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CLAIMS AGAINST YOUR BID, PAYMENT AND PERFORMANCE BONDS - STRATEGIES TO HELP YOU PROTECT YOURSELF WHEN TIMES GET TOUGH

by Attorney Jonathan P. Sauer

Introduction

Those familiar with our website (www.sauerconstructionlaw.com) know that there are several articles on it as to how claimants can or should pursue various bond claims of one kind or another. These are, if you will, ‘offensive’ strategies in terms of how to pursue claimants’ rights under various bonds: the plaintiff’s perspective. Plaintiffs will generally be material suppliers or subcontractors on payment bonds. And, defendants will often be general contractors, a large number of which I have represented over the years and do represent today.

The purpose of this article will be purely ‘defensive’ in orientation. Namely, how do you protect yourself when claims are made against your bonds? And, the thrust of the article isn’t to explain how to handle isolated and small bond claims for a viable business. The purpose underlying this article is to discuss how to prepare for and handle business-threatening bond claims: claims that are made against your company which can or might put it out of business and claims made against your company when you are out of business.

The various sources of law referenced will be from Massachusetts.

This is a long article. But, think of the purpose behind it. If and when you are in the process of potentially going out of business, things will be coming at you from any and all directions. You are not going to be at your best. You will be exhausted, overwhelmed, fearful, angry and extremely disappointed. A lot of the suggestions contained in this article are not intuitive. They would not simply occur to you as events unfold. And, your not understanding how the whole game is played – from declaration of default until personal discharge in bankruptcy - can cause you to make a lot of mistakes. Mistakes that can cost you and your loved ones a lot of money at a time that you don’t have a lot of money. For bonded principals with a lot at stake for the individual owners, this is one of my articles that you should truly read first. I am going to be brutally honest in what I say to you in this article, sharing information that can only come from someone who has represented a lot of sureties and is familiar with their practices. You need to be brutally earnest and attentive in your reading of this article to get the maximum benefit from it.

As I have spent most of my thirty-five years as a construction lawyer representing more than two dozen bonding companies - fifteen years of which time, this was essentially all that I did - I have a good understanding of how all three processes work: representing sureties and representing clients claiming against sureties or defending clients against claims from sureties. Some of the suggestions contained herein (such as how to settle a payment bond claim and the proactive use of payment plans) might not win merit badges or awards for being the best of all possible business practices. Having said that, I am simply pointing out strategies that I have seen employed and which are available when significant surety problems raise their ugly head, as they often do/will. And, the premise for employing these ideas is that your company and you – as an individual indemnitor – are in some measure of trouble, possibly serious trouble. While one might be critical of some of these approaches in a vacuum, when one’s professional and, especially, personal and family life hangs in the balance, that individual is entitled to know what arrows are in his quiver. I leave it to the archer to decide on which arrow he will select.

Some of what is discussed below is applicable to general estate planning for anyone: not just limited to those who execute general indemnity agreements to secure bonds.

In the construction business, most contractors are only concerned with ‘contract’ bonds, which, for these purposes, will be bid, payment and performance bonds. (One of the forms of lien bond could also be considered a contract bond - the so-called section 12 bond, which is given by the general contractor at the outset of a private project to prevent mechanic’s liens. By my experience, these are fairly rare these days.)

As this is a complex subject, I suspect there will be a second article on this subject later on. Let’s look at the basics now.

1. Understanding The General Indemnity Agreement.

The first thing I will say about the general indemnity agreement is that you should do some serious work as to asset protection before you sign it. This is discussed later in this article under section 2.B.

Typically, most principal-surety relationships commence with a contractor’s signing a general indemnity agreement (GIA). This is analogous to a mortgage, which you would sign to get a loan to buy a house. I have found that many contractors, when trouble arises, either are not aware of the fact that they signed such an agreement and/or do not have a copy of such agreement. So, the first idea we have is to make sure you have a copy of the GIA and you read it through at least once. Most of them are difficult to understand, as they are written in legalese and surety legalese, at that. However difficult, these are extremely serious documents with distinctly serious potential ramifications.

Incidentally, while most suretyship arrangements do depend on there being a written GIA, there is case law to the effect that the surety is entitled to indemnity even in the absence of a written agreement.

In the case of New England Merchants Nat. Bank v. Latshaw, 12 Mass.App.Ct. 150, 152, 421 N.E.2d 1264 ( Mass.App., 1981), the Appeals Court stated:

“By the pledge of his stock, Latshaw stood surety for Gemico. As a surety he was entitled, even without an express agreement, to indemnity when he was injured by payment in discharge of Gemico's liability. Ricker v. Ricker, 248 Mass. 549, 551, 143 N.E. 539 (1924). Wolverine Ins. Co. v. Tower Iron Works, Inc., 370 F.2d 700, 703-704 (1st Cir. 1966). Williston, Contracts s 1274, at 866-868 (3d ed. 1967). See Eliot Sav. Bank v. Aetna Cas. & Sur. Co., 310 Mass. 355, 357-358, 38 N.E.2d 59 (1941).”

The basic idea behind the GIA is one of the distinguishing factors between insurance and surety. Generally speaking, when an insurance claim is made against you, you do not have to pay the insurance company back for either its expense payments (payments to lawyers, accountants, outside adjusters) or for its loss payments (what amounts actually get paid to the claimant.) That makes sense! After all, what is insurance for? The purpose of insurance is simply to transfer the risk and exposure from yourself to a financial institution, which agrees to accept the transfer in exchange for the payment of a premium.

Suretyship, however, is not insurance. While there are a variety of differences between the two (e.g. surety premiums, generally, are not actuarily-determined unlike insurance premiums), for present purposes, the key thing to keep in mind is that if the surety loses any money on your account - expense payments, loss payments or both - you have to reimburse the surety and pay them back every penny, including interest and the counsel fees employed to get a judgment against you as to your indemnity obligation.

When does this apply? What about when you are completely right as to the underlying surety claim? This doesn’t matter; you have to pay them back. What about if you are partially or completely wrong? You have to pay them back. If the claims department opens a file and begins generating loss and expense payments, you have to pay them back. And, a very important incidence of this is that not only does your company - the principal - have to pay the surety back. The personal guarantors (or indemnitors) have to also pay the insurance company back. Typically, a surety will look for the owners to sign personally on the indemnity agreement, including spouses (even when they are not involved in the business.) Some sureties have formulas: for example, those owning 10% or more of the corporation’s stock have to sign.

What if when the agreement was signed, a husband and wife were married and when the principal went into claim, the individuals are no longer married? This has no effect on the obligation of the signing ex-spouse as to the surety. (It may be that the ex-spouse may have rights for indemnity over against the former spouse; but, there is no effect as to the surety.) What about if the principal files bankruptcy and gets a discharge? Does this excuse the obligations of the individual indemnitors? The simple answer is ‘no’, unless the personal indemnitors file bankruptcy at the same time as the company. If the personal indemnitors do not also file bankruptcy, the discharge of the principal does not remove this obligation on the part of the individual indemnitors.

An indemnity agreement is a contract. The following are some Massachusetts cases discussing the enforceability of contracts:

Parties competent to contract may not accept provisions of bargain they favor and reject those they wish to avoid. Rogers v. Okin, 478 F.Supp. 1342 (D.Mass. 1979). Agreements voluntarily made between competent persons should not be lightly set aside on ground of hardship. Crimmins & Peirce Co. v. Kidder Peabody Acceptance Corp., 185 N.E. 383, 282 Mass. 367, 88 A.L.R. 1122 (Mass. 1933). When language in a contract is unambiguous, enforcement of such contract will not be denied because of hardship to one of the parties.

J.F. White Contracting Co. v. Massachusetts Bay Transp. Authority, 666 N.E.2d 518, 40 Mass.App.Ct. 937, review denied 670 N.E.2d 966, 423 Mass. 1106 (Mass.App.Ct. 1996).

Privately held and uncommunicated intent of any party to agreement is not controlling on other parties; mutually manifested intent controls. Jacobs v. Pierce, 208 B.R. 261 (D.Mass. 1997)

Under Massachusetts law, individual who signs document is charged with knowledge of what it says. Kravetz v. U.S. Trust Co., 941 F.Supp. 1295 (D.Mass. 1996) A party to a contract is legally bound by its terms, whether or not he read them. Abbasciano v. Home Lines Agency, Inc., 144 F.Supp. 235 (D.C.Mass. 1956 ) Generally, in absence of fraud, one signing a written agreement is bound by its terms whether he reads and understands it or not or whether he can read or not. Spritz v. Lishner, 243 N.E.2d 163, 355 Mass. 162 (Mass. 1969) Under Massachusetts law, contract is to be construed so as to give reasonable effect to each of its provisions. Bank One Texas, N.A. v. A.J. Warehouse, Inc., 968 F.2d 94 (C.A.1 Mass. 1992)

Under Massachusetts law, whenever possible the provisions of a contract are to be construed with reference to one another as to make entire contract a rational business instrument which will effectuate apparent intention of parties. Kagan v. Industrial Washing Mach. Corp., 182 F.2d 139 (C.A.1 Mass. 1950)

Personal liability for corporate debts is an exception to the rule as – generally speaking -under basic principles of Massachusetts corporate law, the owners of interests in corporations and limited liability companies are not generally liable for the contractual debts of that entity absent fraud. After all, that is why you do business as a corporation or as a limited liability company: to separate your business exposures and risks from your personal assets. Please keep in mind that this general principle of law has no application to contractual obligations you personally and voluntarily incur. In a business failure situation, this would largely be obligations to the bank (as to lines of credit and loans) and obligations to bonding companies (as to losses and expenses incurred with regard to your bonds that have gone into claim.)

Please keep in mind that the surety does not have to have your permission to incur an expense or to pay a claim. The indemnity agreements typically give them complete discretion to incur expenses and pay claims, even against the principal’s vociferous objection. Some of the more aggressive GIA forms give the surety the right to sign the principal’s name to settlement agreements, even where the principal doesn’t want to settle. Some GIAs even make provision for the surety to sign your name to a ‘confession of judgment’ in a court action, acknowledging your responsibility for an indemnity debt. This would, in effect, establish your indemnity obligation without a trial and, possibly, without your even knowing about it. Scared yet?

