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

FIDELITY AND SURETY

June 2014

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

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

ABOUT THE COMMITTEE

The Fidelity and Surety Committee serves all members who represent fidelity and surety carriers. Committee
members publish newsletters and journal articles, including an annual update of recent developments in the
law. Learn more about the Committee at www.iadclaw.org. To contribute a newsletter article, contact:
Samuel J. Arena, Jr.
Vice Chair of Newsletters
Stradley Ronon Stevens & Young, LLP
sarena@stradley.com
The International Association of Defense Counsel serves a distinguished, invitation-only membership of corporate and insurance
defense lawyers. The IADC dedicates itself to enhancing the development of skills, professionalism and camaraderie in the
practice of law in order to serve and benefit the civil justice system, the legal profession, society and our members.

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-2International Association of Defense Counsel

FIDELITY AND SURETY COMMITTEE NEWSLETTER

Much has been written about the effects of the
economy upon the construction industry.
This Newsletter will focus upon a unique
perspective applicable to the surety context.
Commercial and sometimes residential
construction compels the necessity for a
contractor to obtain a surety bond to
guarantee performance leading to the
successful conclusion of a construction
project.
Upon that occasion, a general
contractor will obtain a surety bond from an
authorized underwriter.
In basic terms, a surety bond is a contract
under which one party (surety) guarantees the
performance of certain obligations of the
second party (principal) to a third party
(obligee).
Generally in the commercial
context and more specifically for public entity
projects construction contractors provide the
project owner, for which they are performing
operations, with a bond guaranteeing that it
will complete the project by a specified date
set forth in the construction contract in
accordance with all plans and specifications.
Usually one or more in any combination of
the following three types of bonds are
underwritten to secure the contractors
performance. The American Institute of
Architects (AIA) is the most common source
of standard construction contracts and bond
forms defining the responsibilities of
contracting parties with respect to
indemnification in the purchase of insurance
coverage. In this context, this Newsletter will
not address contractors all risk insurance or
contractors professional liability insurance.
Nor will this Newsletter speculate upon the
liability of a producer who places a bond with
an underwriter whose financial strength rating
is less than secure.

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June 2014

Three types of bonds are most common.

1. Bid Bond. Issued in conjunction with
construction bidding processes. This
bond acts as a guarantee that, if
awarded the contract based on the bid
submitted, the contractor will enter
into a contract to perform the work at
the price quoted. If the contractor
declines to enter into a contract to
perform the work at the agreed upon
price, the bid bond will reimburse the
obligee (owner) the difference
between the defaulting contractors
bid and the next lowest bid, up to the
penal sum of the bond.
2. Performance Bond.
This bond
guarantees that the contractor will
perform the work in accordance with
the construction contract.
The
purpose is to protect the owner from
financial loss up to the penal sum limit
of the bond should the contractor fail
to fulfill its contractual obligations.
3. Payment Bond. This last bond form
guarantees
that
suppliers
and
subcontractors will be paid for
materials and labor furnished to the
contractor. A project owner generally
insists upon a payment bond that upon
completion, the project is free of
contractor mechanics liens.
An essential part of the suretys underwriting
process is the preparation and execution of a
General Agreement of Indemnity (GAI). The
GAI is akin to a personal indemnification
guaranty. In short, this is a two party contract
between the surety and the principal
(contractor) that if the principal fails to
perform the surety may prosecute a civil
action against the principal in the event the

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-3International Association of Defense Counsel

