Surety Bond Quarterly - Winter 2017 - 18

since it impacts that contractor's cash
flow and ability to pay its other subcontractors. If the general contractor
cannot or chooses not to pay its subcontractors, those subcontractors are
left without recourse to file a claim. In
essence, only a larger contractor with
the ability to build a reserve to pay for
deductibles and any co-payments will
be successful with SDI. Even then, the
insured contractor is contractually obligated to recover funds paid out under
the policy. The burden and expense for
contesting determinations with carriers fall on the contractor, leaving it to
devote significant time and resources
not reasonably related to construction
of the project.32 Even if the contractor
has built up a reserve, sometimes that
may not be enough.33
Competing/
Overlapping Coverage
What happens when the responsibilities of the general contractor and
the surety overlap? A new scenario
has arisen where an SDI policy is in
place, the general contractor defaults
the covered subcontractor and submits a claim, and the proceeds are
issued under the policy to complete
the defaulting subcontractor's scope of
work. Thereafter, the general contractor
also defaults, triggering performance
bond coverage. This scenario opens up
a flood of new issues through which
the surety claims professional must
navigate with little to no jurisprudence
for guidance.
A primary question is whether, in
this event, by stepping into the shoes
of the principal (the defaulted general
contractor), the surety has the same
rights and defenses (and, significantly,
obligations) as the contractor under the
terms of the SDI policy. To help answer
this question, the surety claims professional should first look to the terms
of the SDI policy to see if there is an
anti-assignment clause. While most
indemnity agreements provide that
the surety has the right to make any
assignments necessary to enforce its
rights as the indemnitor(s)' attorney-infact, in turn, most SDI policies contain
an anti-assignment clause prohibiting
the insured general contractor from

18

assigning the policy absent the insurer's written consent and endorsement.
Even if the anti-assignment clause is in
place, however, depending on the governing law applied to the interpretation
of that clause,34 it may or may not be
held valid as to "post-loss proceeds" of
the policy, or proceeds resulting from
the subcontractor's existing defaults.
For example, under both New York
and Florida law, while assignment of
the policy itself prior to a loss is invalid
without the insurer's consent, no such
consent is necessary for an assignment of the right to policy proceeds
after the loss.35
Whether an assignment is determined "pre-loss" or "post-loss" is
based on whether the assignment
increases the risk to the insurer. On
this point, a completing surety and
insurer will likely disagree. The surety
claims professional should argue that
the insurer is still covering the risk it
evaluated when the policy was written-that is, the same scope of work. On
the other hand, the insurer may counter that the risk has changed since the
entity responsible for the obligations
under the SDI policy has changed (from
insured general contractor to completing surety). The surety can sidestep
this argument when the assignment
is for the insured's rights in the SDI
proceeds only and not in the policy
itself. By not assigning the actual policy
(which again would likely be forbidden
anyway through an anti-assignment
clause) but rather assigning only the
post-loss proceeds of the policy, the
surety receives the policy benefits
while the responsibilities (including any
repayment provisions) remain with the
general contractor.36
The surety claims professional must
also be wary in this scenario of how
SDI coverage impacts the surety's performance options.37 When the bonded
contract requires SDI and the surety
opts to take over completion of the
bonded project, this action could void
SDI coverage as the entity responsible for the obligation has changed.
Because the terms of the bonded
contract requiring SDI must be met,
unless waived by the owner, the surety's completing contractor will have to

SURETY BOND QUARTERLY | WINTER 2017

provide SDI coverage.38 A lapse in SDI
coverage during the period between
default and takeover could also result
in a lack of coverage for defective work
performed by the original subcontractors.39 Therefore, this type of coverage may not be possible if the surety
chooses to do a takeover and re-let. To
remedy this, an owner may demand
that the surety expand its coverage
under the performance bond to cover
defective work.
Further, in light of these potential
coverage issues, the completion contractor may not even be able to ratify
the original subcontractors. In lieu of
incorporating lower priced ratified subcontracts into the completion contractor's bid, the surety may be forced to
accept higher bids from subcontractors
new to the project. This likely result
leaves the surety with an unwanted
higher cost to complete.
Notably, the above-mentioned difficulties in a takeover, where SDI coverage is contractually required, arguably
tips the surety's risk scale in favor of
financing, rather than re-let. Financing
allows a surety to avoid the insurer's
"changed entity" argument and, working with the principal general contractor, secures unbroken SDI coverage for
past, present, and future subcontractor failures. One potential solution is
for a surety pre-claim to request that
the principal obtain a financial interest
endorsement to the SDI policy in favor
of the surety. If such an endorsement
is not obtained, the surety claims professional should investigate whether
there is such an endorsement in place
in favor of the owner, which would
allow the surety claims professional
to work with the owner to preserve
SDI coverage. In the absence of either
endorsement, post-claim a surety must
account for the potential absence of SDI
coverage in assessing the surety's risk
in selecting a completion option.
In sum, although currently rare, this
scenario could become more and more
common with the increased use of SDI
on larger private projects. A surety
claims professional faced with these
facts should thoroughly investigate
continued on page 22



