PRINCIPALS' AND INDEMNITORS' RIGHTS AND OBLIGATIONS

1. INTRODUCTION 1
2. RELATIONSHIP OF THE PARTIES 1
   1. Identity of the Primary Players 1
      1. The Principal 1
      2. The Obligee 1
      3. The Surety 2
      4. The Indemnitors 2
   2. The Role of the GIA 3
3. PRINCIPALS' AND INDEMNITORS' OBLIGATIONS PRIOR TO DEFAULT 4
   1. Investigation 4
      1. Surety's Rights to Have Financial Information Furnished to it by Principal 5
      2. Surety's Right to Obtain Information From Third Parties 5
   2. Refusal to Issue Bonds 6
      1. As to New Projects 6
      2. As to Bid Bonds 6
   3. Exoneration 8
   4. Establishment of Collateral Deposit Reserves 8
4. PRINCIPALS' AND INDEMNITORS' OBLIGATIONS AFTER CLAIMS HAVE BECOME OBVIOUS 9
   1. Quia Timet Lawsuit 10
   2. Posting of Collateral 11
   3. Opening of Joint Control Trust Accounts 12
   4. Assignment of Contract Rights, Funds and Materials 12
      1. Nature of the Assignments 12
      2. Issues Raised by Assignments 14
         1. Priority 14
         2. Surety "Control" 15
5. DEFAULT 17
   1. Types of Default 17
   2. Performance Bond Claims 17
      1. Need to Investigate and Establish Default 17
      2. Surety's Options 18
      3. Multiple Projects and a Principal in Chapter XI After Default 21
   3. Payment Bond Claims 22
   4. Tensions Between the Surety and Principal/Indemnitors 23
   5. "Bad Faith" Claims and Their Effect 24
6. AFTERMATH OF DEFAULT – THE PARTIES' RIGHTS AND OBLIGATIONS 25
   1. Surety's Right to Indemnity 25
      1. Suits for Reimbursement 26
         1. Scope of Recovery 26
         2. The Standard for Reimbursement 27
            1. Requirement of No Bad Faith 27
            2. Burden of Proof 28
   2. Rights of Equitable Subrogation 29
      1. Nature of Right 29
      2. Priority of Subrogation Rights 30
7. CONCLUSION 32

Abstract

In the construction industry, almost every moderate to large size construction project is bonded by performance and payment bonds. In turn, surety companies invariably require indemnity agreements from their principals and indemnitors. In connection with the underlying contract which the principal contractor or subcontractor has agreed to perform, the bond and the General Indemnity Agreement (hereinafter "GIA") interact to create a network of rights and duties running among and between the principal, obligee, surety and indemnitors. This paper will examine the rights and obligations as between the surety and its principal and indemnitors.

The rights and duties of the principal and indemnitors on one hand, and their surety on the other, are clearly set out in a GIA. The GIA is designed to govern the parties' relationship through the issuance and life of a series of bonds. The GIAs provisions establish workable arrangements to keep the surety abreast of the principals' situation and to allow any takeover of the project to be accomplished with as little difficulty as possible. The GIA also preserves and sets out the traditional rights and remedies available to the surety to minimize its losses. The relationships of all the parties to a bonded construction project are property fixed by the laws governing these rights and duties as embodied in the GIA. Attempts by obligees to impose a "duty of good faith and fair dealing" have impacted the relationship between principals and indemnitors, as sureties are naturally unwilling to bear the brunt of defending against both the merits of a claim and potential bad faith accusations alone.

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