FIDELITY AND SURETY COMMITTEE NEWSLETTER

surety becomes obligated to pay a portion or
all of the penal sum of the bond. Most GAIs
provide the surety with measures to protect
itself from a decaying situation. Three basic
rights are contained within the GAI:
1. Collateral Security;
2. Inspection of the Principal and
Indemnitors financial books and
records; and
3. Settlement of claims without the
approval of the principal.
One of the economic consequences that has
become all too apparent, in circumstances
when a contractor defaults, is usually because
of the poor financial condition of the
contractor. Efforts to exercise the suretys
rights pursuant to the GAI has more
frequently resulted as a recognized
consequence in this economy, that being the
insolvency of the contractor. If the surety
underwriter has an adverse selection book of
business, the likelihood is over time the surety
will find itself in hazardous financial
condition because it has not been able to
recoup losses from the personal GAI. In part,
this is what has happened to two sureties
fairly recently:
a. First Sealord Surety, Inc., a
Pennsylvania domiciled surety; and
b. Centennial
Insurance
Company,
domiciled in New York.
Recognizing that other business of insurance
factors may have played a role in the ultimate
financial condition of both companies, be that
as it may, each were ordered into liquidation
by the respective insurance departments
having financial condition oversight. When
that unfortunate event happens, a liquidator is
appointed to manage the runoff of the
insolvent estate. Complicating the issue, is
that some states do not recognize surety as a

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June 2014
line of business eligible for Guaranty Fund
protection. Looking back at the types and
nature of bonds described earlier in this
Newsletter, one can see that if the surety is
declared insolvent, further complicated by a
jurisdiction which does not permit a Guaranty
Fund claim, then obligees, project owners,
and even the principal are adversely affected
and subject to risk.
Upon that occurrence, legal intervention to
investigate whether or not the surety has
reinsurance may prove prudent. Reinsurance,
by way of treaty or agreement, is where an
insurance company including a surety,
transfers risk to another insurance company
called a reinsurer. Therefore, a reinsurer, in
consideration of a premium paid by the surety
in this example, agrees to indemnify the
reinsured for part or all of the liability
assumed by the ceding company. The legal
focus will concentrate upon a careful
investigation of the treaty provisions in the
reinsurance contract specifically looking for a
cut
through
endorsement.
This
endorsement is a provision in the reinsurance
contract that sets forth how the reinsurer will
pay any loss covered by the reinsurance
contract directly to the insured when the
surety is insolvent.
This provision is
sometimes
called
an
Assumption
Endorsement and may also contain drop down
properties. However, not all state court
decisions uniformly agree upon the propriety
of drop down principles.
In conclusion, the lawyer and law firm
experienced in undertaking construction law
and surety law matters can perform the
requisite due diligence and risk management
to evaluate a reinsurance agreement to
determine if any of the parties may seek direct
relief from the reinsurer, when a surety is
declared insolvent.

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-4International Association of Defense Counsel

FIDELITY AND SURETY COMMITTEE NEWSLETTER

June 2014

PAST COMMITTEE NEWSLETTERS

Visit the Committees newsletter archive online at www.iadclaw.org to read other articles published by
the Committee. Prior articles include:
MAY 2014
Enforcement of Jurisdiction/Venue Provisions of Indemnity Agreements
Steven Weinberg
APRIL 2014
Enforcing Forum Selection Clauses after Atlantic Marine
G. Steven Ruprecht and Diane Hastings Lewis
MARCH 2014
Bad News for Construction Insurers Might be Good News for Sureties
David W. Kash and Bruce Kahn
NOVEMBER 2013
Getting to Zero: A Method of Projecting Losses on Your Clients Next Surety Claim
David W. Kash, Bruce Kahn and Steve Leach
AUGUST 2013
Davis-Bacon Act: Subcontractor's Obligation to Pay Prevailing Wages
G. Steven Ruprecht
JULY 2013
Can a Contractor Implead the State in an Action Brought Against it by its Subcontractor?
Charles Bud Herman
FEBRUARY 2013
Getting to Zero Through a Great Takeover Agreement
Bruce Kahn and David Kash
OCTOBER 2012
Pay-if-Paid Clauses Valid in Indiana Says the Seventh Circuit
Steven J. Strawbridge and Cade Laverty
JULY 2012
Recent Decision by the United States Supreme Court Dealing with the Statute of Repose
Charles Bud Herman

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