A Connecticut superior court judge recently granted a performance bond surety a $1.3 million prejudgment remedy against individual indemnitors following the bonded contractor’s default and the surety’s payment of a claim arising from that default. While a surety’s discretion to make settlement payments is not unfettered, Connecticut (like most jurisdictions) has held that a surety is entitled to indemnification under its general agreement of indemnity only for payments that were made in good faith. By granting the surety the relief it requested, the court sharpened the focus on the steep hill that must be climbed in order to demonstrate bad faith on the part of a surety in settling a performance bond claim.

In Travelers Casualty and Surety Company of America v. Michael Caridi, et al., the indemnitors alleged that the surety acted in bad faith because it failed to “properly investigate” the performance bond claim made by a local housing authority following the bonded contractor’s failure to complete performance of a senior center in Atlantic City, New Jersey. Specifically, the indemnitors contended that the surety failed to investigate whether any of the officers or directors of the housing authority were under State investigation for criminal or ethical violations, and further failed to have an independent audit performed to determine if the housing authority had sufficient funds to pay for completion of the project.

In a thoughtful decision that outlined the steps taken by the surety to investigate the performance bond claim and the surety’s claim counsel’s testimony regarding each category of indemnity payments, expenses and the loss reserve, the court held that the indemnitors failed to meet their burden to prove that the surety engaged in bad faith in paying the housing authority’s claim. The surety was therefore entitled to the prejudgment remedy. The decision offers sureties affirmation of important steps to be considered in an independent investigation of a performance bond claim. The trial court specifically found that an internal financial audit of the bond claimant is not the type of investigation that is required by a surety to fulfill its good faith obligation.

Another key component of the court’s opinion from the surety’s perspective was the legal effect of the “right to settle” and “prima facie evidence of payment” clauses in the general agreement of indemnity. The court held that under the aforementioned clauses, that once the surety established probable cause that it had incurred a loss under the performance bond, the burden shifts to the defendants to prove that the surety made payments in violation of their good faith obligation by a preponderance of the evidence in the prejudgment remedy proceeding. At trial, however, bad faith must be proven by clear and convincing evidence – an even higher standard.

From the contractor’s perspective, the case serves to emphasize the heavy burden a claimant must satisfy when alleging that a surety has acted in bad faith. It is critical for indemnitors to have a complete and thorough understanding of the various provisions in a general agreement of indemnity and the wide leeway afforded to a surety in handling performance bond claims.