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My Surety Paid... Now What?

As I’ve written about before, the Miller Act offers protection for those who provide labor and materials on federal government projects where bonds are required. The subcontractor who has not been paid can sue the prime’s surety on the bond under a violation of the Miller Act cause of action once a claim has been perfected. Accordingly, the prime and its surety are joint defendants from which a subcontractor can recover.

While often the surety will tender the defense to its principal, it is not required to do so, sometimes choosing to have separate counsel. In such cases, the prime must carefully maneuver the dynamics of defending itself against the sub’s claims and convincing its surety of the viability of its defenses (and ability to pay on a judgment) to prevent the surety from settling the claims.

Indemnity agreements, the documents that memorialize the relationship between the prime and the surety, make it clear that the surety is not required to conference with or obtain permission from its principal to settle claims. And, if they do not, precedent supports this position. Thus, it is not an impossibility that a prime’s surety will settle with the subcontractor without conferencing with it, which creates litigation havoc for the prime.

When a surety pays on a Miller Act claim, it will then (if it has not already done so) sue the prime for indemnification of that loss. Indemnity agreements are adhesion contracts, meaning they are virtually one-sided in favor of the surety. However, there may be a glimmer of hope for the prime if the indemnity agreement includes a very simple phrase: “in good faith.”

In Texas, if an indemnity agreement requires the surety to make disbursements in good faith, its principal will have a defense to indemnification; whether the defense is viable depends on how that term has been judicially defined and the circumstances surrounding the settlement. A lack of good faith defense or a breach of contract action for failure to act in good faith is an uphill battle. The surety’s conduct must rise to the level of willfulness, which goes well beyond a requirement to conduct a reasonable investigation.

The takeaway here is that primes whose surety has paid out may have a defense to indemnification, but the smarter course of action, to the extent possible as some sureties prefer a siloed approach, is to keep the surety close. During the underlying litigation, a prime will want to ensure the surety is aware of and well-informed on the Miller Act defenses the prime intends to mount. Being proactive and making a best effort at preventing the surety settling, particularly given how difficult it is to demonstrate a lack of good faith by the surety, is ideal.

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