You have to understand that bonds are underwritten on what is known as a ‘zero percent loss expectation’. This means that since the surety has at least theoretical indemnity for all of its losses, sureties have this rather arcane, possibly amusing, idea that they shouldn’t lose anything as the result of having underwritten contract bonds, notwithstanding that the Bible has at least six anti-surety statements in it! I know this as one afternoon, an insurance agent – possibly half in the bag – called me and read them to me! Here are a couple:

“Do not be one of those who shakes hands in a pledge, one of those who is surety for debts; If you have nothing with which to pay, Why should he take away your bed from under you?” (Proverbs 22:26, 27)

Proverbs 11:15 “He who is a surety for a stranger will suffer, But one who hates being surety is secure.”

So, if a surety expects to lose absolutely nothing in exchange for its receipt of premiums, what is the value to the principal of being bonded?

One well-known New England underwriter, when confronted with this question, said with all sincerity: “A surety earns its premiums by prequalifying its principals for jobs”. My response to this is that this is nice work, if you can get it!

Friends, there are a number of things to keep in mind when thinking of possible litigation between your company (or yourself, as a personal indemnitor) and the surety. Because of the terms of the GIA, the deck is distinctly and utterly stacked against you, because these agreements are, by design, heavy-handed in favor of the surety. And, looking at this issue objectively, why shouldn’t they be? After all, you are entering into a credit relationship with the surety and no one is forcing you to accept any particular company’s indemnity requirements or bonds.

Think about your relationship with your bank with regard to your car loan or with regard to your mortgage. The paperwork that you sign to get either makes it almost certain that if you fail to make a car payment, they will take your car away from you. And, if you fail to make a mortgage payment, they will foreclose on your mortgage and throw you out into the street. As they say: life is hard and then you die.

Additionally, a surety has a significantly stronger economic ability than you do to litigate from now until . . . forever. They can far better afford lawyers and other consultants than you can. If the surety incurs loss and expense payments on your company’s account and then sues its indemnitors, more likely than not, it will win. Assuming any different would not be sensible.

In any litigation between a surety and indemnitors, in the vast majority of circumstances, the surety will win the case.

If that is the likely result, what, then, can be done to protect yourself as to possible claims by your surety against you? And, assuming there is a claim, what can be done to minimize the loss and expense payments the surety might incur, which you might have to reimburse?

2. Set up your personal financial situation as early as possible, preferably before you incur the surety obligation.

A. This is especially important as most construction companies will ultimately fail.

Folks, if you are in the construction business - particularly as a general contractor - if you do any significant level of business, it is very likely you are going to be sued by some creditor or claimant. After all, on a general contractor’s statutory payment bond, you are contractually obligated to pay your first tier subcontractors debts to their material suppliers and subcontractors, even when you fully and completely paid your subcontractors. While I have three or four calls a year in which a contractor tells me he has never had any court cases in thirty years of being in business, I find this to be incredibly unusual and not typical at all as to what I see.

Therefore, it behooves you to establish the personal security of your family as early as possible and, when talking about surety bonds, before you enter the principal-surety relationship. Really, this should be done before you commence performing construction activities as a company. Since it is human nature to look away from the things that truly scare us, I have got to get your undivided attention.

We start with an unhappy premise. Having represented hundreds of contractors over the years - and having observed what is going on with other companies - I operate on the working premise that all contractors will eventually fail. Don’t be offended. You do buy life insurance because you know at some point in time you are going to wake up on the wrong side of the dirt. Human life is limited. Why should the life of your company be any different?

A very successful steel fabricator I know of was put out of business by a sustained period of cheaper Canadian steel. That was nothing of its own doing. Your market may change or even disappear. (Do you often see advertised public housing jobs on the water in New England seeking a dryvit re-do?) You may blow a bid. (Everyone blows bids.) You may book a job with a very expensive differing site condition or change that the owner and architect will not recognize or can not afford or both. Your contracting party may lose the ability to pay you (or, possibly, never had the ability to pay you.) You may seriously screw up one of your jobs. Your contracting party on any given job might suddenly file bankruptcy, leaving you in the lurch. Several of the twenty largest unsecured trade creditors in the Modern Continental bankruptcy had debts of considerable size, in the millions. How many subcontractors can survive that?

You might contract a job that is unbuildable because of architectural and engineering errors. One very good company I know of was put out of business by a difficult architect who devised a ‘phasing’ system for the renovation of a school that was completely unworkable. One good contractor I am aware of made the mistake of signing five jobs more or less at the same time with an extremely tough general contractor it was not familiar with, losing money - and getting jammed - on each such job other than the first. (This is something to be very aware of. The first job may look good but, for whatever reasons, it may turn out to be the only good job. This might be by design, in some instances.)

You may incur a serious obligation that isn’t covered by insurance. One of my clients closed its business when the principal got seriously injured in a skiing accident and was no longer able to serve as the general outside superintendent. Your life may change. You might get very sick. You may get divorced. You might suffer from depression. You might develop substance abuse. As you hit middle age, you might start riding motorcycles, having a girl friend, wearing too much gold jewelry or jump out of airplanes! As hard to believe as it might seem, at some point, you might simply get tired of what you do, even if it is only dealing with all of the BS which surrounds your work. I am aware of several companies which failed due to cocaine use by a principal. Similarly, I am aware of companies who went out of business because the principal had a serious gambling problem. I know of any number of companies where the company went out of business by embezzlement and employee theft of an employee. (This can particularly happen in a very small office where there is one person who seems to handle everything and who has too much access to the checking account with too much time alone in the office.) I know of any number of businesses where one day a key employee (project manager or estimator) simply suddenly quits (usually with no notice), taking with him/her the Rolodex and a variety of bids you were hoping to get, who then start immediately competing against you by working for a competitor or having started his or her own company. (You might want to take a look at my website at an article entitled “Employment Agreements for Key Employees” and make sure you have some understanding of the concept of a ‘covenant not to compete’). Many companies enjoy close relationships with major customers because of their relationship with one or two key individuals at that company, who then move on with the business being lost. Some family businesses often suffer when the founders are replaced by later generations who simply don’t have the founders’ drive or talent. I represented one general contractor for year where the kids all drove BMW’s. How does one develop the requisite toughness to be in business when one starts his life thinking that a car necessarily means a BMW? My first car was a Gremlin and it didn’t even have a back seat!

You know how they say that some company is too big to fail? Modern Continental, at one time, was one of the largest general contractors in the United States. There were claims made in its bankruptcy which totaled close to one billion dollars.

Then again, as has happened in the last several years, the country goes into a deep unexpected recession - some say depression - largely related to immigrant cab drivers owning five or six houses they have no equity in and which they absolutely can not afford, each with a gargantuan mortgage. Dear reader, ten years ago, did you ever even contemplate that the entire financial system in this country might almost completely self-destruct, as it nearly did a few years ago? Certainly, there is less work for contractors under these circumstances. For the work there is, the profit margins have eroded faster than a chronic candy eater’s gums. I would be surprised if there were many readers whose only personal 401k, IRA and SEP situations survived fully intact during this period. Retirement? That’s something you do when you die.

For a great many of us as the year 2011 winds down, ‘retirement’ is essentially only a word in the dictionary.

Who knows? The Wicked Witch of the West might simply drop her house on you!

That would be a Toto bummer! (Sorry . . . I couldn’t resist.)

Now, as Bobby McFerrin says in his song, ‘don’t worry, be happy’! We all know that we are not likely to escape this life alive. Only two figures in the Bible went to heaven without first dying: Enoch and Elijah. But, we can all take some comfort from the fact that all of us live under the same circumstances, some of which are difficult. We have to relax, do the best we can to enjoy our lives, protect our families and, hopefully, make some meaningful contribution to the world. Along the way, hopefully, we will have some fun. Whether a corporation or limited liability company you formed survives or doesn’t survive is, in the final analysis, relatively unimportant. After all, most of say “I do” with the best of intentions and then find out somewhere down the road that at least half of these marriages won’t work out, causing all kinds of emotional and financial pain.

And, a business failure doesn’t begin to compare in importance with an unexpected phone call from the police, late at night, to the effect that . . . . there has been an accident.

Now, after having read these past several paragraphs, that we are all thoroughly miserable, what is it that we should do?

B. Good estate planning and insolvency planning will work best when it is done earlier and before the wolf is at the door.

So, having accepted the fact, however reluctantly, that our present success might prove to be illusory, what do we do? We use that wonderful brain God blessed us with. We plan.

Being business owners, one of the things we plan for is to understand which of our personal assets we might get to keep if our company (or we) had to go through an insolvency procedure such as bankruptcy. Understanding the various bankruptcy exemptions (as to property a debtor can keep) should hopefully cause us to better structure the ownership of our assets to meet the requirements of these exemptions.

Under the law, a corporation is seen as an ‘artificial person’. In other words, despite how much your company might mean to you emotionally, the corporation is not you: it’s something different and apart. When difficulties occur, remember you can always form another company. It’s part of the culture of construction that no one ever really goes out of business. And, some of us already do things like this today. Companies doing horizontal construction frequently form other companies to own substantial amounts of their equipment, which then lease their services back to the original company. This is very smart because of the fact that the second company doesn’t have any construction contracts that could cause it to fail due to business problems. So, in your corporate life, you are already thinking of ways to separate those activities which cause you risk (the performance of construction contracts) from the pricey assets you don’t want to lose (the assets of the second company.)

I believe someone once referred to this as not having all of your eggs in the same basket. Brown eggs might be local eggs and local eggs are fresh. Still, like any other egg, they still have that disturbing tendency to break.

The key is to protect your personal and family interests and assets from such adverse effects you might suffer as caused by your business activities. Earlier action and planning is almost always better than later.

This is because of laws such as those laws pertaining to ‘fraudulent conveyances’. For example, note the following statute:

M.G.L.A. 109A § 6. Fraudulent transfer or obligation where creditor's claim arose before transfer or obligation

“(a) A transfer made or obligation incurred by a debtor is fraudulent as to a creditor whose claim arosebefore the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at that time or the debtor became insolvent as a result of the transfer or obligation.

