TWENTY SIXTH ANNUAL SOUTHERN SURETY AND FIDELITY CLAIMS

Transcription

1 TWENTY SIXTH ANNUAL SOUTHERN SURETY AND FIDELITY CLAIMS CONFERENCE Clearwater Beach, Florida RD TH APRIL 23 & 24, 2015 PRE-LOSS RECOVERY STRATEGIES PRESENTED BY: T. Bennett Acuff Erik P. Raines Hill Ward Henderson Stacy H. Goetz Liberty Mutual Surety Barbara Carlos

2 Pre-Loss Recovery Strategies (Erik Raines, Bennett Acuff, Stacy Hipsak Goetz, and Barb Carlos) A. Introduction Much has been said and written about what a surety can do to mitigate its losses once a principal has defaulted. There are scores of scholarly articles and relevant case law that illuminate how a surety should operate once a loss has been incurred. 1 However, in many circumstances, once a surety has experienced a loss, the damage has been done and may be irreversible. Tinkering with a general indemnity agreement or pursuing litigation after suffering a significant loss can be a bit like locking the barn door after the horse has already bolted. If a surety waits until it has suffered a loss then depending on the financial status of the principal its chances of recovery against either the principal and or the indemnitors may be greatly diminished. A principal could be insolvent. Contract proceeds could have already been distributed. Collateral could have been compromised. There are, however, several proactive, pre-loss steps a surety can take to protect itself. Many of the actions and each action s respective success are contingent upon the surety maintaining active communication with its principal; closely monitoring project status; and having concrete and forward-thinking indemnification language. This paper and corresponding presentation will unpack several rights a surety may have and chose to exercise pre loss to put itself in the best position to either avoid a loss all together, or otherwise mitigate an inevitable loss. B. Protecting Rights to Contract Balances Contract proceeds can be the most significant source of collateral for a surety when a principal has defaulted. Contract proceeds can, however, also be the most contentious recovery source if a principal has defaulted and there are numerous claimants, creditors, finance institutions, etc. seeking payment. Once a principal has defaulted and claimants/creditors are lining up at the door, it can be more difficult for a surety to establish and enforce priority. It is very important, therefore, for a surety to take all actions pre loss to establish its right to contract proceeds before a principal is in default and a loss is already realized. 1 These include articles presented at Forcon s previous conferences. See, e.g., Trusts on Contract Balances by Michael Burkhardt and Jeffrey S. Price (21 st Annual Southern Surety and Fidelity Claims Conference) and Seven Myths About Equitable Subrogation by J. Michael Franks, Gregory H. Oakley, Jeffrey S. Price, and Christopher A. Haney (11 th Annual Southern Surety and Fidelity Claims Conference). 1

3 Contract Balances (A/K/A Pay me the money ) In general, there are three primary bases upon which the surety can claim a right to contract funds: 1. Equitable rights; 2. Contractual rights; and 3. Statutory rights Equitable Rights: Equitable Subrogation One of the more useful tools a surety has in its tool bag is the right of equitable subrogation. Generally speaking, the doctrine of equitable subrogation entitles a performance or payment bond surety to assert a superior claim to contract balances in the event of a default. 3 It has been noted that: The most cherished ancient right of the surety is its right of equitable subrogation the right to stand in the shoes of any and all parties benefited directly by the surety's performance of its bonded obligation. 4 There is potential, depending on the nature of the bond and the surety s obligations, for the surety to stand in the shoes of the obligee, the principal and/or bond claimants. Courts in most jurisdictions hold that a surety s common law right to equitable subrogation has priority over the rights of bankruptcy trustees, lenders and taxing authorities. So what exactly is a surety s common law right to equitable subrogation? As stated by the U.S. Supreme Court: A surety who discharges or performs the obligations of its principal is entitled to step into the shoes and assert the rights of those persons to whom or on whose behalf the surety has performed or made payment. 5 The term equitably subrogated is synonymous with entitled to assert. So what types of rights does a surety become equitably subrogated to, i.e., what types of rights does a surety become entitled to assert upon discharging the performance of its principal? In the case of a performance bond where the surety discharges its principal s obligation to perform under the bonded contract, the surety becomes entitled to assert: 2 Bruner & O'Connor Construction Law 12:102 3 Ronald P. Friedberg, Construction Sureties: Don't Put All Your Eggs in the Equitable Subrogation Basket, 41 Case W. Res. L. Rev. 305 (1990) 4 Bruner & O'Connor Construction Law 12:100 5 Peralman v. Reliance Ins. Co., 371 U.S. 132 (1962) 2

