Court Grants Surety's Demand for Deposit of Collateral After Reserve Established

In a case decided in mid-July, 2008, the US District Court in Kansas held that indemnitors were obligated to deposit collateral with a surety which had established a reserve to cover claims that had been both paid and asserted. The court rejected the demand by the indemnitors to examine the actions of the surety under a “good faith” standard since only the demand for specific performance was before the court and not the demand for actual indemnity. Fidelity & Deposit Company of Maryland v. D.M. Ward Construction Co., Inc. 2008 U.S. Dist. LEXIS 53971 (District of Kansas July 14, 2008)

Fidelity & Deposit Company of Maryland (“F&D”) brought suit against its principal as well as corporate and personal indemnitors seeking to enforce the provisions of a written indemnity agreement. F&D had executed surety bonds on behalf of D.M. Ward Construction Co., Inc. for nine construction projects. The surety was presented with a number of claims, paid some and had others still pending. Further, the surety had received claims with at least one obligee under a performance bond. The surety brought an action for indemnity and then filed a Motion for Partial Summary Judgment seeking an order from the court to direct the principal and indemnitor to deposit collateral security in the full amount of the reserves that have been set by the surety. The indemnitors opposed the motion on the basis of the equitable principle of “unclean hands” and the need to pursue discovery before responding to the pending Motion.

In a written decision filed on July 14, 2008, the United States District Court in Kansas upheld the surety’s right to specific performance and directed that the indemnitors post the collateral security in the full amount of the reserves that had been set. The court examined the provisions of the written indemnity agreement as well as the surety’s right to demand collateral and found that the surety’s position was supported by the written agreement as well as established law.

There was no question that liability had been asserted under the terms of the various surety bonds, that the surety had established a reserve of more than $2.8 million, that the surety had demanded the deposit of collateral, and that no collateral had been posted. The plain reading of the indemnity agreement, therefore, would have obligated the indemnitors to post the collateral. The indemnitors argued, however, that the court should look beyond these bare facts and examine the surety’s “inequitable conduct in handling the claims.” In support of their objections, the indemnitors sited various cases for the general legal precept that a party seeking equity must have done equity. Upon further analysis, the court found that none of these cases applied to the context of a surety seeking to enforce a written indemnity agreement.

The court examined the terms of the written indemnity agreement and found that the surety had the right to demand collateral and also substantial discretion in the claims handling process. The court found that the defendants had “bargained away the right to contest how plaintiff [the surety] handle claims upon the bonds unless they were willing to post collateral satisfactory to plaintiff.” The indemnitors also pointed to the provision that, in order to obtain actual indemnity, the surety would have to show that it made payments in “good faith.” The court properly distinguished between the posting of collateral and the ability of the surety to seize that collateral. While the surety may be required to prove that payments and disbursements were made in good faith in order to actually take the collateral into its possession, the narrow issue before the court was the demand for specific performance of the collateral deposit provision. This analysis did not require an assessment of the good faith or bad faith components of the actions of the surety. The court held as follows:

This portion of the paragraph [of the indemnity agreement] reflects an intent by the parties to inject a good faith element at the time of actual indemnification. The same good faith element does not appear in the portion relating to preliminary posting of collateral security. The absence of a reference to good faith in relation to collateral security supports the court’s determination that the plain language of the agreement requires defendants to post collateral in the amount of the reserve without regard to other factors.

The court also cited with favor the cases that held that a surety’s right to demand collateral is an important right such that a denial of the right to collateralization cannot be adequately remedied by monetary damages alone. The court determined, therefore, that the surety was entitled to the equitable remedy of specific performance under the terms of the written indemnity agreement.

This case contains a clear and concise discussion of the various rights enjoyed by a surety under the terms of its indemnity agreement to demand collateral once a reserve has been set.

Posted by: David C. Olson