Table of Contents for the Digital Edition of Surety Bond Quarterly - Winter 2017

NASBP Upcoming Meetings & Events
2017–2018 Executive Committee
From the CEO: Looking Backward to Reach Forward
Relationships for the Long Run
Subcontractor Default Insurance: Relevant Considerations for the Surety Claims Professional
Bottom Line Protection with Job Cost Accumulation & Allocation
Inside the AIA’s New Insurance and Bonding Contract Exhibit
The Calm After the Storm: Managing Disaster Response Contracts
Practical Tools to Help Jump-Start Your Company’s Cyber Plan
Index to Advertisers
Surety Bond Quarterly - Winter 2017 - Intro
Surety Bond Quarterly - Winter 2017 - cover1
Surety Bond Quarterly - Winter 2017 - cover2
Surety Bond Quarterly - Winter 2017 - 3
Surety Bond Quarterly - Winter 2017 - 4
Surety Bond Quarterly - Winter 2017 - 5
Surety Bond Quarterly - Winter 2017 - 6
Surety Bond Quarterly - Winter 2017 - 2017–2018 Executive Committee
Surety Bond Quarterly - Winter 2017 - 8
Surety Bond Quarterly - Winter 2017 - From the CEO: Looking Backward to Reach Forward
Surety Bond Quarterly - Winter 2017 - 10
Surety Bond Quarterly - Winter 2017 - Relationships for the Long Run
Surety Bond Quarterly - Winter 2017 - 12
Surety Bond Quarterly - Winter 2017 - 13
Surety Bond Quarterly - Winter 2017 - Subcontractor Default Insurance: Relevant Considerations for the Surety Claims Professional
Surety Bond Quarterly - Winter 2017 - 15
Surety Bond Quarterly - Winter 2017 - 16
Surety Bond Quarterly - Winter 2017 - 17
Surety Bond Quarterly - Winter 2017 - 18
Surety Bond Quarterly - Winter 2017 - 19
Surety Bond Quarterly - Winter 2017 - 20
Surety Bond Quarterly - Winter 2017 - 21
Surety Bond Quarterly - Winter 2017 - 22
Surety Bond Quarterly - Winter 2017 - 23
Surety Bond Quarterly - Winter 2017 - 24
Surety Bond Quarterly - Winter 2017 - 25
Surety Bond Quarterly - Winter 2017 - Bottom Line Protection with Job Cost Accumulation & Allocation
Surety Bond Quarterly - Winter 2017 - 27
Surety Bond Quarterly - Winter 2017 - 28
Surety Bond Quarterly - Winter 2017 - 29
Surety Bond Quarterly - Winter 2017 - Inside the AIA’s New Insurance and Bonding Contract Exhibit
Surety Bond Quarterly - Winter 2017 - 31
Surety Bond Quarterly - Winter 2017 - 32
Surety Bond Quarterly - Winter 2017 - The Calm After the Storm: Managing Disaster Response Contracts
Surety Bond Quarterly - Winter 2017 - 34
Surety Bond Quarterly - Winter 2017 - Practical Tools to Help Jump-Start Your Company’s Cyber Plan
Surety Bond Quarterly - Winter 2017 - 36
Surety Bond Quarterly - Winter 2017 - 37
Surety Bond Quarterly - Winter 2017 - Index to Advertisers
Surety Bond Quarterly - Winter 2017 - cover3
Surety Bond Quarterly - Winter 2017 - cover4
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https://www.nxtbook.com/naylor/SBPQ/SBPQ0417
https://www.nxtbook.com/naylor/SBPQ/SBPQ0317
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