4 a. The obligee s right to apply earned but unpaid progress payments to the cost of completing the work. b. The principal s rights against subcontractors, sub-subs and suppliers relating to delays, defects, etc. In the case of a payment bond, when a surety discharges its principal s obligation to pay subcontractors, the surety becomes entitled to assert: c. Subcontractor s rights to assert lien claims, breach of contract claims against the GC or upstream subcontractors. 6 One interesting note about equitable subrogation is that the right extends to the full amount of the loss incurred by the surety, and it is not limited to the amount actually owed by the principal to a payment bond claimant. 7 In a case out of the Federal District Court in Pennsylvania, the court found that even in the absence of an indemnification agreement, the surety would be entitled to reimbursement under the doctrine of equitable subrogation for the total amount paid on a claim and not the amount that the principal argued was actually owed. There is, however, a split among jurisdictions regarding whether a surety s equitable subrogation rights entitle it to assert claims against a principal s equipment or personal property not dedicated to the specific bonded contract declared to be in default. In certain jurisdictions, the surety will not be entitled to assert claims against a principal s equipment or personal property not dedicated to the specific bonded contract. In other jurisdictions, the surety will be entitled to assert such claims. It is therefore important to understand both the jurisdiction where the dispute exists as well as the status of the principal s equipment or personal property i.e., was it dedicated to the specific bonded project. Either way, equitable subrogation is a valuable tool to mitigate or avoid a surety s loss. 2. Contractual Rights: ( Head s Up, I Own Your Shoes ) As discussed above, equitable subrogation is one of the most useful and widely recognized methods of pursuing contract balances based on equity. However, equitable subrogation really only comes into play after the surety has started making payments upon a principal s default or otherwise began performing a principal s obligations. Aside from equitable remedies, a surety may avail itself of certain contractual rights and 6 Bruner & O'Connor Construction Law 12:100 7 Fid. & Deposit Co. of Maryland v. Westra Const., Inc., No. CIV.A. 1:08-CV-1219, 2010 WL , at *4 (M.D. Pa. May 10, 2010). 3

5 statutory rights to assert entitlement to contract balances prior to a default and suffering a loss. Most contractual rights are contained in the General Indemnity Agreement ( GIA ) that sets forth all of the obligations of the principal and any individual indemnitors in the event of a default. Although different sureties use different variations of a GIA many common provisions can be found in the model GIA put forth by the Fidelity and Surety Committee of the International Association of Insurance Counsel. 8 The central provision to every GIA is the indemnification clause. As set forth in the model GIA this provision typically provides: The [indemnitors] shall indemnify and keep indemnified the Surety against any and all liability, loss and expense of whatsoever kind or nature, including, but not limited to, court costs, attorneys' fees, and interest, which the surety may sustain or incur (i) by reason of having executed or procured execution of any Bond or Bonds as surety for any of the [Indemnitors], (ii) by reason of the failure of the [Indemnitors] to perform or comply with this Agreement, or (iii) to enforce any of the covenants and conditions of this Agreement. In addition to the standard indemnity provision, the GIA should also set forth the rights and obligations of the surety and the indemnitors in the event of a default. On the more important provisions that can establish or protect a surety s right to contract balances is a trust provision. A trust fund provision serves two (2) purposes: 1. Allows the surety to demand that the principal open trust accounts at a bank for the deposit of contract funds. Withdrawals from such accounts can be made only with the surety s agreement. Id.; and 2. The trust fund provision may also prevent an indemnitor s debt from being discharged in bankruptcy THE GENERAL INDEMNITY AGREEMENT, Aspen Publishers Practical Guide to Construction Contract Surety Claims s In re McCormick, 283 B.R. 680 (Bankr. W.D. Pa. 2002). See also In re Thomas, 2010 WL (E.D. Mo. Feb. 24, 2010) (since language of the indemnity agreement requiring principal and indemnitors to hold all payments received on bonded contracts as trust funds created an express trust, the indemnitors' failure to pay job obligations with contract funds was deemed a defalcation while in a fiduciary capacity, and was nondischargeable in indemnitors' bankruptcy); In re Foy, 2010 WL (Bankr. D. Kan. June 21, 2010) (same). But see In re Munson, 2011 WL (Bankr. C.D. Cal. Mar. 9, 2011) (indemnity agreement providing that all payments received on bonded contracts were to be held as trust funds created an express trust only as to the corporate principal/indemnitor, even though the individual indemnitors were the sole owners of the principal); Acuity, a Mut. Ins. Co. v. Planters Bank, Inc., 362 F. Supp. 2d 885 (W.D. Ky. Mar. 28, 2005) (construction contractor did not hold funds in an express trust, and bank's seizure of contract draws deposited in bank was not improper, where construction 4