(b) A transfer made by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made if the transfer was made to an insider for an antecedent debt, the debtor was insolvent at that time, and the insider had reasonable cause to believe that the debtor was insolvent.” (Emphasis added)

Keep in mind that homesteads may not work in terms of discharging already established debts. Note the following statute:

M.G.L.A. 188 § 3. Acquisition and creation of estate of homestead; exemptions

“. . . . (b) An estate of homestead shall be exempt from the laws of conveyance, descent, devise, attachment, seizure, execution on judgment, levy and sale for payment of debts or legacies except as follows:

(1) for a sale for federal, state and local taxes, assessments, claims and liens;

(2) for a lien on the home recorded prior to the creation of the estate of homestead;” (Emphasis added)

Here is a case illustrative of the principle that protections you create are more effective when they are created before a potential debt situation has arisen. This case deals with an earlier version of the homestead statute and this case may no longer be good law as to homesteads. However, it’s a good case to illustrate and explain the different situations of debtors depending on when their debt situation was created in relation to the activity they attempted to protect against that debt. This is the case of Gruet v. F.D. I. C, 879 F. Supp. 153, 155-156 (District of Massachusetts, 1995) in which the Court said:

“In contrast to liability for damages resulting from a personal injury tort or violation of law, the liability of a guarantor to a loan is contractual. In re Goodman Indus., Inc., 21 B.R. 512, 519 (Bankr.D.Mass.1982). It is true that not all contractual obligations are considered “debts” under Massachusetts law. H.G. Kilbourne Co. v. Standard Stamp Affixer Co., 216 Mass. 118, 119, 103 N.E. 469 (1913) (“The word ‘debt’ has never been made to include the simple possibility of being found responsible in damages for the breach of an executory contract, where neither the fact of liability nor the amount can be held affirmatively to exist until a judgment shall have been recovered.”) (emphasis added). Nonetheless, the obligation of a guarantor on a loan, even a revolving line of credit such as the one issued by the Bank to Kahn in this case, is distinguishable from that of a party to an executory contract, where neither the fact of liability nor the actual amount of damages exists until a judgment has been rendered. Id. at 121, 103 N.E. 469. See also Garsson v. American Diesel Engine Corp., 310 Mass. 618, 621, 39 N.E.2d 566 (1942) ( “debt” includes agreements for payment which require some calculation to determine exact amount, provided debtor has made distinct and binding promise to pay).

Plaintiff's contract with the bank was not executory, nor was it contingent upon a finding of damages. Plaintiff executed an Unlimited Guaranty of the Loan, obligating her to pay Kahn's “indebtedness, obligations, liabilities and undertakings ... upon default,” in return for the Bank's extension of credit to Kahn. Defendant's Exhibit A, “Unlimited Guaranty.” One who guarantees a loan is bound, and her obligations are coextensive with that of the principal. Merchant's National Bank v. Stone, 296 Mass 243, 251, 5 N.E.2d 430 (1936). Further, the fact that the amount of the loan may be uncertain does not relieve the guarantor of her liability under the contract. H.F. Rieser's Sons, Inc. v. Parker, 126 F.Supp. 1, 5 (D.Mass.1954) (citing Bishop v. Eaton, 161 Mass. 496, 37 N.E. 665 (1894)) (a guaranty can be for an indefinite amount). Plaintiff's obligation to the Bank was thus a “debt contracted” under the meaning of the statute, and she became liable for the full amount of Kahn's indebtedness to the Bank when she executed her guaranty in February 1987. Since her debt to the Bank was contracted before she filed her Declaration of Homestead in April 1990, it must follow that her homestead interest is not exempt from attachment and sale under ch. 188 § 1(2).” (Emphasis added)

These two examples - fraudulent conveyances and homesteads - simply illustrate the principle that the time to take steps to protect your assets is before the trouble comes. After the trouble comes, many of these steps will be ineffective or less than fully effective. Some sureties tend to be very aggressive in pursuing their indemnity obligations. They might go into court and attempt to get an ex parte (you don’t get notice of this) real estate attachment against your house. Whether such an attachment is issued with or without notice to you, at such point in time that an attachment has been created, a homestead declared after the attachment issues will probably be no good as to that attachment.

When this article was written in late 2011, the filing fee for a declaration of homestead was only $35.00. As they say in Manhattan: such a bargain! For that $35.00, you get up to $500,000 debt protection for your house. Quite a good deal for any of us, provided that we don’t screw it up!

There is one overriding principle, particularly for very small contractors and new contractors. And, that is, don’t ever conduct business as a ‘d/b/a’. Why would/should you put your house at risk for business problems you might have (and everyone has some problems)? I had a Russian contractor who did home improvement work who told me repeatedly over a period of time that he would ‘get to it’ (form a corporation) when he had the money. He said that he felt comfortable doing what he did and how he did it because he only worked for other Russians living in Massachusetts. Before he could get to it, however, the sky fell in and fell in significantly. And, please keep in mind that business failures are frequently accompanied by damage to your family, divorce being one of the most common consequences. It is not uncommon for ill health to result from business reverses, as well.

Forming a corporation or a limited liability company is not that complicated and not particularly expensive. The Massachusetts Secretary of State’s Office at “http://www.sec.state.ma.us/” has on-line forms and procedures for on-line filing of domestic profit corporations, nonprofit corporations, domestic limited partnerships and domestic limited liability companies. This is not to say that legal advice as to the appropriate business form might not be desirable or necessary. And, particularly, some advice from a very good accountant might also be useful in deciding what form of business makes sense for you from a tax standpoint. Still, I am aware of one contractor I have seen over the years who has had a number of business failures - he had this unusual idea about paying material suppliers and subcontractors: he didn’t - who would actually fill out the various forms himself in his own handwriting, creating his own corporations.

Folks, there is at least one thing I can tell you about “John Smith d/b/a Smith Roofing”. He’s a complete idiot! For any of you who may have been insulted by reading this: good! Now, go out and do something about it while you have the chance for it to do you some good! If you don’t – especially after having read this article – then you have, unfortunately, proved my point.

How do you get good legal advice in the area of what your rights would be in insolvency? Certainly, in the main, not from your usual ‘business’ lawyer. Law, like medicine, is very specialized and a jack of all trades is truly a master of none. If we are talking about protecting millions of dollars, then talk with your construction attorney about finding someone who is well-suited to serve your interests at this level (and at a price that is commensurate!)

In a more ordinary situation, this is the advice I typically give. First of all, without particulars, summarize your assets and liabilities on a piece of paper. “I have this much trade debt, owe this much for taxes, owe this much on my vehicles and have exposures in this amount for this and that.” Then, list your assets in terms of cash, receivables and equipment. Again, it is not necessary to have a lot of details as to specifics: just be accurate, generally, concerning the amounts of assets and liabilities. Then, either look at the internet for the geographical area you live in or go to the yellow pages (how twentieth century!) and look at who has the largest ads under lawyers who do business planning, insolvency and bankruptcy. Many of these will say that there will be no charge for an initial consultation, although this may not apply to you where you are not actually considering insolvency at that time. So, having checked the qualifications of the practitioner or firm by such resources available to you – including their websites - make appointments with two or three of them and listen to what they have to say. In the law business, the greatest deal of clarity as to what will happen in any given situation is on the first day of the problem or on the day after the problem has been concluded. The middle of a problem is something characterized by an expression attributed to the Prussian military analyst Carl von Clausewitz as ‘the fog of war’.

Why go to an insolvency guy when you aren’t insolvent and you are not planning on being insolvent? The short answer to this is that you need to discuss your situation with someone who is very familiar about what assets you can protect should you need to seek bankruptcy protection someday. Knowing this, this should help you with your planning so that you will be able to preserve and protect the maximum amount of those assets capable of being protected in insolvency. For there are some creditors, such as your surety, that will require some prior preparation for.

And, as is stated elsewhere in this article, if you ever litigate your indemnity obligations with the surety, based on the terms of the general indemnity agreement coupled with court cases describing the interpretation and enforcement of contractual obligations, you are most likely to lose. Indemnitors lose an overwhelmingly high percentage of the time. This is because this is the way the system is set up. The only really good defense to an indemnity action is to not having signed the general indemnity agreement in the first place! Sometimes, it may only be that the threat of an actual insolvency procedure is what will get you an acceptable settlement on your indemnity obligation with the surety. And, you can’t make such a realistic threat if you haven’t set up your estate plan in such a way that will protect the maximum amount of your assets and if you don’t know, in advance, which of your (remaining) assets will survive a bankruptcy.

3. You are ‘in claim’ with the surety. What do you do when claims are made against your bonds?

For this section of the article, we are assuming that claims are being made against one of your bonds and the surety is contacting you. What can you or should you do?

Well, first of all, let’s hope that you were able to do some estate planning, along the lines discussed above in section 2. B. If not, consult with an insolvency attorney if the situation is really egregious to see what kinds of things you can still do to keep as many of your assets as possible from your creditors, such as the surety, as early in the problem as you can. And, if your company is truly failing, I hope that you were able to avoid the all-too-typical and understandable knee-jerk reaction within the last year or two of your business’s life of having pumped into it all of the money you personally have, taking mortgages out on your home, cashing in on your retirement accounts, etc. If these don’t work, when the inevitable happens, you might be left with nothing. You will certainly need money to live and you will definitely need money to be in a position to maneuver.

Here are twelve ideas to consider as strategies for dealing with your surety. (Some other ideas and strategies are included in the discussion of specific kinds of bond claims, infra.)

A. If it is clear that someone is very likely to file a claim against your bond, try to make your letter to the surety the first in the file.

There will be times when it is fairly clear that someone will be making a claim on your bid bond or on your payment bond or on your performance bond. Frequently, the claimant may not really understand how to do this. A common mistake is to send a claim letter to the insurance agent who signed the bond. That agent usually will have nothing to do with claims handling: he is in ‘sales’ (underwriting) and what the claimant needs is ‘service’ (the claims department). Often, the claimant will simply send the claim letter “to the insurance company”, not to either the claims department or to any specific individual. Many of these letters get disregarded or just plain lost, as the mail room clerk doesn’t know to whom such a letter should be routed. Or, the claimant might write a letter to the claims department and/or to a specific individual but fail to actually make a claim. Letters to the claim department informing them of a debt owed - but not making an actual claim against the bond - or letters asking the bonding company for help in getting the principal to pay a debt don’t generally actually trigger the condition of the bond, which is that someone actually makes a claim against the surety bond.

So, for a variety of reasons, although you know or suspect that a claim letter will be coming, it may not be coming - or reach anyone - for awhile. So, what action do you take?

