . . . .

   All rights or interests of the Principal or Indemnitors in any contract, the work and all supplies, tools, plant, machinery, equipment and materials of whatsoever kind that may then or thereafter be upon the work, or in, on or about the site of the work, or elsewhere for the purposes of the contract, including all materials ordered for the contract . . . .

   Assignment provisions generally permit the surety to recover all funds due the principal on both bonded and unbonded contracts. In addition, such provisions often assign to the surety the principal’s interest in subcontracts and the bonds issued on such subcontracts. Most assignment provisions assign to the surety the principal’s interest in project tools, equipment, and materials. The assignment provision can be triggered by notice of claims, or failure of the principal to perform, or other events of default under the GIA.

7. Surety’s Right to Examine Books and Records

   GIAs typically provide the surety with the right to examine and review the books and records of the principal and indemnitors. A typical such provision follows:

   Upon Surety’s request, Principal and Indemnitors shall immediately turn over to Surety, or its designee, as often as requested and at a time and place and in a manner determined by Surety, such books, records, accounts, documents, computer software and other electronically-stored information, as and when requested by Surety.

   This right to examine accorded the surety in the GIA is intended to allow the surety to conduct a proper and timely investigation of bond claims. This provision is likely to be of particular interest to bond producers, as a producer might be contacted by a surety to help facilitate the surety’s examination of the principal’s and/or indemnitors’ books and records.

8. Surety’s Access to Information from Third Parties

   GIAs typically provide the surety with the right to obtain financial and other information concerning the principal or indemnitors in control of a third party, such as banks, credit reporting agencies, obligees, and subcontractors. A sample such provision follows:

   Any bank, depository, creditor, obligee of a bond, subcontractor, material supplier or other person, firm or corporation possessing records or having information concerning the financial affairs of the Undersigned is hereby authorized to furnish the Surety and its representatives or consultants any such records or information requested by the Surety.

   This provision is important to an investigating surety as it allows the surety to obtain financial information about the principal or indemnitors that is untainted by the possible mendacity or recalcitrance of the principal or indemnitors.

9. Indemnitors’ Duty to Cooperate

   Most GIAs contain a provision that requires the principal and indemnitors to cooperate with the surety in the investigation, litigation, or arbitration of claims. A typical such provision follows:

   The Undersigned shall give the Surety prompt notice of any claim, demand, suit, arbitration proceeding or other action which purports to be instituted on any bond and shall cooperate with the Surety in the defense thereof.

   This is another provision in the GIA whereby the bond producer might be called upon to assist the surety in obtaining the cooperation of its principal and indemnitors.

   Contractors and subcontractors and their bond producers should read and carefully consider a surety’s GIA. The above nine provisions are only examples of a few of the significant clauses that are typically found in a GIA. It should be well noted that the language of GIAs varies from surety to surety. In addition, different jurisdictions might interpret provisions of the GIA differently. In addition, bond producers should advise their contractors that any entity or individual who signs a GIA will be responsible for indemnifying the surety. Few sureties will negotiate the terms of their specific GIA. Accordingly, bond producers should advise their contractors to carefully review an indemnity agreement with experienced and knowledgeable legal counsel.

The author of this article is Martha L. Perkins, Esq., a Partner in the Washington, DC office of Whiteford, Taylor & Preston, LLP. She can be reached at mperkins@wtplaw.com.

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.