6 Pursuant to the Model GIA, a trust provision should include the following language: The Principal agrees and hereby expressly declares that all funds due or to become due under any contract covered by a Bond are trust funds, whether in the possession of the Principal or another, for the benefit and payment of all persons to whom the Principal incurs obligations in the performance of such contract, for which the Surety would be liable under the Bond. If the Surety discharges any such obligations, it shall be entitled to assert the claim of such person to the trust funds. [ ] Said trust or trusts shall terminate on the payment by the Principal of all the contractual obligations for the payment of which the trust or trusts are hereby created or upon the expiration of twenty years from the date hereto, whichever shall first occur. Whether the trust fund provision of the GIA is valid and provides a surety with an interest in the contract funds must be determined by state law. 10 In most jurisdictions, a trust is defined as the right to the beneficial enjoyment of property, the legal title to which is vested in another. However, the determination of whether a trust exists may vary from jurisdiction to jurisdiction and will largely be based on the specific language contained in the GIA and the express intent of the parties manifested therein. Although sureties will be entitled to equitable relief, it is important to also include key language in the GIA establishing indemnification rights and including a trust provision. Including those provisions will allow the most protection and give a surety the best chance of avoiding and/or mitigating a loss. 3. Statutory Rights Although it is important to include trust provisions within the GIA, there are also significant statutory rights provided by state trust fund statutes. The difference and variety of state trust statutes alone could provide enough material for a white paper. contract neither created a trust nor required that contract draws be paid in trust, indemnity agreement did not evidence contractor's original intent to create a trust, and contractor's expression of intent to place in trust certain assets that did not yet exist and over which it held no right, title, or interest had no legal effect as to construction contract funds); Argonaut Ins. Co. v. Wolverine Constr., Inc., 976 F. Supp. 2d 646 (D. Md. Sept. 13, 2013) (surety filed a cause of action for breach of the Maryland Trust Fund Statute (Md. Code Ann. Real Prop et seq.) against the principal's president who was not an indemnitor, for misappropriation of trust funds; as to whether the surety was entitled to bring suit in its own name, or whether it must rely on its subrogation rights to bring such an action, the court found that the Maryland Trust Fund Statute provided that any officer or director of a contractor or subcontractor who knowingly misappropriated trust funds shall be personally liable to any person damaged by the action ; the court held that the surety was entitled to bring an action in its own name, however motion for summary judgment was denied as there was a genuine dispute as to whether the principal's president had the requisite knowledge for personal liability under the Maryland Trust Fund Statute). 10 George J. Bachrach & Cynthia E. Rodgers-Waire, The Surety's Rights to the Contract Funds in the Principal's Chapter 11 Bankruptcy Case, 35 Tort & Ins. L.J. 1 (1999) 5

7 For example, states like Arizona, Maryland, Delaware, Illinois, Michigan, New Jersey, and Oklahoma expressly require the formation of a trust for construction project funds and payments. However, some of those state statutes do not expressly require that the funds be held in separate accounts. 11 In short, a surety should include trust language in the GIA regardless of the jurisdiction, but also be aware of any jurisdictional statutory trust rights. C. Enforcing the Surety s Rights to Indemnitors Collateral One of the most important strategies a surety can employ to mitigate potential bond losses is to actively seek to assess and if possible, enforce its rights to the indemnitors collateral before the surety suffers a loss. A principal s collateral is often the surety s best security against a potential loss and it can also be the sole source of any recovery if the surety ultimately sustains a loss. Therefore, it is critical for the surety to understand its rights vis-à-vis its principal s collateral, and how and when it can enforce those rights. This is especially important in light of the myriad ways especially in debtor-friendly jurisdictions in which principals who see the default writing on the wall can attempt to shield any available collateral through asset protection. As noted by the former Fifth Circuit court in 1932, [a] surety is indeed a favorite of equity, which will extend its aid in exoneration, quia timet, before he pays, and will subrogate him after he pays, liberally and fully, as against others primarily liable on the debt. Am. Surety Co. v. Lewis State Bank, 58 F. 2d 559, 560 (5 th Cir. 1932). The general rule remains that a surety can seek to enforce a principal s duty to perform through its equitable right of exoneration as well as the equitable remedy of quia timet. 12 In addition to its common-law based equitable remedies, a surety may seek to avail itself of its principal s contractual obligations to post collateral contained in the indemnity agreement. 13 Of course, these common law and contractual rights are only as good as they are enforceable. Indeed, what good is having a right to force the principal post collateral before losses are suffered if a Court won t enforce it before the surety suffers a loss? The question therefore becomes how does a surety who is faced with a potential liability on its bond enforce these significant rights and minimize any potential losses? The answer, including a discussion of the surety s right to exoneration, quia timet relief and ability to obtain specific performance of collateral posting obligations, follows See e.g. 770 Ill. Comp. Stat. Ann. 60/21.02 (expressly stating that funds are not required to be in separate accounts). 12 Quia Timet is a Latin term that literally translates to because he fears, and is defined as a legal doctrine that allows a person to seek equitable relief from future probably harm to a specific right or interest. Black s Law Dictionary, 1443 (10 th Ed. 2014). 13 Assuming that there is such a provision. If there isn t one in your indemnity agreement, there needs to be. 14 The authors would like to thank David J. Krebs, Esq., whose paper, Sureties Equitable Remedies: The Writ of Quia Timet and Injunctive Relief presented at the Southern Surety and Fidelity Claims Conference 6

