General Indemnity Agreements, Applications, Workout Agreements in Surety Claims
While the details of the construction surety bond are complicated and detailed, the concept is simple: a contractor promises to build according to plans and specifications by a certain time and within a certain price. The penalties are outlined in the contract, and covered by a third party, usually a business insurance company. The applications and additional documentation help make sure that contractors are qualified and able to do the work, and that of they default, they can repay or reimburse any money spent on behalf of the contractor to complete the work promised.
Although it isn’t always possible to prevent defaults, the agreements can be constructed to be flexible and yet clear. This will help avoid defaults and outline the proper steps to take at the firs sign the project is in jeopardy. There are expenses in time and funds when there a party is in default, and avoidance is the best technique. Whether the contract provides strict or loose guidelines, there are times when it is still possible to save the relationships.
Although open-minded negotiations are always best, it’s also helpful to have clear expectations. The general indemnity agreement will help provide for backup funds and collateral in case of a complete breakdown of a project; the application supplies the information and signatures for the agreement and helps the surety investigate all possible alternatives for funds; and workout agreements provide avenues for all parties to avoid default claims.
General Indemnity Agreement
If the contractor defaults on performance of the construction project, the project owner will formally notify the insurance company of a claim. The surety provides for completion of the project, even if another contractor must be hired to complete the work. However, the original contractor is liable to repay any money spent on this completion.
The general indemnity agreement allows the surety alternative places to get funds owed by the contractor. For instance, if the contractor has not paid the subcontractors what is due them, the surety will make that payment and the contractor will have to repay the surety. In the event that the contractor doesn’t have the funds or otherwise fails to pay, the surety has other sources to get the money back.
How the Agreement Works
Often contractors don’t have the funds available for paying people and vendors—if they did, they would likely have been able to complete the endangered projects. Sometimes it results from mismanagement, sometimes from credit problems or other factors. However, sometimes it’s not the doing of the contractor—there are examples of contractors who had a subcontractor default or another project fall through due to no fault of theirs, and this event led to the collapse of the project covered under a certain surety bond.
For the above reasons, most surety bond companies require a general indemnity agreement. The indemnity agreement brings others into the bond agreement by asking them to pay the debts if the contractor is unable. Often this involves a parent or sister company in the case of larger contracting firms, and friends or relatives in the case of the smaller contractor. This helps make sure that someone is there to cover the losses if a new contractor has to be brought in.
The people indicated on the general indemnity agreement act like a co-signer for a loan. Sometimes people just starting out in life will purchase a car, and will need to have another person with good credit sign for them, making the second party liable for the payments of the owner doesn’t make payments.
Provisions of the Agreement
The details of the indemnity agreement are many and could fill a small textbook. These provisions help make the agreement flexible and give all parties a chance to save their position in the contract. However, there are some basic points that are covered often in the agreements; here are some of those points and a short description:
- Collateral deposits—the contractor agrees to keep a fund available (very much like an escrow fund) for payment of the claim;
- Right to take over the work—this allows the surety company to hand over completion of the project to another contractor, or to loan the original contractor enough money to complete the project, both of which would be repaid by the indemnitor(s) if the contractor defaults; and
- Assignment of contracts—this ensures that the surety company may continue employing all subcontractors if the contractor defaults.
Some contract details include an agreement that the surety company may file collateral documents as security agreements as provided by the Uniform Commercial Code—this puts the surety in a higher position as a creditor to the contractor. The indemnity agreement also allows for the project owner’s payments to be held in a special trust fund for payment of the contractor’s employees and suppliers.
Other provisions in the indemnity agreement include the right of the surety to decide on payment of claims, and to examine the financial information of any indemnitors (including credit reports and bank records). Together, this collection of provisions helps ensure the project will be completed well and on time regardless of the contractor’s difficulties.
When contractors apply for surety bonds, they must supply detailed information about their business and its financial condition. They have to disclose many facts about their businesses, including the names of all officers and responsible people within the company. The surety company will usually do a complete investigation of these people before issuing the bond.
Normally, the surety bond application will include a questionnaire about the contractor’s business, and asks for information such as how long the company has been in business, state of incorporation, the percentage of the company each officer owns, whether spouses will indemnify the surety, and many other details. The contractor must also disclose how many work crews are employed, and if the company is currently involved in any lawsuits or bankruptcies.
A contractor also needs to be prepared with a list of references, from recent job contracts and architects to suppliers and subcontractors. There is also a section to list company credit and limits, accounting staff, and tax information, as well as how the company files its financial statements. Other paperwork is also required, such as contracts in progress and recently completed. There are many details about contractors’ operations in this form, and they help the surety company make decisions on the bond itself, including whether to cover the company or not.
Workout Agreements in Surety Claims
Despite the evaluations of the contractor, prompt payment on the part of the owner, and everyone’s good intentions, problems sometimes still arise and a default is in the near future. Sometimes this default can still be avoided, even when the project becomes seriously troubled—this should be the goal of all parties involved in the surety bond agreement.
The surety company should first be notified of the possibility of a default before a claim is made (and often they see problems before the project owner does). A meeting between the surety and all involved parties is often held then, and the surety’s specialists are given a chance to help work out the current agreement without a claim being filed.
Negotiating the Workout Agreement
There are various ways of handling the negotiations. For instance, if the contracting company is still able to handle the project and is simply short of funds to procure additional building materials, the surety may lend the contractor enough money to keep the project moving forward. If the contractor has problems keeping a subcontractor, the surety can help find a new one. These steps are much preferred to a default claim.
The surety company will take a proactive position and conduct investigations into the reasons for a contractor’s difficulty, and depends on communication from both the project owner and the contractor. Many times a contractor who is in trouble is helped by the surety company without the owner even knowing about it.
When All Else Fails
Sometimes a default can’t be avoided. Some of the bond contracts outline specific actions parties are to take in case of default, and others don’t. Regardless, it still pays for the parties to consider all alternatives to completing the work. Some parties will hire a replacement contractor, who will then provide a new surety bond. This is provided for in the “Tender Option” of the surety bond, and allows the work to continue as before with the project owner in charge.
Often when the project has progressed far enough, the surety company has to take on the project itself, and would hire out the work to be completed (usually led by a completion contractor). When this happens, the result of the negotiations is a takeover agreement instead of a workout agreement. Putting this agreement into writing avoids possible problems later in the project’s life, and helps keep clear steps in place for completion.
Even with the provisions of workout and takeover agreements don’t guarantee that the surety will take over a project or have anything to with completion. There are many other options that can be used in a bond contract to allow for flexibility in negotiations, and vary from performance of the original contractor to cash settlements.