Subcontractor Default Insurance

Presented by Thomas S. Tripodianos

And Anthony P. Carlucci, Jr.

w w w . w b g l l p . c o m

What You Need to Know

Acarlucci@wbgllp.com Ttripodianos@wbgllp.com(914)607-6430 (914)607-6440

Multiple Offices in the Greater Tri-State Area

What is Subcontractor Default Insurance (SDI)?

Alternate Method to Performance Bond to Transfer RiskFirst policies sold by Zurich/Steadfast in 1996Arose in response to complaints about lack of surety responsiveness

Both SDI and Performance Bonds are a method of risk transferBonds

Risk transferred to surety—first dollar coverageSurety transfers risk to bond principal through indemnification agreements

SDIInsurance carrier assumes most risk

Insured retains some risk in form of deductibles / co-pays: Skin in the Game

Insurance carrier cannot pass on risk directly (no indemnification agreement) Carrier must attempt subrogation after payment

* Risk is limited to penal sum of bond (typically amount of original contract)Penal sum may be insufficient if default occurs early or contract is underbid

* Policy amount may exceed amount of contract, no penal sum limitation

SubgrogationSubrogation is a legal doctrine whereby one person is entitled to enforce the subsisting or revived rights of another for one's own benefit. A right of subrogation typically arises by operation of law, but can also arise by statute or by agreement.

Wikipedia

Default: The Triggering EventMaterial breach (or series of breaches) of such extent that the insured is justified in terminating the subcontract.

SDI

BondsSurety generally involved in investigation at time of defaultMany forms of bond require involvement of surety before default declaredSurety may assist its principal to prevent the default in the first place

Declaration of default largely up to insured, who submits claim after default and receives payment of damages caused by the default.Even if claim is paid, default may be challenged when carrier attempts to subrogate

The InvestigationBonds

Three party agreement between Principal, Surety and Obligee

Surety also has obligation to principal to investigate propriety of defaultSurety may forfeit rights under indemnification agreement if it pays claim improperlyObligee may forfeit its protection under the bond by failing to follow the terms of the bond or the underlying contract.

Surety has obligation to pay obligee in the event of a valid claim

The InvestigationSDI

Two party agreement between Insured and CarrierCarrier has no obligations to defaulted contractorNo prompt assessment of the adequacy of the carrier’s investigation/payment of claimCarrier may attempt to subrogate claims, forcing defaulted party to defend lawsuitCarrier has obligation to confirm compliance with contract termination procedures

Qualifications

SDI

BondsSurety undertakes extensive, independent assessment of risk of principal

Bond premium calculated by risk assessment of principal and creditworthiness

Admissibility to SDI program is less stringent than “bondability”Does Insured do financial vetting like a surety? Enrolled contractor may be reluctant to share certain information with the Insured

“Bondable Contractor”

Does not tap bonding capacity - Is enrolled contractor over-extended?Intrusive, information is sensitive, could reveal competitive disadvantage

Financials, jobs in progress, claim history, business plan, assets of principals, etc.

Controlling the Process

SDI

BondsSurety actively involved in default process from pre-default

Biggest complaint of Obligee: surety’s “extensive” investigation

Insured controls the processDeclares default, retains replacement contractor, submits claim with SDI carrierInsured has freedom to make decisions without seeking approval of surety

If surety takes over for defaulted principal, surety maintains control over the process

Insured does not know if SDI carrier is going to pay the claimSDI carrier doesn’t know if it will be able to recover against defaulted contractor

Surety is relatively certain it will recover under the General Agreement of Indemnity

Other ConsiderationsBonds

Extensive existing case law interpreting provisions of bondsCoverage for single project only

Greater number of available sureties as compared to carriersSurety may have option of using defaulted principal to complete work (with supervision)Performance Bonds are typically accompanied by Payment Bonds

Other ConsiderationsSDI

Less obstacles for Insured to default a contractor

No Payment Bond protections

Covers multiple projects for term of policyMethod to increase M/D/WBE utilization as they are typically not bonded

Newer product, not as much case law interpreting policy provisionsDoes not meet statutory requirements for bonds on public jobs

Premium savings as compared to bond premiums

False Claims Act: Use of SDI on federally funded work is not a violation of the federal Miller Act because the Act only addresses general contractor bonding on federally funded work and SDI is not intended to be a substitute for a general contractor bond. However, the use of SDI on federally funded projects can pose legal concerns/liability regarding the False Claims Act unless there is prior disclosure and a program pricing agreement with the proper government authorities.

INDEMNIFICATION vs. SUBROGATION

Indemnification: A covenant to be held liable to another for a loss they incurSurety has rights of indemnification from the principal, and possibly others

Independent from obligation to respond to bondIn exchange for right to recover its losses from indemnitees, surety has obligation to thoroughly investigate claimFailing to investigate/acquiescing in improper default & paying claim on bad default:

Tortious interference with contract (the subcontract)Could forfeit its right of indemnificationCould be subject to sanctions from the Dept. of Financial Svcs (Insurance Dept.)

The principal is the surety’s customer: NOT the InsuredThere may be legitimate defenses to payment of the obligee’s claim

SDI Carriers Seek to Mitigate Their LossesSubrogation

SDI is insurance not suretyDefaulted contractor has limited/no participation in investigation of default

SDI carrier has no independent obligation to defaulted partyThe Insured is the carrier’s customer: NOT the defaulted party

Subcontractor Default Insurance

Presented by Thomas S. Tripodianos

And Anthony P. Carlucci, Jr.

w w w . w b g l l p . c o m

What You Need to Know

Acarlucci@wbgllp.com Ttripodianos@wbgllp.com(914)607-6430 (914)607-6440

Multiple Offices in the Greater Tri-State Area