My experience is that particularly where you have some defense to the claim it is better for you to write the surety and tell them about the problem and give them your side to it first. Giving them particulars and documentation can be useful. This way, it doesn’t appear that you are hiding from the claim. And, this way, you get to attempt to frame the problem with your spin and theory rather than the claimant’s doing this by having the first letter. Where, as a matter of law, a surety’s defenses include all of the principal’s defenses, the surety will be interested in knowing that: (a) you have a position; (b) that it looks defensible. Since having the surety trust the principal is one of the most important things for both the principal and the surety in a claims situation, notice of problems first from the principal to the surety is usually a good idea.

B. Always answer surety requests for information as to specific jobs and claimants.

Don’t fail to return phone calls and answer every letter from the surety. Most claims representatives work in regional or national claims offices. They don’t know anything about you or your company. Frankly, you are just a file to them. But, whether consciously or not, they will compare your behavior against the aggregate lowest common denominator of typical principal behavior they experience in claims situations. A surety is much more likely to refer the matter to counsel when you are: (a) playing hard to get; (b) are unavailable: ( c ) are acting not interested; or, (d) are not providing the bonding company with information and documentation. Also, it is only human nature to infer from this type of behavior that you are not responding because there isn’t anything you can say in your defense. Your job is to try to delay – or prevent – the bonding company’s writing of checks. And, particularly with payment bond claims when there are a number of them, once the first check is written to a claimant, it is likely that others will follow.

Also, pay attention to the following. Construction cases are tried in court based more on the written record than on anything else. What that means for you is that letters are better than phone calls and emails are better than phone calls, as there is no reliable record of what is said during a phone call and they may not be admissible into evidence for various evidentiary reasons.

C. Be as honest as you can be and document your positions.

These are good ways of earning the surety’s trust and confidence. Remember that the claims representative doesn’t know you and doesn’t know the obligee (the entity to whom the bond runs, the bond’s beneficiary) or the claimants. Surety claims are, to some extent, a ‘he said, she said’ type situation, where each side has a diametrically-opposed opinion about any given situation. To the extent you can provide the surety with useful information and documentation, this helps establish and maintain their trust for a period of time. When I have my plaintiff’s hat on, I encourage payment bond claimants to get ‘third party verification’ letters from those not involved with the dispute (i.e. the clerk of the works, the project engineer, the project architect, the owner) to verify that the subcontractor has done its work. The same approach can also apply in a defensive situation. Letters from third parties supporting your contentions may be useful in the handling of a claim against you.

At the same time, be careful as to what you admit to in writing. Prior statements of a party to a future legal action are generally admissible in evidence as either an ‘admission’ or as a ‘declaration against interest’. Ill-advised statements might haunt you. They can particularly haunt you in a bid bond claim situation: more on that later. Remember this statement from Chapter 10 of George Orwell’sAnimal Farm: “All animals are equal but some animals are more equal than others.” Honesty is almost always the best policy . . . . except when it isn’t.

D. Be ready fairly early in the claims process to offer a repayment plan once it is clear that there will likely be a loss payment(s).

Sureties tend to defer filing legal actions against indemnitors as long as they have some evidence that their indemnitors are not attempting to walk away from their indemnity obligations. Since you, as either a corporate or a personal indemnitor, will have to reimburse the surety for potentially all of its legal costs, trying to minimize those costs - or deferring them for as long as possible - seems a desirable goal.

E. Some sureties will not fully pursue indemnitors who have really worked hard to save money for the surety.

This is more of a surety-culture thing rather than a legal thing. But, I have seen it happen before. To be sure, this is not something that is done easily or often. I have seen this in situations where an individual has attended numerous meetings, participated in lots of phone calls, testified in a lot of cases, has worked hard in the settlement of payment bond claims and performance bond claims and, generally, has made significant efforts to assist surety counsel or the bond claims representative in the defense of claims. This happens when an individual has made real efforts to save the surety money, usually over a period of years. In some of these situations, the relationship between the indemnitor and the surety claims representative or the relationship between the indemnitor and the surety’s attorney approaches something that looks a lot like friendship. They spend a lot of time together. They have common interests in protecting the surety’s interests against claimants. How likely are you to sue your friends when things go wrong? After all, you (the principal and the surety) are - as to claimants - more or less on the same side, at least in the beginning, and you are both dealing with common opponents. Even when the indemnitor is not completely excused from the indemnity obligation, it may be that you can negotiate a deal for only being responsible for a percentage of the loss. Another possibility: if there are four personal indemnitors, try to negotiate a situation where you are only liable for 25% of the loss. I had one surety situation where a well-known quality surety said through an experienced attorney bond claims representative early in a performance bond claim that when the time arrived where the surety and the principal would have to settle up as to the losses - when the matter was over - the surety claims representative would put fifty thousand dollars to the principal’s account to the good.

Why would one do this? The surety needs the principal’s cooperation in order to defend its interests and to save money and a better relationship with the principal helps it in doing so.

In these situations, it doesn’t hurt to ask for a deal. The answer might be ‘no’. But, if you never ask, the answer will definitely be ‘no’. And, even when the answer is ‘no’ today, the answer might be different down the road.

F. The surety most likely will not expect you to repay the entire debt.

Try to arrange for having to pay for only a percentage of the loss. And, as to a proposed repayment plan, offer a very low percentage rate of interest over an extended period of time. Think long repayment periods. From the surety perspective, they are less interested in getting repaid in a shorter time than they are in having the principal (or individual indemnitors) make some offer to pay the loss back at some time. If you really intend on paying them back, give yourself a really long period of time to make the payments, more than you think you will need. After all, other life events might occur which will diminish your ability to repay at a certain level.

Why did I say ‘if you really intend on paying them back’? In some circumstances, your making an offer might be primarily a tactical move. You might be planning, for example, on filing bankruptcy or some other insolvency proceeding or device - such as an assignment for benefit of creditors - in the future, but not presently. Holding the surety at bay by having a repayment plan in effect can be a good strategy to avoid incurring costs of litigation in the interim while you prepare your situation for an ultimate resolution.

Here’s another similar idea. I have seen countless times where material suppliers and even subcontractors will accept a ‘payment plan’ in lieu of a more aggressive collection attitude, including mechanic’s liens and the pursuit of payment bonds. More times than I can count, material suppliers and subcontractors have lost lien and payment bond rights because they were under a ‘payment plan’. So, as a way of potentially minimizing mechanics liens, payment bond claims and litigations against you, the effective and especially proactive (rather than merely defensive) use of payment plans has its uses. Having gone to the rodeo for more than thirty-five years, I can’t recall a single time out of hundreds where someone actually got all of his money from the payment plan and on time. Where there are lien and bond rights, I always suggest to my clients to pursue these also. Effective mechanics liens and payment bond claims will convert unsecured trade debt into secured trade debt – much better for the claimant and much worse for you. Quite often, the material supplier or subcontractor does not pursue the lien or the bond claim because he is afraid of it, is timid, is concerned about legal costs or simply wants to attempt to maintain the relationship with the debtor for future business opportunities.

I would say that for the plans I have seen, if they proposed twelve monthly payments over the course of a year, it would be a lot to get four or five payments during that time, at least two or three of them late. I’ve had a number of circumstances where no payments were received. I have had a lot of situations where with a certain amount of legal pressure, this number might have gone to seven or eight, with maybe only the first one being on time.

If a business were planning for a dissolution or insolvency proceeding in the next six to nine months, having as many payment plans as possible for your trade debt in place might minimize litigation and minimize mechanics’ liens and payment bond claims against your interests. Some businesses’ failures seem to be hastened by having to defend against numerous litigations because of the legal costs involved and because of possible injunctions that can issue. In a reach and apply situation or in a trustee process situation (bank account attachment), having numerous litigations might hasten your company’s demise, even if it is ultimately inevitable in any event, by stripping your available cash from you.

For material suppliers and subcontractors who say “this isn’t good for us, why suggest it?”, most of the time, you are right: it isn’t good for you! When you boil it all down, why would you give up a potentially secured claim – by a mechanic’s lien or a payment bond claim – and substitute for it an unsecured payment plan, which will not only not likely fully work (if at all), but which will exhaust whatever time periods you have to file a mechanic’s lien or a payment bond claim? This doesn’t make any sense to me conceptually and, especially, based on my experience with payment plans representing creditors, which hasn’t been good. After all, this being a free country – more or less, reasonable minds might differ! – no one actually forces anyone else to take a payment plan, right? An unsecured payment plan is ordinarily dischargeable in bankruptcy. A payment bond claim, generally speaking, is not affected by the bankruptcy of the principal. And, in many situations, a mechanic’s lien may survive a bankruptcy.

G. Sureties sometimes will pay for your time as a consultant or as an employee of your company.

This could be in a financing situation (discussed elsewhere) or in other claims situations in terms of assisting in the handling of claims or in working on performance problems in the completion of your work. I am aware of a situation where a mid-sized general contractor went into bankruptcy and its principal, who had had previous business failures, was paid at least one hundred dollars per hour to assist the surety in working on claims. (This was twenty years ago so the one hundred dollars would be at least two hundred dollars today.)

When I used to do this work more regularly, when a contractor was being financed, the owner would typically receive some kind of paycheck on a periodic basis if he or she was doing any actual work. Particularly in a financing situation, sometimes it seemed as if the only work the owner was doing was to try to get the surety to pay as many of its bills unrelated to the bond claim as possible.

H. If the surety does not record the GIA as a ‘financing statement’ or ‘security agreement’ under the Uniform Commercial Code, its rights against you in bankruptcy might only be as an unsecured creditor, which means such claims might be discharged.

This could mean that in a liquidation (a chapter 7) you might be able to discharge your individual indemnity obligation to the surety. I have found that threats don’t necessarily always work in some legal situations. In fact, I would say that they usually don’t work all that often, except in usual circumstances, frequently involving people not well-versed in legal proceedings. However, this is an area where they sometimes do work. And, I have found that the threat of something is often more valuable than the actual taking of the action you threaten.

