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I suggest the following simple ten ways to avoid malpractice in litigation: FIDELITY AND SURETY

June 2014

IN THIS ISSUE Searching for a “lifeline” in Surety basic principles should the Surety become insolvent.

SURETY BONDS

A BASIC PRIMER AND THE INSOLVENCY TWIST

ABOUT THE AUTHOR Carl Anthony Maio, Esquire, is a Partner at the law firm of Fox Rothschild LLP, whose principal office is in Philadelphia, Pennsylvania. Carl is Chair of the Corporate Insurance Practice Group where he emphasizes in Reinsurance Arbitrations, Corporate Insurance Merger and Acquisition, Licensure, Regulatory Compliance, Demutualizations, and represents clients nationally and internationally. Carl has been practicing law forty-one years and enjoys the honor of being a continuous member of IADC for the past thirty-one years. Having served as Chair, Vice Chair and Program Chair for many IADC standing and substantive committees, Carl has authored many articles published by the IADC, inclusive of: committee newsletters; the Defense Counsel Journal; and, has often times been a presenter at IADC Midyear Meetings, Annual Meetings, and Special Presentations. Carl is admitted to practice in Pennsylvania, Maryland, District of Columbia, and the International Court of Justice. He is AV Preeminent rated by Martindale-Hubbell, and has been recognized for multiple years as a Pennsylvania Super Lawyer. He can be reached at [email protected].

ABOUT THE COMMITTEE The Fidelity and Surety Committee serves all members who represent fidelity and surety carriers. Committee members publish newsletters and journal articles, including an annual update of recent developments in the law. Learn more about the Committee at www.iadclaw.org. To contribute a newsletter article, contact:

Samuel J. Arena, Jr. Vice Chair of Newsletters Stradley Ronon Stevens & Young, LLP [email protected]

The International Association of Defense Counsel serves a distinguished, invitation-only membership of corporate and insurance defense lawyers. The IADC dedicates itself to enhancing the development of skills, professionalism and camaraderie in the practice of law in order to serve and benefit the civil justice system, the legal profession, society and our members.

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Much has been written about the effects of the Three types of bonds are most common. economy upon the construction industry. This Newsletter will focus upon a unique 1. Bid Bond. Issued in conjunction with perspective applicable to the surety context. construction bidding processes. This Commercial and sometimes residential bond acts as a guarantee that, if construction compels the necessity for a awarded the contract based on the bid contractor to obtain a surety bond to submitted, the contractor will enter guarantee performance leading to the into a contract to perform the work at successful conclusion of a construction the price quoted. If the contractor project. Upon that occasion, a general declines to enter into a contract to contractor will obtain a surety bond from an perform the work at the agreed upon authorized underwriter. price, the bid bond will reimburse the obligee (owner) the difference In basic terms, a surety bond is a contract between the defaulting contractor’s under which one party (surety) guarantees the bid and the next lowest bid, up to the performance of certain obligations of the penal sum of the bond. second party (principal) to a third party (obligee). Generally in the commercial 2. Performance Bond. This bond context and more specifically for public entity guarantees that the contractor will projects construction contractors provide the perform the work in accordance with project owner, for which they are performing the construction contract. The operations, with a bond guaranteeing that it purpose is to protect the owner from will complete the project by a specified date financial loss up to the penal sum limit set forth in the construction contract in of the bond should the contractor fail accordance with all plans and specifications. to fulfill its contractual obligations. Usually one or more in any combination of the following three types of bonds are 3. Payment Bond. This last bond form underwritten to secure the contractor’s guarantees that suppliers and performance. The American Institute of subcontractors will be paid for Architects (AIA) is the most common source materials and labor furnished to the of standard construction contracts and bond contractor. A project owner generally forms defining the responsibilities of insists upon a payment bond that upon contracting parties with respect to completion, the project is free of indemnification in the purchase of insurance contractor mechanic’s liens. coverage. In this context, this Newsletter will not address contractor’s all risk insurance or An essential part of the surety’s underwriting contractor’s professional liability insurance. process is the preparation and execution of a Nor will this Newsletter speculate upon the General Agreement of Indemnity (GAI). The liability of a producer who places a bond with GAI is akin to a personal indemnification an underwriter whose financial strength rating guaranty. In short, this is a two party contract is less than “secure”. between the surety and the principal (contractor) that if the principal fails to perform the surety may prosecute a civil action against the principal in the event the

