Surety Case Law Note: Iowa Court Issues Preliminary Injunction Requiring Indemnitors To Post Collateral
September 24, 2024
In this Surety Today: The Blog post, as we did last week, we once again consider a Case Law Note addressing the issue of obtaining a mandatory preliminary injunction requiring the indemnitors to post collateral, but this time, it is under Iowa law, but with the same result. The case is:
Philadelphia Indem. Ins. Co. v. DB Booneville, LLC, No. 4:24-CV-00029-SMR-WPK
2024 WL 4016373, at *1–10 (S.D. Iowa July 12, 2024)
This case arises out of indemnity obligations in connection with two subdivision surety bonds issued by Philadelphia Indemnity Insurance Company (“Surety”). The surety filed suit seeking specific performance and injunctive relief to compel its Indemnitors to provide collateral security on the bonds and provide access to their financial records. The subdivision was located in the City of West Des Moines, Iowa, known as The Village at Sugar Creek Plat 1. The Bonds guarantee the performance obligations of the principal regarding specified municipal infrastructure improvements related to the Project. The underpinning of the suit was an Indemnity Agreement in which the Indemnitors agreed to indemnify, exonerate, and hold harmless the Surety from actual and anticipated losses arising from the bonds and to deposit collateral immediately upon demand from the surety for protection and collateralization. Pursuant to the Indemnity Agreement, the Surety also was given unrestricted access to the Indemnitors’ financial information. The Indemnity Agreement expressly provided that injunctive relief and specific performance were available remedies to the Surety.
The City, as obligee on the bonds, made a demand on the Surety in the amount of $3,410,515.00, the full penal sums of the bonds, claiming that the principal failed to perform the bonded subdivision improvements related to the project. Shortly thereafter, the Surety made demand upon the Indemnitors for the deposit of $3,410,515.00 as collateral. The Indemnitors failed to provide the collateral. The City subsequently filed suit against the Surety.
Iowa Legal Standard
Preliminary injunctive relief is an extraordinary remedy that is not issued routinely or “as a matter of right.” Winter v. Nat’l Res. Def. Council, Inc., 555 U.S. 7, 24 (2008) (quoting Munaf v. Green, 553 U.S. 674, 689–90 (2008)). The main purpose of a preliminary injunction is to preserve the status quo and prevent irreparable harm until the court can make a final decision on the merits. