Oh No! The Surety Went Belly Up! Now What?

Northwest exposure of the Pentagon's construct...

Northwest exposure of the Pentagon’s construction underway, July 1, 1942 (Photo credit: Wikipedia)

Here at Construction Law Musings, I have often discussed payment bond claims under the federal Miller Act and its state specific analogs (so called “Little Miller Acts“). Most of these discussions have assumed without actually stating that the surety carrying the payment bond would be solvent and available to pay any judgment against it. Unfortunately, given the general economy (and the construction economy specifically), such an assumption may not be warranted in all cases.

The reality of the situation is that sureties, like every other company in today’s world, are subject to the same economic pressures as the rest of us. The economic slowdown has affected them and some of the well known ones have gone into receivership or worse. Such news can and should give general contractors, subcontractors and material suppliers pause before performing low bid government projects.

Before bidding these types of construction jobs, all of the parties should work together to assure, as best is possible, that the surety posting any payment or performance bond on the project is on sound financial ground. This is particularly true where the parties may not have a long standing relationship with the bonding agent proposing to sell them the bond. Cheapest is not always best even in a low bid situation. Taking the steps to investigate the surety is a great first step in avoiding disaster.

You’ve done your due diligence, you’ve worked with the Owner to assure a financially sound surety, and even with this investigation the heretofore solid and respected surety goes belly up. What now?

From the general contractor’s perspective, your risk is that you could be on the hook for any damages incurred by a second tier subcontractor with whom you have no relationship. The law, at least in Virginia, seems to point toward subcontractors and suppliers being third party beneficiaries under that bond (and possibly under the Prime Contract). In short, without the surety to back it up, the general contractor could end up paying twice in an even more direct fashion than the bond’s indemnification provisions would allow.

From a subcontractor’s perspective, the lack of a solvent surety lowers the probability of collection of course. However, with the possible third party claim against the general contractor a subcontractor could have a claim against what is hopefully a solvent party (assuming that the party that didn’t pay is now insolvent or refusing to make payment). With the help of an experienced construction attorney, a subcontractor or supplier may be able to at least bring more money to the table by making a valid claim against a general contractor under a third party beneficiary theory. More folks at the table should mean a better chance of at least partial recovery.

Hopefully you will never be in this position, however, at least in the Commonwealth of Virginia, hope is not completely lost when a surety goes under.

I would love to hear from attorneys or contractors in other states, and in Virginia, with any ideas and insight into how to best deal with this unfortunate situation.

I encourage you to comment below and subscribe to keep up with the latest Construction Law Musings.

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10 Responses to Oh No! The Surety Went Belly Up! Now What?
  1. Rob Pitkin
    Twitter:
    October 22, 2012 | 2:34 PM

    I actually had this happen one time in Kansas and Missouri where I primarily practice. We fortunately were able to get paid out of the receivership.

  2. Christopher G. Hill
    Twitter:
    October 22, 2012 | 2:37 PM

    Glad to hear your client got paid. Thanks for the comment.
    Christopher G. Hill recently posted..Reminder: Don’t Waive Your Mechanic’s Lien Rights (or Bond Rights For That Matter)My Profile

  3. Brian Perlberg
    October 23, 2012 | 11:52 AM

    So I hear that a new problem is people using individual surety that really isn’t financed well to save money. This isn’t really a good practice. We are updating the ConsensusDocs 752 Federal Subcontract to specifically call this out (not to do). This revised document will be out in Noveber. Meanwhile I’m moderating an AGC webinar today on Sub default and we will cover both sub bonds and subguard insurance. Best, Brian

  4. Christopher G. Hill
    Twitter:
    October 23, 2012 | 5:50 PM

    Thanks for the comment Brian. Glad to hear ConsensusDOCS is keeping up with things.

  5. Scott Wolfe
    Twitter:
    October 24, 2012 | 10:00 AM

    Not only is this a problem (admittedly, a relatively small and unlikely problem), but it’s also reason why we should all support the Miller Act bond legislation in congress right now: U.S. House Bill Looks to Fix Problem With Miller Act Bonds.

  6. Christopher G. Hill
    Twitter:
    October 24, 2012 | 10:04 AM

    The problem is likely to get bigger before it gets smaller given the higher percentage of jobs that are subject to the low bid rules for gov’t contracts. The temptation to go with a cheaper (rather than better) bond will get greater under this circumstance.
    Christopher G. Hill recently posted..Reminder: Don’t Waive Your Mechanic’s Lien Rights (or Bond Rights For That Matter)My Profile

  7. David Frey@surety bond
    Twitter:
    October 30, 2012 | 4:53 PM

    In addition to Western Insurance Company, another surety went down early this year: First Sealord.
    David Frey@surety bond recently posted..Change Orders Should Trigger Surety Bond RidersMy Profile

  8. […] Oh No! The Surety Went Belly Up! Now What? […]

  9. Surety Bonds
    March 8, 2013 | 3:47 PM

    Chris:

    First off – great article. Second, surety insolvency, although rare, often results in a chaotic grab for cash which I’m sure you’ve seen. But, it’s tough to be completely sure of a surety’s ability to pay claims at any given time. Much of the uncertainty stems from the types of business a surety writes and their exposure to key accounts. For example: A surety company could be rated A- by AM Best with a stable outlook. However, they may also have a large ratio of very risky bond classes (i.e. subdivision). In 2007 this was perfectly acceptable but, when the bottom dropped out of the real estate market, many surety companies were left holding the bag on subdivision claims. Long story short – you can only do so much in terms of qualifying a surety but you can never be certain.

  10. […] Oh No! The Surety Went Belly Up! Now What? […]

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About Musings

I am a construction lawyer in Richmond, Virginia, a LEED AP, and have been nominated by my peers to Virginia's Legal Elite in Construction Law on multiple occasions. I provide advice and assistance with mechanic's liens, contract review and consulting, occupational safety issues (VOSH and OSHA), and risk management for construction professionals.

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