The Surety Right to Make The Dreaded Collateral Call

SURETY’S RIGHT TO MAKE A COLLATERAL CALL ON BONDED CONTRACTOR AND ITS PRINCIPALS

By: Robert S. Tanner, Esq.

It is pretty much a rule that a surety will not issue performance or payment bonds to a contractor unless the surety is assured that it has very little risk. This means that the contractor, i.e., the business entity, as well as its principals and often their spouses, must have excellent credit. Even when there is excellent credit, the surety generally requires the contractor, its principals, and their spouses to execute an indemnity agreement that gives the surety extensive rights to increase its chances of recovering payments it makes under a bond.

In Travelers Casualty and Surety Company of America v. Industrial Structures, Inc., 2012 WL 4792906 (M.D. Fla. Oct. 9, 2012), Contractor entered into a contract for a residential construction project in Jupiter Beach, Florida. Contractor procured a performance bond from Surety in the amount of $4,927,670.00. Contractor, the business entity, and two individuals (probably the principal of Contractor and the principal’s wife) executed a General Agreement of Indemnity (“GAI”) in favor of Surety. The GAI included the following “Collateral Security” provision:

Indemnitors agree to deposit with [Surety], upon demand, an amount as determined by [Surety] sufficient to discharge any Loss or anticipated loss.

The provision essentially allowed Surety to demand that Contractor and the personally involved individuals (“Indemnitors”) deposit funds to protect Surety in the event of a claim against the bond. This is known as a collateral call.

At some point during the project, Owner terminated Contractor and made a claim against the bond. Contractor sued Owner in state court. Owner counterclaimed against Contractor and also sued Surety on the bond.

Surety made a written demand on Indemnitors to deposit $300,000.00, which Surety stated represented its “estimated legal fees, expert fees, and expenses through trial” of the dispute with Owner. Indemnitors did not deposit the $300,000.00. Surety sued Indemnitors in federal court and asked the court to issue a temporary injunction requiring Indemnitors to make the deposit. The court evaluated the evidence and parties’ arguments against the “elements” required for a party to obtain a preliminary injunction.

First, Surety had to establish that it likely would win on the merits at trial. Indemnitors argued that to prove this, Surety had to prove that it would likely have to pay the Owner’s claim in the state court action. The court rejected that argument, finding that Surety had to establish only that Surety likely would win its claim that Indemnitors breached the Collateral Security provision of the GAI. There was no dispute that Indemnitors had not tendered collateral in response to Surety’s demand. Further, the court rejected Indemnitors’ argument that Surety had to prove that Indemnitors were in financial difficulty or were moving assets in order to win its claim. Therefore, the court concluded that Surety proved the likelihood of winning that claim.

Second, Surety had to show that it would be irreparably injured if Indemnitors were not compelled to comply with the Collateral Security provision. Indemnitors argued that Surety could not make this showing because Surety could proceed to trial and obtain a money judgment. The court rejected that argument, finding that the irreparable injury Surety was facing was Indemnitors’ failure to provide collateral security while the Surety’s claim was pending. That particular injury could not be remedied by an eventual money judgment. Thus, Surety proved the irreparable injury element.

Third, Surety had to show that the damage it would suffer in the absence of an injunction outweighed any potential harm Indemnitors might suffer if the court granted the injunction. The court noted that “[Surety] is only asking the Court to require Defendants to do that which [they] contractually agreed to do.” Upon that, the court concluded that Surety made the required showing.

Fourth, Surety had to show that “the public interest weighs in favor of the granting of an injunction.” On this point, the court noted that the public interest generally favors enforcement of contracts and the solvency of sureties, both of which would be advanced by granting an injunction. Therefore, the court determined that the element had been satisfied.

Accordingly, the court granted the temporary injunction and required Indemnitors to deposit with Surety $300,000.00.

Finally, due to a rule in the Federal Rules of Civil Procedure, the Court also required that Surety post an injunction bond of $100,000.00 to protect Indemnitors against potential harm from the injunction eventually being found to have been wrongfully entered.

The Court’s order on the preliminary injunction was based only on Surety’s action for breach of the Collateral Security provision and, therefore, was tied to Surety’s demand for collateral. However, Surety’s action also included a claim for indemnity, which positioned Surety to obtain a judgment against Indemnitors for Surety’s liability to Owner on the performance bond.