8 Exoneration (a/k/a Pay Them the Money ) Black s Law dictionary defines exoneration as [t]he equitable right of a surety confirmed by statute in many states to compel the principal debtor to satisfy the obligation as when, even though the surety would have a right of reimbursement, it would be inequitable for the surety to be compelled to perform if the principal debtor can satisfy the obligation. 15 Essentially, a surety s exoneration rights permit it to either: (i) require the principal to pay its own debt once they come due in advance of the surety being compelled to perform on its bond obligations; or (ii) require other parties to bypass payment to the principal in favor of paying the debts owed by the principal directly to its creditors. 16 The surety s exoneration rights are recognized in the Restatement (Third) of Suretyship and Guaranty, 18, comment (a), which states: a. Recourse against principal obligor. As between the principal obligor and the secondary obligor, it is the principal obligor that has the duty to perform or bear the cost of performance. See 1. Suretyship status provides the secondary obligor the right to effectuate that relationship by application of four mechanisms: enforcement of the principal obligor's duty of performance (also known as exoneration or quia timet relief), reimbursement, restitution, and subrogation. In addition, the Restatement (Third) of Suretyship and Guaranty, 21, provides: (1) If the principal obligor is charged with notice of the secondary obligation ( 20), the principal obligor has the duty to the secondary obligor (a) to perform the underlying obligation to the extent that failure to do so would leave the secondary obligor liable for performance that would entitle the secondary obligor to reimbursement by the principal obligor, and (b) to refrain from conduct that impairs the expectation of the secondary obligor that the principal obligor will honor its duty of performance. (April, 1998), served as a valuable resource for this section of the paper. For additional in-depth discussion of this topic, please see The Surety s Indemnity Agreement: Law and Practice, 2 nd Ed. (2008) and Jay M. Mann, Exoneration and Quia Timet in The Law of Suretyship, 2 nd Ed (Edwin Graham Gallagher, ed., American Bar Association 2000). It is important to note that jurisdictions vary in their enforcement in application of these remedies. It is therefore important for a surety to immediately consult with counsel in the applicable jurisdiction once a potential loss is feared so that all available common law and contractual loss recovery tools can be evaluated. 15 Black s Law Dictionary, 696 (10 th Ed. 2014). 16 See, e.g., National Surety Corporation v. Barth, 20 N.J. Super 100, 89 A.2d 104 (N.J. Super Ct. Ch. Div. 1952) (holding that contract funds should first be applied to unpaid bonded claims rather than to principal pursuant to the surety s right to exoneration). 7

