Subcontractor default insurance thomas tripodianos & anthony carlucci - welby, brady & greenblatt

1. 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

2. What is Subcontractor Default Insurance (SDI)?
Alternate Method to Performance Bond to Transfer Risk
First policies sold by Zurich/Steadfast in 1996
Arose in response to complaints about lack of surety responsiveness

3. Both SDI and Performance Bonds are a method of risk transfer
Bonds
Risk transferred to surety—first dollar coverage
Surety transfers risk to bond principal through indemnification agreements
SDI
Insurance 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

4. Subgrogation
Subrogation 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

5. Default: The Triggering Event
Material breach (or series of breaches) of such extent that the insured is justified in
terminating the subcontract.
SDI
Bonds
Surety generally involved in investigation at time of default
Many forms of bond require involvement of surety before default declared
Surety 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

6. The Investigation
Bonds
Three party agreement between Principal, Surety and Obligee
Surety also has obligation to principal to investigate propriety of default
Surety may forfeit rights under indemnification agreement if it pays claim improperly
Obligee 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

7. The Investigation
SDI
Two party agreement between Insured and Carrier
Carrier has no obligations to defaulted contractor
No prompt assessment of the adequacy of the carrier’s investigation/payment of
claim
Carrier may attempt to subrogate claims, forcing defaulted party to defend
lawsuit
Carrier has obligation to confirm compliance with contract termination procedures

8. Qualifications
SDI
Bonds
Surety 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.

9. Controlling the Process
SDI
Bonds
Surety actively involved in default process from pre-default
Biggest complaint of Obligee: surety’s “extensive” investigation
Insured controls the process
Declares default, retains replacement contractor, submits claim with SDI carrier
Insured 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 claim
SDI 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

10. Other Considerations
Bonds
Extensive existing case law interpreting provisions of bonds
Coverage for single project only
Greater number of available sureties as compared to carriers
Surety may have option of using defaulted principal to complete work (with
supervision)
Performance Bonds are typically accompanied by Payment Bonds

11. Other Considerations
SDI
Less obstacles for Insured to default a contractor
No Payment Bond protections
Covers multiple projects for term of policy
Method to increase M/D/WBE utilization as they are typically not bonded
Newer product, not as much case law interpreting policy provisions
Does 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.

12. INDEMNIFICATION vs. SUBROGATION

13. Indemnification: A covenant to be held liable to another for a loss they incur
Surety has rights of indemnification from the principal, and possibly others
Independent from obligation to respond to bond
In exchange for right to recover its losses from indemnitees, surety has obligation to
thoroughly investigate claim
Failing to investigate/acquiescing in improper default & paying claim on bad default:
Tortious interference with contract (the subcontract)
Could forfeit its right of indemnification
Could be subject to sanctions from the Dept. of Financial Svcs (Insurance Dept.)
The principal is the surety’s customer: NOT the Insured
There may be legitimate defenses to payment of the obligee’s claim

14. SDI Carriers Seek to Mitigate Their Losses
Subrogation
SDI is insurance not surety
Defaulted contractor has limited/no participation in investigation of default
SDI carrier has no independent obligation to defaulted party
The Insured is the carrier’s customer: NOT the defaulted party

15. 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