Example. Your statement to the surety that ‘you (the surety) should take 30% reimbursement over five years rather than forcing a liquidation of my company into bankruptcy, which will net you nothing’ might resonate with some bond claims representatives and their supervisors. They want to minimize their own legal expenses and costs. There is a word for surety bond claims representatives and supervisors who run up heavy legal and consultants’ bills: unemployed. I represented one surety many years ago where one of the bond claims representatives seemed to simply pay every single claim. And, for a while, she was much admired for having such low expense payments even though she clearly overpaid on some claims and probably paid on some claims not entitled to be paid at all.

I. Alleging bad faith against the surety.

A bad faith claim against a surety is what is known from the surety perspective as a possible “extra contractual liability.” What this simply means is that this is claimed liability that is not covered by the bond, as a surety’s claimed bad faith is not part of the condition of the bond. And, it is the first great surety sin to pay for something that is not covered by the bond or which exceeds the limits of the bond. Other than the unlikely possibility that you might actually recover multiple damages against the surety under a statute such as Massachusetts’ C. 93A, bad faith allegations have incidences which are distasteful to the surety. Usually, allegations of extra contractual liability mean that the cases might have separate supervision: one level for the actual bond claim and another level for the allegations of extra contractual liability. Some sureties will have two separate claims representatives in these situations: one for the bond claim and the second for the bad faith claim. These claims can make some claims representatives and supervisors nervous. I know this from my representation of more than two dozen bonding companies and a number of insurance companies with regard to insurance claims. Certainly, it can be easily understood that if any particular claims representative has too many allegations of bad faith, this is not a factor featuring prominently in future promotion possibilities! I do know of one case where the principal owed a surety one or two million dollars for losses rightly incurred on the performance bond and for which the surety had sued the principal for indemnity. However, at the end of the bad faith case by the principal against the surety, the surety somehow ended up paying the principal a million dollars or so as a settlement, not judgment as the result of the bad faith claims, with the indemnity claim being dropped.

These types of situations are not for the sensitive or for those who are faint of heart or squeamish. This typically is blood sport. And, please keep in mind that the possibility of this being successful is quite small, if any particular matter were to actually go to trial.

Here’s a Massachusetts case discussing the results of an indemnitor’s claiming bad faith against the surety in an indemnity action:

“Want of good faith involves more than bad judgment, negligence or insufficient zeal. It carries an implication of a dishonest purpose, conscious doing of wrong, or breach of duty through motive of self-interest or ill will.” Hartford Accident and Indemnity Company v. Millis Roofing and Sheet Metal, Inc. 11 Mass. App. Ct. 998,999-1000, 418 N.E.2d 645 (1981)

It is very hard for an indemnitor to prove a ‘conscious doing of wrong, or a breach of duty through motive of self-interest or ill will’. After all, how does it work to a surety’s

self-interest to make a payment to a claimant?

At the same time, these things sometimes, if infrequently, do work. If nothing else, the possible allegation of bad faith is something that might give you a small level of leverage against the surety, which usually has overwhelming superiority and chance of success in surety-indemnitor litigation matters. Such allegations, particularly if there is even a slight basis for them, might support a reduction in your indemnity debt, which is a positive value. However, if there is no basis for such a claim – i.e. the surety first heard about your payment bond claim when you sued the surety – alleging bad faith against the surety might be a very bad strategy. I have found over thirty-five years of practice that annoying or angering an opponent for no good reason – especially one who is infinitely better-heeled than you are and who can afford to litigate more than you can - is a very bad idea and counter-productive.

J. Protect your performance and payment bonds.

There is a joke in the surety industry. Someone from the bonding company says to either the principal or to the claimant or to the obligee: “I’m from the bonding company and I’m here to help you.” Not so! One definition of a surety bond is an “unsecured extension of credit”. I ask you: if you don’t pay on your mortgage, do you expect the bank to be interested in your problems as to why you can’t pay? Of course not! A surety claim situation is not dissimilar from a problem in paying back a loan, as both situations deal with extensions of credit and are (or can be) financial transactions.

Many principals don’t understand the GIA and its implications and their obligations to repay the surety. They don’t understand that, more likely than not, the surety will win the vast majority of its indemnity cases against corporate and personal indemnitors. Also, there are provisions in the public bid laws where you will be asked during prequalification proceedings if a surety company ever sustained a loss on your account. And, during the course of your company’s ‘bonding life’, you will find that your agent will shop your account at different times to different sureties for a whole host of different reasons. You need a bigger single bond limit or a larger total program. You want a lower premium rate, wanting to go from substandard market rates to standard market rates . You are interested in getting a surety that doesn’t require personal indemnity, which was a big sales pitch for some sureties maybe twenty years ago and during times of intense competition for a principal’s premium dollar. Your financials might get either significantly better or, more usually, significantly worse.

It is a typical question from the potential new surety in this situation: has any surety incurred a loss on any of your bonds? It is for these reasons that, as well as for a number of other additional reasons, if you are viable, having the surety pay a claim for you - even if you almost immediately repay it - is unthinkable. One of the reasons that makes it unthinkable is that if your company goes seriously into claim, it is quite possible, even likely, that you will have difficulty getting your next bid and contract bonds from that surety. For a company doing public work, this could put you out of business and quickly.

Protecting your bonds is something you should keep in mind at all times. In saying this, I am not advocating for the surety industry. Rather, I am only concerned with your acceptability to public owners as to your ‘responsibility’ as a bidder (a public bid requirement) and whether or not your account would be acceptable to a new surety if you feel the need to change sureties or, for a variety of reasons, have to change sureties.

K. Smaller losses.

I have had dealings with at least one surety active in the New England market which took the position that a loss under one hundred thousand dollars was a small loss. From the circumstances of that matter, I made the inference that this particular surety was less likely to be aggressive in pursuing indemnity and that such pursuit was not likely to be sooner rather than later. Mind you, this is not a guarantee. Still, keeping the loss as small as possible may help you once the indemnity subject comes up for discussion. Finding ways to save the surety money on claims against your company make you more valuable, more of an asset to the surety and someone the surety has less reason to sue because it needs you.

L. Offer defending the surety under a ‘tender of defense’.

When the surety gets sued on a payment or performance bond, it will have to hire an attorney. Massachusetts law requires that all corporations who use the court system have to be represented by attorneys. Since your company will also likely be sued at the same time as the surety is sued, you will also have to hire an attorney. Ultimately, it will be your responsibility to pay both of these bills because of the typical wording of the GIA.

Since the principal and the surety have similar interests much of the time, the surety industry often will allow the principal to defend it with your attorney (provided your attorney can demonstrate some experience and sophistication in construction and surety matters). That way, you will only have one attorney to pay: your own. And, as a practical matter, to some extent you can control the amount and kind of information the surety learns about the case (and when) if your lawyer is representing the surety’s interests.

So, if a suit comes, if the surety doesn’t suggest it, you might consider requesting the surety to allow you to defend it under a ‘tender of defense’. They are more likely to do this in situations where you can demonstrate a real dispute: in other words, there is some real issue as to whether the party suing the bond is entitled to recover or there is some real issue as to the amount claimed. Also, a surety is much more likely to do this in a payment bond situation than in a performance bond situation. This is because performance bond suits are generally more complicated, they involve greater sums of money and they have a greater potential for generating bad faith claims from the claimants against sureties, something sureties try to minimize.

4. Claims against your bid bond.

If it is Massachusetts public work, your bid bond is set at five percent of your bid, generally. Therefore, your bid bond’s condition is to cover the bid spread between you and the next low guy up to the amount of your bid bond if you won’t sign the contract or can’t produce contract payment and performance bonds. In other words, if the spread is less than five percent of your bid, that is what your surety is liable for. If the spread is more than five percent of your bid, the surety is liable for just the five percent. And, of course, you will typically have the obligation to pay the surety back, the same as with any other kind of bond claim.

An important thing to understand is when the obligation of a bid bond is triggered.

By my experience, bid bonds are usually required more for public work than anywhere else. There is Massachusetts law about under what circumstances you are entitled to a return of your bid security on a public project:

MGL, C. 149, s.44B. Plans and specifications; bid deposits

(2) Every bid submitted for a contract subject to section forty-four A and every sub-bid submitted in connection with such a contract for a subtrade pursuant to section forty-four F shall be accompanied by a bid deposit in the form of a bid bond, or cash, or a certified check on, or a treasurer's or cashier's check issued by, a responsible bank or trust company, payable to the commonwealth or public agency in the name of which the contract for the work is to be executed. A bid bond shall be (a) in a form satisfactory to the awarding authority, (b) with a surety company qualified to do business in the commonwealth and satisfactory to the awarding authority and (c) conditioned upon the faithful performance by the principal of the agreements contained in the bid. The amount of such bid deposit shall be five per cent of the value of the bid.

(3) All bid deposits of general bidders, except those of the three lowest responsible and eligible general bidders, shall be returned within five days, Saturdays, Sundays and legal holidays excluded, after the opening of the general bids. The bid deposits of the three lowest responsible and eligible general bidders shall be returned upon the execution and delivery of the general contract or, if no award is made, upon the expiration of the time prescribed in section forty-four A for making an award; except that, if any general bidder who fails to perform his agreement to execute a contract and furnish a performance bond and also a labor and materials or payment bond as stated in his bid in accordance with section forty-four E, his bid deposit shall become and be the property of the commonwealth or the public agency to which it is payable, as liquidated damages; provided that the amount of the bid deposit which becomes the property of the commonwealth or the public agency shall not, in any event, exceed the difference between his bid price and the bid price of the next lowest responsible and eligible bidder; and provided further that, in case of death, disability, bona fide clerical or mechanical error of a substantial nature, or other similar unforeseen circumstances affecting the general bidder, his bid deposit shall be returned to him. (Emphasis added)

As to subbidders, same statute:

(4) All bids deposits of sub-bidders, except (a) those of the sub-bidders named in the general bids of the three lowest responsible and eligible general

bidders and (b) those of the three lowest responsible and eligible sub-bidders for each sub-trade, shall be returned within five days, Saturdays, Sundays and legal holidays excluded, after the opening of the general bids. The bid deposits of sub-bidders not returned pursuant to the provisions of the preceding sentence shall be returned within five days, Saturdays, Sundays, and legal holidays excluded, after the execution of the general contract; except that, if a selected sub-bidder fails to perform his agreement to execute a sub- contract with the general bidder selected as the general contractor, contingent upon the execution of the general contract, and, if requested to do so in the general bid by such general bidder, to furnish a performance and payment bond as stated in his sub-bid in accordance with section forty-four F(2), the bid deposit of such sub-bidder shall become and be the property of the commonwealth or the governmental unit thereof to which it is payable, as liquidated damages, provided that, the amount of the bid deposit which becomes the property of the commonwealth or the governmental unit thereof shall not, in any event, exceed the difference between his sub-bid price and the sub-bid price of the next lowest responsible and eligible sub-bidder; and provided further that, in case of death, disability, bona fide clerical or mechanical error of a substantial nature, or other unforeseen circumstances affecting any such sub-bidder, his bid deposit shall be returned to him.” (Emphasis added)

What does this mean? It generally means that if you make a substantive error in bidding

your job - you are super low because you didn’t take off all of the drawings or missed some specifications - you are not able to have your bid bond released. However, if you make some kind of error in failing to transfer correctly information from subsidiary estimating documents to the bid form, including making mathematical errors, then, under those circumstances, you are entitled to a return of your bid security. So, if you make an honest error, you’re liable and there is no relief. However, if you make a careless error, you might not be liable.