9 Although a surety s common law exoneration rights can be a powerful tool for loss avoidance, the rights are somewhat limited in scope because they only arise once the principal s debt has become due and the surety s liability has actually matured. See Allegheny Cas. Co. v. United Const. Co. of Central Florida, Inc., 2014 WL (M.D. Fla. 2014); Northwestern Nat. Ins. Co. of Milwaukee, WI v. Alberts, 741 F.Supp. 424, 429 (S.D.N.Y.1990). Although courts are not hesitant to uphold a surety s equitable right to exoneration, the timing of that relief may sometimes be of little help to the surety whose principal has long since known of its debt before the surety s liability has actually matured. As discussed below, the surety s stronger rights lie in the doctrine of quia timet. Quia Timet (a/k/a Let Me Hold Your Money ) Quia timet is a common law doctrine that provides a surety with a mechanism to obtain equitable relief against its principal before a bond claim is made and before the surety sustains an injury. The typical nature of quia timet relief sought is to require the principal to deposit with the surety the anticipated cost and expense of a loss under a bond. Unlike its exoneration rights, a surety s quia timet rights are not dependent on the existence of an actual debt by the principal. 17 Indeed, because the doctrine of quia timet permits a surety to obtain relief even before its liability has matured, and even before a bond default is declared, a surety s quia timet rights are much broader and stronger than its rights to exoneration. The Restatement (Third) of Suretyship and Guaranty, 21, Comment on Subsection (2), provides: j. Enforcement of the duty of performance; quia timet. The principal obligor has a duty to refrain from conduct that impairs the expectation of the secondary obligor that the principal obligor will honor its duty of performance. Relief that protects the rights of the secondary obligor with respect to this duty is sometimes referred to as quia timet relief. In such a case, the relief should be considered as a present remedy for the current breach of the duty to refrain from conduct impairing the secondary obligor's expectation, rather than as anticipatory relief for a future breach of the duty to perform or the duty to reimburse. In reference to the Restatement, a principal s duty to refrain from conduct that impairs a surety s expectation that it will not suffer a loss carries an implicit duty to post collateral. Stated differently, a surety is entitled expect that it will suffer no loss and quia timet relief allows a surety to demand the principal to post collateral to preserve this expectation. 17 The Second Circuit, in Borey v. Nat'l Union Fire Ins. Co., 934 F.2d 30, 32 (2d Cir.1991), aptly describes the difference between a surety s quia timet and exoneration rights: Quia timet is the right of a surety to demand that the principal place the surety in funds when there are reasonable grounds to believe that the surety will suffer a loss in the future because the principal is likely to default on its primary obligation to the creditor. Exoneration, though closely related, is distinct. It is the surety's right, after the debt has matured, to compel the principal to honor its obligation to the debtor. 8

10 Obviously, a surety s ability to demand that its principal post collateral even before a loss occurs is a powerful one. Indeed, a surety s common law quia timet rights are especially critical when the surety s general indemnification agreement does not expressly provide the surety with a right to demand collateral (as will be further discussed in Section iii below). See Great American Inc. Co. v. General Contractors & Constr. Mgmt., Inc., 2008 WL , *5 (S.D. Fla. 2008) (upholding surety s common law quia timet rights and requiring principal to post collateral even where the general indemnity agreement did not contain a collateral-posting provision); but see Borey, 934 F.2d 30 at 32 (2d Cir. 1991) (holding that a surety s loss of its quia timet rights did not constitute irreparable harm where it could be fully compensated on its indemnity claim). However, the surety s equitable quia timet rights are not without limits. To invoke its quia timet rights to be collateralized, Courts have held that a surety must have a rational basis to fear a loss. Transamerica Premium Ins. Co. v. Calvary Constr., Inc., 552 So.2d 225, 227 (Fla. 5th DCA 1989); Great American Inc. Co. v. General Contractors & Constr. Mgmt., Inc., 2008 WL (S.D. Fla. 2008) (enforcing surety s right to quia timet relief and requiring principal to post collateral). Whether a surety s fear of loss and the corresponding amount of the collateral demanded to combat that fear is rational will depend on the circumstances of each case. See, e.g., Great American, supra at *5 (holding that a surety s fear of loss is rational and therefore supported quia timet relief when a general contractor was facing a default judgment on a payment bond claim). Contractual Collateral Posting Obligations In addition to the surety s expansive indemnity rights, a typical general indemnity agreement contains collateral posting obligations, which permit the surety to determine in its sole discretion and without first having suffered any loss or received any notice of a formal default that a potential liability exists on the bond and to make a demand that the principal perform (i.e., pay its debts) or to post collateral in an amount that the surety determines will be sufficient to cover any potential liability. These contractual rights are essentially memorialized versions of the surety s common law equitable exoneration and quia timet rights. 18 A standard collateral posting obligation provision will contain language similar to the following: the indemnitors agree to pay to Surety upon demand... an amount sufficient to discharge any claim made against Surety to pay such claim or be held by Surety as collateral security against loss on any Bond; (ii) Surety shall have the exclusive right for itself and the indemnitors to determine in good faith whether any claim or suit upon the Bond shall be 18 See Restatement (Third) of Suretyship and Guaranty, 18, comment (b) (acknowledging that [s]uretyship status confers on the secondary obligor certain rights of recourse against the principal obligor. Those parties may, by agreement, augment, modify, or limit those rights. See 6. Such an agreement between the principal obligor and the secondary obligor, often called an indemnity agreement, is quite common. ). See also, Allegheny Cas. Co. v. United Const. Co. of Central Florida, Inc., 2014 WL (M.D. Fla. 2014) (finding that judgment on a surety s contractual exoneration claim mooted its common law exoneration and quia timet claims). 9