w: www.iadclaw.org p: 312.368.1494 f: 312.368.1854 e: [email protected] -3- International Association of Defense Counsel FIDELITY AND SURETY COMMITTEE NEWSLETTER June 2014 surety becomes obligated to pay a portion or line of business eligible for Guaranty Fund all of the penal sum of the bond. Most GAI’s protection. Looking back at the types and provide the surety with measures to protect nature of bonds described earlier in this itself from a decaying situation. Three basic Newsletter, one can see that if the surety is rights are contained within the GAI: declared insolvent, further complicated by a jurisdiction which does not permit a Guaranty 1. Collateral Security; Fund claim, then obligees, project owners, 2. Inspection of the Principal and and even the principal are adversely affected Indemnitor’s financial books and and subject to risk. records; and 3. Settlement of claims without the Upon that occurrence, legal intervention to approval of the principal. investigate whether or not the surety has reinsurance may prove prudent. Reinsurance, One of the economic consequences that has by way of treaty or agreement, is where an become all too apparent, in circumstances insurance company including a surety, when a contractor defaults, is usually because transfers risk to another insurance company of the poor financial condition of the called a “reinsurer”. Therefore, a reinsurer, in contractor. Efforts to exercise the surety’s consideration of a premium paid by the surety rights pursuant to the GAI has more in this example, agrees to indemnify the frequently resulted as a recognized reinsured for part or all of the liability consequence in this economy, that being the assumed by the ceding company. The legal insolvency of the contractor. If the surety focus will concentrate upon a careful underwriter has an adverse selection book of investigation of the treaty provisions in the business, the likelihood is over time the surety reinsurance contract specifically looking for a will find itself in hazardous financial “cut through” endorsement. This condition because it has not been able to endorsement is a provision in the reinsurance recoup losses from the personal GAI. In part, contract that sets forth how the reinsurer will this is what has happened to two sureties pay any loss covered by the reinsurance fairly recently: contract directly to the insured when the surety is insolvent. This provision is a. First Sealord Surety, Inc., a sometimes called an Assumption Pennsylvania domiciled surety; and Endorsement and may also contain drop down b. Centennial Insurance Company, properties. However, not all state court domiciled in New York. decisions uniformly agree upon the propriety of drop down principles. Recognizing that other business of insurance factors may have played a role in the ultimate In conclusion, the lawyer and law firm financial condition of both companies, be that experienced in undertaking construction law as it may, each were ordered into liquidation and surety law matters can perform the by the respective insurance departments requisite due diligence and risk management having financial condition oversight. When to evaluate a reinsurance agreement to that unfortunate event happens, a liquidator is determine if any of the parties may seek direct appointed to manage the runoff of the relief from the reinsurer, when a surety is insolvent estate. Complicating the issue, is declared insolvent. that some states do not recognize surety as a

w: www.iadclaw.org p: 312.368.1494 f: 312.368.1854 e: [email protected] -4- International Association of Defense Counsel FIDELITY AND SURETY COMMITTEE NEWSLETTER June 2014

PAST COMMITTEE NEWSLETTERS

Visit the Committee’s newsletter archive online at www.iadclaw.org to read other articles published by the Committee. Prior articles include:

MAY 2014 Enforcement of Jurisdiction/Venue Provisions of Indemnity Agreements Steven Weinberg

APRIL 2014 Enforcing Forum Selection Clauses after Atlantic Marine G. Steven Ruprecht and Diane Hastings Lewis

MARCH 2014 Bad News for Construction Insurers Might be Good News for Sureties David W. Kash and Bruce Kahn

NOVEMBER 2013 Getting to Zero: A Method of Projecting Losses on Your Client’s Next Surety Claim David W. Kash, Bruce Kahn and Steve Leach

AUGUST 2013 Davis-Bacon Act: Subcontractor's Obligation to Pay Prevailing Wages G. Steven Ruprecht

JULY 2013 Can a Contractor Implead the State in an Action Brought Against it by its Subcontractor? Charles “Bud” Herman

FEBRUARY 2013 Getting to Zero Through a Great Takeover Agreement Bruce Kahn and David Kash

OCTOBER 2012 Pay-if-Paid Clauses Valid in Indiana Says the Seventh Circuit Steven J. Strawbridge and Cade Laverty

JULY 2012 Recent Decision by the United States Supreme Court Dealing with the Statute of Repose Charles “Bud” Herman

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