My experience has been that when bidders are apprised of these two alternatives with regard to bid errors, usually, they advise me that the error actually was an error of transcription or a clerical or mathematical error rather than a substantive error.

Therefore, your initial statements to the architect and owner as to your wanting to withdraw your bid have to be made with an understanding of the two circumstances: one which leads to liability; the other which leads away from liability. Once you tell them you neglected to bid all of the contract documents, particularly if this is in writing, there is little that can be done to help you.

Here’s the leading case on this subject:

As stated by the Supreme Judicial Court in the case of Lincoln-Sudbury Regional School District v. Brandt-Jordan Corp. of New Bedford et al., 356 Mass. 114, 117-118, 248 N.E.2d 477 (1969):

“ It is the ‘general and familiar rule’ that a statute is interpreted ‘according to the intent of the Legislature ascertained from all the words construed by the ordinary and approved usage of the language, considered in connection with the cause of its enactment, the mischief or imperfection to be remedied and the main object to be accomplished, to the end that the purpose of its framers may be effectuated.’ Hanlon v. Rollins, 286 Mass. 444, 447, 190 N.E. 606, 608. See also G.L. c. 4, s 6. We are of opinion that in s 44B the Legislature intended the term ‘clerical or mechanical error’ to be limited to errors of copying, transference or transcription, including mistakes of arithmetical computation, which occur during the final stages of bid preparation. This is the ‘ordinary and approved usage’ of the term. In addition, the Legislature did not enact a general ‘unilateral mistake’ provision, but rather responded to a specific mischief. The ‘main object to be accomplished’ was to relieve contractors of the financial hardship resulting from the inevitable errors which occur during the hurried, last minute calculations and compilations required by competitive bidding.” (Emphasis added)

In all of the bid bond claims I have been involved with over the years, those bidders stating that their mistakes were clerical, mathematical or mechanical have been successful every single time in withdrawing their bids without penalty with one exception. In that one case, I believe that the surety or its attorney might have been intimidated, for some reason, by either the obligee or by the obligee’s attorney. Alternatively, the surety simply didn’t understand the difference between excusable mistakes and inexcusable mistakes. When it was clear that the surety was going to pay the claim irrespective of the principal’s position – or, for that matter, by our contention, irrespective of the law - we were able to settle the matter for the principal with some savings even though in that particular case, probably nothing should have been paid.

Some owners will require bidders to supply evidence of their claims of mechanical, mathematical and clerical error, which might be a production of the underlying papers and your explaining specifically what information did not get transferred to the bid form. In some instances, the bidder seeking to avoid the bid may have to sign an affidavit – a sworn statement – as to the facts of that particular bid with regard to the claimed error. My sense is that the requirement for affidavits comes more from architects than it does from owners.

A couple of other things to remember. Again, if possible, don’t let the bonding company make any payments, for the reasons stated above and elsewhere. At the same time, more knowledgeable principals will figure out what is more: the payment that would be due under a bid bond claim as compared with how much money the contractor would stand to lose if it actually performed the job. Performing the job at a loss greater than the amount of what might have to be paid under the bid bond will not usually make a lot of sense, unless it is a good customer or someone you want to do some work for in the future.

5. Claims against your payment bond.

Here’s the one of the most important things I can tell you about this subject. If you owe the money, chances are excellent that the claimant will win. I once had a general, who owed the sub, say something to me like: “maybe they won’t win their case”.

The following describes a bare bones approach to a plaintiff’s claim on a materialman’s claim or a subcontractor claim against a payment bond. They produce into evidence the contract between the parties. They produce into evidence the invoices. They produce into evidence what they were paid as compared with what they billed. They may testify that they did not have any backcharges or requested deduct change orders. (This is not a good factor for general contractors defending against such claims.) They may testify that they substantially completed their work required for the job. Assuming all of these answers are as anticipated, they have proved a prima facie case, which means they have produced a sufficient amount of evidence to have their claim accepted by the finder of fact, only subject to the extent the defendant(s) can rebut this evidence.

Now, what do you say as the defending party? If you don’t have much to say in terms of your defense, more often than not, you will lose. You have to keep in mind paragraph four of the statutory subcontract for filed subbidders which says that notice of claims by the general contractor against the subcontractor for labor and materials the general contractor has supplied to the subcontractor’s account has to be provided to the subcontractor within ten days of the next month after the claim originates. My experience has been that a lot of generals don’t comply with that provision or comply with it only after it is woefully late. They may not be aware of the provision. Or, they know if they give such notice, the relationship with the subcontractor (and possibly its performance on the job) might suffer. Or, they don’t ‘discover’ the claim until they enter into a dispute situation, often much later.

Are there dumb judges? Yes. Are there less than competent arbitrators? Absolutely. Do juries sometimes fail to understand the evidence? This happens all the time. Still, in looking at any given claim situation, if the evidence is that the plaintiff performed its contract and didn’t get paid, it is going to win more often than not in the absence of any significant evidence to the contrary. So, in looking at the legal system, it would be a mistake to assume that it is a mere crap shoot either for the plaintiff or for the defendant. Usually, it is not. Contract claims, particularly simple ones, are rather cut and dried.

I know of one well-known general contractor who seemed to force many of its subcontractors to go to trial on their claims. The thinking was: “maybe they can’t afford to go all of the way. Maybe they won’t last the several years it takes to get to trial.” Sometimes, this strategy was successful, even spectacularly for a six figure savings in one case I was aware of. When it wasn’t successful – i.e. the subcontractor had sufficient staying power - I found that the general contractor would simply pay the claim on the courthouse steps along with the interest that was due and move on to something else. Whether it is significant or not, this general contractor is no longer in business. It is no secret that generals that operate in this manner will have many filed subbidders restrict against them as to their future filed subbids on public building projects. Apparently, this prospect doesn’t worry some companies. What is moral, what is right and what is legal are all separate things an awful lot of the time, for better or for worse.

Needless litigation is a drain on your time and money resources. The lawyer will have to be paid. The claimant will be entitled to interest on a judgment at the rate of (at least) 12% simple interest per year (and superior court cases don’t usually go to trial with construction disputes for at least three years.) Statutory payment bond claims on the general contractor’s payment bond for public work in Massachusetts include the award of the plaintiff’s attorney’s fees when the plaintiff is successful. This can get expensive!

So, one strategy is to get the claim paid on some basis as quickly as possible, and even if the surety will be the party paying. There are a couple of ways of doing this. If your company owes a trade debt in a payment bond claim situation, the following formula – which I didn’t originate - has been found to be successful in some cases:

This is how it goes. (First Approach) You (the debtor) go to the claimant/creditor and give them your tale of woe. You tell them how this job or these circumstances have ruined your life or have destroyed your company. You tell them how much money you lost on this job and how unreasonable the owner or architect is. You tell them that you will likely be either closing your doors or filing bankruptcy fairly soon (or both) and that the claimant will have to litigate years with the surety because, let’s face it, sureties hardly ever pay anyone. But, because you (the creditor) and I (the debtor) go back a bunch of years, if you work with me and accept 50% (fill in the blank as to what you will try for) of your claim, I’ll push it hard with the surety to get you your money pretty quickly, even where somehow I am going to have to pay them back some day. Otherwise, you are on your own and you are committed to years of litigation with the surety and all those legal costs.

A variant of this (Second Approach) is most of the foregoing but saying that you will be paying the claim out of your own funds and that you can’t afford much. Both situations may involve trading on the relationship when it saw better days. In fact, this type of approach seems more successful in dealing with long-standing accounts. It is not uncommon for some tears to be shed in the process. Sometimes, it can be quite maudlin. It is also more successful when there is any possibility of future business with the debtor. I can think of one particular general contractor which has a long-standing reputation of being a poor payer. I have sued this general contractor many times and sometimes multiple times for the same subcontractors on successive jobs. “He has the work and his jobs are bonded” is a common response to my question of ‘Why?’

The variant (Second Approach) might work more in some situations with a more sophisticated creditor, including creditors who have been to the rodeo before, because the creditor might say: ‘Why should the surety be given a discount? If I go against the bond, at some point I am going to get one hundred cents on the dollar. Anyways, sureties almost always lose in court.’ However, even with the variant, if you can obtain a release of your company and of the surety as consideration for the payment, which you usually would get before the check is released, usually the creditor will accept the surety’s check when it is tendered even when the creditor was told that it was going to be your check. In the final analysis, money is money and money is the life blood of every business. After all, who is going to turn away a check that the creditor is holding in his/her hands?

Either strategy works more often than you might think, particularly with material suppliers and small contractors who are either gun shy at hiring lawyers to pursue their claims (material suppliers) or who really need the money now (small subcontractors). Once the possibility of a payment bond claim or of a mechanics lien is lost due to passage of time, this method seems to work better.

If a surety were to do this, more likely than not, a court would consider this to be either an unfair and deceptive trade practice or an unfair insurance claims settlement practice or both. There could be some sanctions for the surety, including the award of multiple damages. However, since the principal is doing this - not the surety - a surety will likely be interested in the results but may not want to know any of the details!

Our material suppliers and subcontractors who have just read this may be horror-struck that this new method is being suggested to general contractors. Why are you giving comfort to the enemy?