11 paid, compromised, defended or appealed;... (iv) the indemnitor will, on request of Surety, procure the discharge of Surety from any Bond and all liability by reason thereof; (v) if such discharge is unattainable, the indemnitors will, if requested by Surety, either deposit collateral with Surety, acceptable to Surety, sufficient to cover all exposure under such bond or bonds, or make provisions acceptable to Surety of the funding of the bonded obligation(s). 19 a. Can the Surety Obtain Specific Performance of the Indemnitors Collateral Posting Obligations? As noted above, a surety s ability to require its indemnitors to post collateral is a powerful right. But it s only as powerful as it is enforceable. A surety whose principal fails to post the demanded collateral must seek recourse through an action for specific performance and pursue preliminary injunctive relief. However, general legal principals typically restrict the availability of equitable claims like specific performance and injunctive relief to situations where the party seeking relief does not have an adequate legal remedy. See Borey v. Nat'l Union Fire Ins. Co., 934 F.2d 30, 32 (2d Cir. 1991) (holding that a surety was not entitled to a preliminary injunction enforcing its common law quia timet rights because any monetary loss alone will generally not amount to irreparable harm. ); Invego Auto Parts, Inc. v. Rodriguez, 34 So. 3d 103 (Fla. 3d DCA 2010) (stating that specific performance can only be granted when 1) the plaintiff is clearly entitled to it, 2) there is no adequate remedy at law, and 3) the judge believes that justice requires it. ) (quoting Castigliano v. O'Connor, 911 So.2d 145, 148 (Fla. 3d DCA 2005)). Principals facing a surety s demand for collateral and subsequently asserted equitable claims will undoubtedly argue that a surety has an adequate remedy at law the pursuit of money damages on an indemnity claim. So, is a surety s contractual right to be collateralized before suffering a loss only worth as much as the paper it s written on? Or can a surety argue that recovering money damages through an indemnity action is actually inadequate and that it will suffer irreparable harm if it is denied the ability to specifically enforce the pre-loss right which it bargained for? This is the precise issue that the Court addressed in Liberty Mut. Ins. Co. V. Aventura Engineering & Const. Corp., 534 F. Supp. 2d 1290, 1316 (S.D. Fla. 2008). In Liberty, the court evaluated whether under Florida law, a surety could obtain specific performance to enforce its contractual right to be collateralized. Id. at The Liberty Court noted that none of the intermediate Florida appellate courts had squarely addressed this issue. Citing a litany of nationwide case law 20 recognizing a surety s 19 Such provisions should also make explicit the indemnitors acknowledgement that the failure to post collateral on demand will result in irreparable harm for which the surety has no adequate remedy of law. Such self-serving statements may not ultimately bind a court to find the existence of irreparable harm, but they surely cannot hurt. 20 Id. citing Auto Owners Ins. Co., No Orl 31, 2007 WL ; Safeco Ins. Co. of Am. v. Schwab, 739 F.2d 431 (9th Cir.1984) ( [S]ureties are ordinarily entitled to specific performance of collateral security clauses. If a creditor is to have the security position for which he bargained, the promise to maintain the security must be specifically enforced ); Milwaukie Constr. Co. v. Glens Falls Ins. Co., 367 F.2d 964 (9th Cir.1966), citing 72 C.J.S., Principal and Surety 303 (1951)(legal remedy of 10