Here’s my response. When the Patriots play the Jets, who is the enemy? From a Patriots’ fan’s perspective, the response is “the Jets, of course, and sexy Rexy.” But, from the Jets’ perspective, the Patriots are the enemy. They can’t both be the enemy, can they? It depends, of course, on who is looking at the situation. It depends on the perspective as to where one is at. And, subcontractors themselves often have payment and performance and bid bonds that will need protecting and this same method (and other ideas suggested in this article) can be (and are) used by them. Whose fault is it when material suppliers and subcontractors fail (or refuse) to file mechanics liens or payment bond claims for whatever reasons?

What if this won’t work? Three other ideas. First, try to settle the claim with the trade creditor itself before he/she/it goes to a lawyer. It is more likely to be both cheaper and more successful. Secondly, even if there is a lawyer involved, try to settle the matter before a suit is filed. Since the statute providing for interest on contract claims discusses interest as being figured from the date of the commencement of the suit, it is more likely that at least interest will have to be paid to settle a claim once a case is filed. Thirdly, if neither of these works, and you have the ability to pay a settlement, try to effect a settlement on whatever basis that you can, recognizing that the definition of a good settlement is where the claimant doesn’t feel it got paid enough and where the payer feels that it paid too much. Other than saving your own time (answering interrogatories, going to depositions), you will save your own legal expenses. And, my experience has been that sureties more often than not lose on payment bond claims, especially where they are relatively clean and the general contractor has a poor file (no backcharges, late notice of general contractor claims, etc.) More likely than not, the surety will settle the claim before trial and it will not ordinarily be able to settle the claim paying the same amount that you would pay. It will almost always cost the surety more. And, of course, these increased costs will be passed on to you, the indemnitor.

And, a final idea. If you can take the matter to mediation, many cases settle with this procedure. It’s a quick process and relatively inexpensive and there is some expectation that the settlement will often be somewhere in the middle between what the demand is (from the subcontractor) and what the offer is (from the general contractor).

What is a mediation? Mediation is a more-or-less non-adversarial process whereby the parties go in front of a non-judicial neutral (meaning, not a judge or arbitrator) for anywhere from between three and four hours - on the low end - to one day or more on the high end. (Typically, a two day hearing would be only with cases making progress by the end of the first day.) Each side pays for one-half of the mediator’s compensation, which varies from about two hundred to four hundred dollars per hour. Various organizations, such as the American Arbitration Association, offer mediation services. Many practitioners use a group of about five to ten very experienced construction attorneys who are well-known to most construction practitioners and who are good at it, who are generally cheaper and less stressful. Through a controlled series of meetings, which are generally in conference rooms located outside of court facilities, the parties try to work out a solution to their problem. The mediator does not per se ‘decide’ the case. There is no written decision rendered. No one either ‘wins’ or ‘loses’. And, by statute, whatever happens in mediation is specifically exempted and kept out of any subsequent trial. This is to keep the mediation process confidential and to encourage the parties to deal with each other earnestly, not concerned about how whatever is said can be used later in subsequent litigation. What normally happens is that the mediator will require each party to prepare before the meeting a mediation memorandum explaining the case and its position to submit before the hearing, exchanging copies with the other side. Then, the parties get together in a room, typically the conference room of the mediator. Each side may make an ‘opening’, explaining its claim or defense, which is usually done by your attorney. Then, the parties are separated for the rest of the day in separate rooms. The mediator goes from one room to the other. What each party tells the mediator is privileged in that the mediator can not reveal this information to the other side without that party’s permission. The mediator points out to each side the strengths of the other side’s position and the weaknesses in your side’s position. While all cases do not settle ‘in the middle’ a number of them will. At such time as there is a settlement, both sides will get together and the attorneys will prepare right there a hand-written memorandum of what the deal is and will sign it. Part of what makes this work is that spending four to six hours in a conference room is very tiring. People get more reasonable as they get bored and tired. If the mediation does not work, this ordinarily has no effect whatsoever with any existing court case. Traditionally, mediations tend to take place fairly late in the court process: around the time that the pretrial memorandum is due. Many disputes clauses currently actually require them much earlier in the process, even before arbitration or litigation is filed.

Here’s a wrinkle. I had dealings with one principal who actually ‘set up’ the surety, my client, to get the surety to pay his bills under the payment bond. Specifically, that principal would send to the surety notarized, sworn letters admitting with some particularity what it owed the claimant with a copy of that letter being sent to the claimant. Since the surety’s defenses to a bond claim are the same as a principal’s defenses – other than ‘personal’ defenses to the surety, such as complying with a bond statute of limitations – at such point in time that the principal admitted to the surety that it had no defenses, the surety would usually have little choice but to pay such claims and quickly.

Why would one do something such as this? I suppose, charitably or optimistically speaking, that one might argue that the principal’s promise to the claimant of speeding payment for the taking of a lesser amount of money might have been tied into a promise of providing this kind of assistance. For this particular principal, however, who had a history of going in and out of business for thirty years or more – faithfully filing bankruptcy as often as the Bankruptcy Code would allow (and sometimes more frequently) – this probably was that principal’s way of keeping the claimant warm, friendly and interested in supplying labor and materials to the principal once he formed his next, new business at the expense of his current surety. Did I remember to say elsewhere in this article that there are at least six specific admonitions against suretyship in the Old Testament? Maybe the one has something to do with the other! After all, when one doesn’t comply with the admonitions of the Great Architect, then what can one expect?! (We all know how difficult it can be dealing with architects!)

6. Claims against your performance bond.

These are the most serious and potentially most expensive claims. These are the claims that are most likely to interfere with your principal-surety relationship and are the most likely to affect future bonds from this surety.

Many of the ideas and strategies outlined above will work with performance bond claims. Here are some ten additional ideas and strategies that might be useful:

A. Try to conclude the claim as quickly as you can.

The longer these things go on, the more likely they are to be more expensive and more damaging to your future bondability. Remember the suggestion to protect your bond? This especially applies to your performance bond.

B. The key issue in a performance bond claim is: did the principal default on its contract.

A surety bond is not insurance and it is surprising how many claimants - and their attorneys - don’t understand this. A performance bond claim, if successful, will always be predicated upon some kind of contract breach on the part of the principal. Here is a non-exhaustive list of things that might constitute a contract breach: (a) failure to meet the schedule; (b) doing defective or non-conforming work; ( c ) failing to pay prevailing wages (on a public job) or to supply the insurances the contract requires; (d) filing bankruptcy or some other form of insolvency; (e) failure to show up at the job day after day until the job is done (provided that there is work for you to do); (f) failure to pay lower tier suppliers and subcontractors; (g) causing delay to the contracting party and to other parties working on-site, such as other subcontractors.

So, the first issue to focus on when trying to defend a performance bond claim is to determine whether or not there has been a material (significant) contract breach. If there have been unexcused things such as indicated in the last paragraph, there is a good chance that a court would find a breach of contract on your part and such a breach of contract triggers the condition of the performance bond. A principal’s strategy on a performance bond claim will often include a dispute of a claimed breach, if such is defensible. Obviously, the more documentation and witnesses you have to support such a contention the better.

C. Sue first.

Sometimes a good strategy is to sue first. You know your contracting party - general contractor or owner - is in the process of terminating your contract. You could consider, in appropriate circumstances, filing a suit, such as a suit contending that the other party has breached the contract. Or, you might file an action for declaratory judgment asking a court to declare the rights and obligations of the parties with regard to the contract at issue. Existing litigation tends to give the surety a more defensible position as to the obligee’s claim, as sureties don’t like to interfere/intervene in a situation where there is litigation between the principal and the obligee (the party to whom the bond runs, the beneficiary).

D. Be creative.

Human beings are messy and their problems also tend to be messy. Court judgments are usually black and white: someone is completely right and the other party is perfectly wrong. However, as we all know, it’s a rare situation where there is only fault on one side in any kind of dispute situation as to the sufficiency of performance.

I was recently involved with a situation with a small site contractor, who had installed a concrete block/poured concrete wall, separating a public parking lot from a small office building which was in the process of being built. Shortly after the wall was constructed, a portion of it began to fail. Without going into a lot of details, the owner had done things that were wrong, the architect had done things that were wrong and the contractor had done things that were wrong. Also, the specialty subcontractor which actually constructed the wall had done so knowing that the soil conditions behind the wall were insufficient to provide lateral support and were not in compliance with its own submittals.

The owner was decent, the contractor was honorable and the architect, while reluctant, wanted to protect other and future jobs for this owner, a municipality. The specialty subcontractor had never had such a failure and was anxious to remove this potential black mark from its record. After some meetings and a lot of back and forth, a methodology was established whereby all three parties (owner, architect, contractor) would each contribute approximately one-third of the cost of the rebuild of only that portion of the wall that truly needed to be re-built. The specialty subcontractor made some concessions on the cost of further materials that were required and provided its best crew to do the work.

Once construction started, the job was substantially completed in three or four weeks and was finally completed in under three months. No lawsuits. Bondability for the general contractor was re-established. A lot of money and headaches and the unpleasantness of three to five years of litigation were avoided.

The contractor had his arguments why this wasn’t his fault. Still, he was fairly small and he didn’t have the resources to litigate with a municipality for three to five years. Moreover, where his target market involved performing a lot of public work, an absence of further bondability would have put him out of business, pure and simple, and irrespective of whether a finder of fact ultimately found him responsible for the problem or not. After the work was fixed, there were several very favorable articles written by the local paper praising everyone.

Does this happen a lot? Maybe not to this extent. But, keep in mind that what a performance bond claim is is essentially just a problem. The good Lord gave you a brain: use it creatively to eliminate (or minimize) the problem and protect your future bonding (and bonding company).

E. Document your positions and respond to all important letters.

Not all of these ideas can be put into practice once the claim has erupted. Still, it is always good practice to keep good daily reports, take a lot of pictures and write the necessary letters and respond to the other side’s important letters. To the extent these things are not done, putting forth your position in any litigation (or with the bonding company) will be more difficult. Put quite simply, construction litigations – other than pure collections and indemnity actions – are tried based on the written record, pictures and videos. Trials occur years after the events happened and, half the time, some of the initial witnesses are either not available or are hostile (as they are ex-employees.) Looking at it from another angle, since an exchange of documents (document production) is fairly routine in the pre-trial preparation period of most litigations, the fact that you don’t have very much of a written record might actually encourage your opposing party to go deeper into the litigation. For a dozen good reasons, good super reports from the job-site are exceptionally helpful and necessary. I don’t know how many times I have had business owners tell me that they can’t get the supers to do this. You pay them, don’t you? And, particularly today, there are a lot of unemployed supers who would jump at the chance to work for you. For someone in authority to remind their employees that there is someone just waiting to take their job – this seems to have effectively worked for the Patriots over the years – might stimulate those daily report-writing juices! Such reminders to be diplomatic, of course!

F. Be aware of what the surety’s options are.

What can or does a surety do with a performance bond claim? Well, it can do nothing: there is a dispute as to which it can’t determine who is right and rather than interfere with its principal’s position, it will abide some kind of court decision. This is why “sue first” is listed as an option elsewhere in this paper. Suretyship operates by some very arcane rules, depending significantly, on some United States Supreme Court decisions that are almost one hundred years old. There used to be a maxim applicable to sureties that a surety should not be a volunteer.

While that expression had some validity many years ago, some sureties seem to follow this, as it is part of the ‘old rules’.

Sometimes, the performance bond surety will tender to the obligee another contractor to complete the principal’s job. If it is utterly impossible for some reason for you to complete your own work, helping the surety to find another contractor who can get the job done without a great increase in price might be a desirable strategy for the surety, possibly for you. The surety will seek such a contractor three ways: (a) it will allow some of its existing principals (customers) to give it prices, which builds up a lot of good will with its other principals; (b) it will contact the other bidders to this job, who already have some familiarity with the job because they figured or bid it; ( c ) it will take bids from a group of more or less local contractors having the reputation and perceived ability to get the job done.

If the problem can be solved by writing a check, sometimes the surety will do this. From a principal’s standpoint, the surety does this with payment bond claims at an alarming rate. This might happen in a situation where there is a clear principal default and the estimated cost of correcting the problem (or completing the project) either exceeds the penal sum (the amount) of the performance bond or might exceed the penal sum of the performance bond. As there is some law to the effect that a surety undertaking performance might actually waive the limitation of its liability to just the penal sum of the bond, sureties are not anxious to undertake performance in situations where the cost is close to the penal sum of the performance bond. Also, since most sureties are not really set up to be in a position to finish a job quickly, some obligees will simply have another subcontractor finish the defaulting subcontractor’s work, the terms of the bond be damned. At such point as the job is done, the surety might write that check, assuming there is no significant issue on default.

One idea to be aware of is that often the surety will complete a job under a ‘takeover’ agreement with the obligee and use its principal - you - to complete the job as its completion contractor. Quite often, obligees don’t like this, as they are sick of you. Others take the position that they will go along with this as long as they only have to deal with the surety. My sense is they accept this a good amount of the time in appropriate circumstances.

G. If it is clear you will be unable to finish the job, bring the surety in yourself.

You might be running out of money. You are running out of time. You have tax liens or attachments that are affecting your cash flow. You recognize that you are no longer a viable business. Your suppliers and subcontractors won’t work for you because you owe them money. Your crew is insufficient to perform the amount of work in question. Key employees are departing, like rats from a sinking ship.

In such situations, indemnitors are sometimes well-served by advising the surety of this state of affairs sooner, rather than later. Time is money in construction. Getting the job done properly as quickly as can be done is usually what will cause the least amount of damages (and loss payments). And, a surety with good counsel can often negotiate away things like possible liquidated damages or delay costs or other obligee claimed costs and possible consequential damages if the surety commits to complete.

It is common for subcontractors and general contractors to have other companies engaged in the same trade as buddies. Part and parcel of ‘taking a voluntary default’ with the surety might be your figuring out the cheapest and best way to get the job done as quickly and as cheaply as possible and then present that method to the surety at or about the same time that you tell them you can’t finish. Since the surety is not a construction company – it is much closer to being a bank or other financial institution – it ordinarily will not have any idea how to finish your work and a well thought out plan might be well received. Remember that I said elsewhere that sureties sometimes give breaks to an indemnitor that significantly helps it? This is one of those things that might ultimately work towards that direction.

When an ostrich puts it head in the sand, this doesn’t change the ultimate result or protect it. It only means that when the ostrich is hit by a car or run over by a truck it won’t see it. Pretending the situation isn’t there isn’t going to prevent bad things from happening. The more time that is available to get the job done may mean that the surety has more options as to how to get the job done and more options might mean that it will spend less money. As an indemnitor, this is what you want, also.

H. Sureties do finance, but only in very limited circumstances.

Principals often want the surety to help pay for construction when they are in trouble. They want the surety to lend it some money to continue the job and its business. The technical term for this is ‘financing the principal’. Sureties hate to do this. They will often claim that they don’t do this. However, when there is no other reasonable economical alternative, they will do this.

Example. Many years ago, a surety I represented had bonded a dozen or so projects whereby its principal would perform a complete evaluation of all residential, commercial and industrial properties in a town for the purposes of assisting taxation. The principal didn’t have the ability (money) to complete these projects and they were only half done when they ran out of gas. It is important to note that such evaluations depend heavily on what is proprietary software. So, if the surety brought someone else in, it would essentially have to pay the cost of performing each job in its entirety, which would cost boatloads of money and contribute to boatloads of delay (and significant possible consequential damages).

In these circumstances, this surety did ‘finance’ the principal. It provided the principal funds to function each week, the distribution of which was overseen by an accountant and by an attorney. Ultimately, this approach was successful.

So, if you are in trouble, don’t automatically assume that the bonding company will give you money to finish the work. Usually, and in the great majority of cases, it won’t. Be aware, however, that bonding companies will do this when this is the only feasible opportunity for finishing the work as quickly and cheaply as possible. A tip. If you really are thinking of requesting financing, prepare a realistic schedule of what monies you will need and when with as much back-up as possible before you make that request.

I. ‘Back door’ financing.

Sureties hate to do financing through the front door: giving money to its principal to finance its operations, which is charged to its performance bond.

Under some circumstances, however, there is another alternative, one that is more palatable to the surety. This is ‘back door’ financing. What this means is that the principal will complete the job using its existing subcontractors, who will then get paid under the payment bond. This is less objectionable to the surety than actually providing money to the principal for a variety of reasons. Also, as a practical matter, the surety may not have anything to say about this. The principal may have figured out that this is how he is going to get the job done and by the time the surety realizes this, there is a fait accompli. The job is done: the subcontractors and suppliers want to get paid. Many times, the surety will be aware that this is what is happening and will not object to it. After all, as we all know, most general contractors don’t perform much of the actual construction work themselves. Most of the work is subcontracted. The subcontractors already on the job have the benefit of the learning curve: they know where the bodies are buried, they understand what work has been done (or not done) and are more or less attuned to the schedule. Also, since they are performing in accordance with subcontracts for which the pricing was determined before a default, this is usually a lot cheaper than procuring new subcontractors. When a bonding company hires contractors to finish a principal’s work, usually the prices are much higher than they would be for the same work as performed by your subcontractors, bid in a competitive and non-emergency situation. The bidders would say that if they have to provide warranties for work that has already been done, they have to include contingencies for things they can’t fully protect themselves for, such as wiring and piping behind walls and what is in (or not in) conduits already set in concrete. This is true. But, equally true is the fact that most completion contractors who work for sureties are looking for cake and ice cream. It’s party time when the surety is paying the bill, a fact the surety is well aware of and a situation it attempts to mitigate whenever possible.

J. Complete bonded work first.

If things are really bad, make sure that the bonded obligations are completed before the unbonded obligations are completed. And, make sure that the trade debt for the bonded obligations gets paid before the trade debt for the unbonded obligations gets paid. And, ahead of everything – including trade debt - make sure that all of the withholding taxes are paid.

If you are performing construction work as a corporation or limited liability company, usually there is no way for your company’s creditors to get to you personally, absent allegations of fraud. This isn’t the case with bonded work, as you, as an individual, have agreed to personally reimburse the surety for your company’s losses by a contractual obligation you voluntarily assumed during rosier times. And, taxes always have to get paid, as tax obligations are not generally dischargeable in bankruptcy and can accumulate horrific interest and penalties.

Moreover, individual officers and individuals in your organization might become personally liable for them under various provisions of law. The whole thrust of this paper has been to protect the individual owners and officers. The corporation, when many of these things are happening or have happened, is like the Titanic sinking in the sea. Or, it may have already sunk.

CONCLUSION.

This is one of my longest articles. It is a complex subject and while I hope that I have at least more than scratched the surface, there are more ideas to be considered and explored. I can certainly see a “Part II” article on this subject at some point in the future. If you have any questions or comments on this subject matter, I would be pleased to receive them and I might possibly address some of them having general interest ‘next time.’

Why would someone take more than thirty hours out of a very busy schedule to write this article and to help you for nothing? It is in my nature to write and teach and, frankly, to nurture. I have gratitude to my industry which has supported me for more than thirty-five years. Construction law is all that we do at Sauer & Sauer, a husband and wife business. My website has more content of information that people can actually use as compared with every other lawyer website I have seen. The more of these articles you read and understand, the better your business life is likely to be. More likely than not, you’ll make (and/or keep) more of the money you have earned. Isn’t that why you go to work every day? Is hanging that next sheet of sheetrock all that exciting? How will installing one hundred more toilets fulfill you? We work to support ourselves and our families. Period.

In writing these articles, am I marketing? Of course, I am marketing! I can always use additional quality material suppliers, subcontractors and general contractors as clients. I would welcome the opportunity to serve you. Why not give us a chance?

Think about these thingsbefore trouble arrives and then make intelligent plans accordingly. Louis Pasteur said: “Chance favors only the prepared mind.” Having read a number of positive thinking books, I have seen the following several times in different forms: “It seems that the harder I work and the better prepared I am, the more lucky I am.” In negotiating with the surety, a good experienced attorney in many circumstances will pay for himself/herself in terms of helping you get a better deal and/or to achieve a better result.

Most of all, if sad events like these overtake you in the future, remember that the bonding company is not there to help you. Capisce?

(Copyright claimed, Jonathan Sauer, November, 2011)

  • This article is not intended to be specific legal advice and should not be taken as such. Rather, it is intended for general educational purposes only. Questions of your rights and obligations when dealing with sureties are best addressed to legal professionals of your own choosing.

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