12 right to obtain specific performance of collateral security obligations, the Liberty Court ultimately posited that the Florida Supreme Court would specifically recognize a surety's entitlement to enforce its contractual rights to collateralization[,] and held that a final decree of specific performance is necessary in this case to protect the surety's contractually acquired rights. Id. In a recent decision following the Court s decision in Liberty, the District Court for the Middle District of Florida in Developers Sur. and Indemn. Co. v. Hansel Innovations, Inc., 2014 WL (M.D. Fla. 2014) evaluated the propriety of a surety s motion for preliminary injunction against its subcontractor principal and the individual indemnitors, which sought to require them to post collateral in an amount corresponding to the surety s reserves. In Developers, the principal and the individual indemnitors failed to post collateral as requested pursuant to the indemnity agreement. The Developers Court, citing Liberty, held that courts addressing the issue recognize that a surety's loss of its right to collateralization cannot be adequately remedied through monetary damages. Id. at *6. The Developers Court further noted that: The rationale for specific performance of such collateral security clauses is that [i]f a creditor is to have the security position for which it bargained, the promise to maintain security must be specifically enforced. Safeco, 739 F.2d at 433 (quotation omitted). Thus, the nature of the injury in collateral security provision cases is the lack of collateralization while claims are pending, and nothing can remedy that injury after the fact. Travelers Cas. & Sur. Co. of Am. v. Indus. Commercial Structures, Inc., No. 6:12cv 1294 T28DAB, 2012 WL , at *3 (M.D. Fla. Oct.9, 2012) (citation omitted). [T]he use of injunctive relief is appropriate to protect the surety's contractual, common-law and equitable rights of exoneration and quia timet. Developers Sur. & Indem. Co. v. Elec. Serv. & Repair, Inc., No , 2009 WL , at *2 (S.D. Fla. Nov.16, 2009) (citations omitted). Based on the cited case law and its analysis of the factors governing the grant of preliminary injunctions 21, the Developers Court granted the surety s motion for money damages was not adequate and specific performance was available to require indemnitors to deposit with surety money or acceptable security equal to its established reserves); Feibus, 15 F.Supp.2d 579 (surety was entitled to specific performance in order to protect the surety's bargained-for rights to collateral security);united Bonding Ins. Co. v. Stein, 273 F.Supp. 929 (E.D.Pa.1967) (legal remedy for subsequent damages will not suffice when indemnitor refuses to voluntarily comply with surety's demands); U.S. Fid. & Guar. Co. v. Stanley Contracting, Inc., 303 F.Supp.2d 1169 (D.Or.2004) (court granted specific enforcement term requiring indemnitors to post security in order to protect the surety from future losses); BIB Construction, Inc. v. Fireman's Ins. Co. of Newark, NJ, 214 A.D.2d 521, 625 N.Y.S.2d 550 (N.Y. 1 App. Div.1995)( [D]amage resulting from failure to give security is not ascertainable, and the legal remedy is therefore inadequate ). The Liberty Court further noted that Restatement (Third) of Suretyship and Guaranty, 21 cmts. i, j, k, also recognizes this right. 21 Id. at *4 (providing that a party seeking entry of a preliminary injunction must establish (1) a substantial likelihood of success on the merits, (2) a substantial threat of irreparable injury if the injunction is not granted, (3) the threatened injury to the moving party outweighs whatever damage the proposed injunction may cause the opposing party, and (4) if issued, the injunction would not be adverse to the 11

13 preliminary injunction and compelled the defendants to post collateral in an amount equal to the reserve account set on the bond. 22 It appears that courts undoubtedly due to the efforts of savvy surety professionals and their attorney counterparts are becoming increasingly more sympathetic to the surety s right to obtain specific performance of their indemnitors collateral posting obligations. Indeed, this trend persists not only in Florida, but in many other jurisdictions as well 23, prompting one commenter to note that: we may recall the year 2014 as a banner year for sureties achieving compelling results in arguments over an indemnitor s obligation to post collateral upon the surety receiving a claim on the bond. 24 In addition to increasingly recognizing a surety s ability to obtain equitable relief to enforce their indemnitors collateral posting obligations, courts are also regularly recognizing an ancillary benefit of the collateral demand: if the principal fails to comply with it, then it will be precluded from asserting bad faith as a defense to an indemnity claim. As noted by the Court in Liberty, as a matter of law, there cannot be a finding of bad faith when an indemnitor fails to post the contractually required collateral. Id. at In support of this conclusion, the Liberty court noted that: public interest.) (citing Four Seasons Hotels & Resorts, B.V. v. Consorcio Barr, S.A., 320 F.3d 1205, 1210 (11th Cir.2003)). 22 See also Travelers Cas. and Sur. Col. Of America v. Design Build Engineers and Contractors, Corp., 2014 WL (M.D. Fla. 2014) (granting surety s preliminary injunction to require the posting of collateral); Hanover Ins. Co. v. Holley Const. Co. & Associates, Inc., 2012 WL (M.D. Georgia 2012) (noting that Georgia state courts had not yet resolved whether a surety would have an adequate remedy at law absent enforcement of its collateral security provision, but holding that the surety did not have an adequate remedy at law and was therefore entitled to a preliminary injunction requiring the indemnitors to post collateral). 23 See, e.g., Int'l Fid. Ins. Co. v. Waterfront Group NC, LLC, 2011 WL , *4 (W.D.N.C. 2011) (granting preliminary injunction in favor of surety enforcing right to collateral even where the obligee had not yet made a claim on the bond, and stating that courts routinely recognize that a surety's loss of its right to collaterization cannot be adequately remedied through monetary damages.); First Nat'l Ins. Co. of Am. V. Sappah Bros. Inc., 771 F. Supp.2d 569, 574 (E.D.N.C. 2011) (holding that, [t]he court finds [Plaintiff] would suffer irreparable harm in the absence of preliminary injunctive relief in the form of collateral security. ); Inter'l Fidelity Ins. Co. v. Anchor Environmental, Inc., 2008 WL *7 (E.D. Pa. 2008) (finding irreparable harm and stating that, [i]f Plaintiff is deprived of the bargained-for collateral security, it will face the risk of being a general unsecured creditor of Defendants and of not being able to collect. To protect Plaintiff from becoming a general creditor, the grant of specific performance to enforce the collateral security provision is warranted. ). 24 Jerome M. Joseph, Banner Year for Courts Requiring Indemnitors to Post Collateral in Favor of Sureties, DRI For The Defense, 57 No. 2 DRI For Def. 20 (February 2015) (citing inter alia Developers and XL Specialty Insurance Co. v. Truland, 2014 WL (E.D. Va. 2014) (enforcing surety s right to be collateralized via preliminary injunction, and expressly stating that [e]x post money damages are inadequate to protect Plaintiffs' expectancy, as the very essence of collateral is to safeguard the surety from losses before it is required to discharge any claims. ); Western Surety Co. v. Mooney, 574 Fed. Appx. 865 (11th Cir. 2014) (upholding grant of summary judgment in favor of surety who sought to be collateralized) Liberty Mutual Insurance v. Applegate, 2014 WL (N.D. Ca. 2014) (enforcing surety s right to collateral via summary judgment on specific performance claim); Hanover Insurance Co. v. Quadrants, Inc., 2014 WL (E.D. Mich. 2014) ((enforcing surety s right to collateral via summary judgment on specific performance claim)). 12

14 several courts have held that a principal's failure to post collateral defeats the defense of bad faith. See, e.g., Employers Ins. of Wausau, 749 F.Supp. at (allegation of bad faith cannot withstand indemnitors' breach by failing to post collateral); Transamerica Ins. Co. v. Avenell, 66 F.3d 715, 721 (5th Cir.1995) (concluding that the surety did not settle in bad faith a disputed claim that was being litigated when the principal failed to post the collateral which would have prevented the surety from settling with the bond obligee); Gen. Accident Ins. Co. of Am., 975 F.Supp. 511 (settling disputed claims after indemnitors failed to post collateral defeats finding of bad faith); United States Fid. & Guar. Co. v. Feibus, 15 F.Supp.2d 579, 585 (M.D.Pa.1998) (concluding that Defendants ignored repeated requests by the plaintiff to provide collateral security, in violation of a surety agreement, weighs against a finding that the surety acted in bad faith in settling claims. ). Id. at Although these trends in the law are undoubtedly favorable to the surety industry, the law in each jurisdiction may vary. Undoubtedly a surety now has plenty of case law ammunition to support a court s award of this relief even if it has not previously been recognized. Therefore, it is important for any surety upon first learning of the potential for a loss to quickly ascertain their indemnitors collateral posting obligations and consult with their attorney to determine whether the courts in the applicable jurisdiction enforce those obligations via specific performance. Sureties who delay exercising their rights do so at their own peril. 25 D. Conclusion There are several steps a surety could and should take before a loss occurs, and this paper is not an exhaustive analysis of all steps a surety could take. However, including key language in the GIA, understanding jurisdictional varieties and exercising all rights to an indemnitor s collateral will give the surety the best chance to mitigate a loss or avoid it all together. 25 See In re Gas Reclamation, Inc. Securities Litigation, 741 F. Supp 1094 (S.D.N.Y. 1990), aff d on other grounds by Abish v. Northwestern Nat. Ins. Co., 924 F. 2d 448 (2d. Cir. 1991) (holding that a surety s three year delay in requesting the principal to post collateral undermined its claim and required the denial of its request for security). 13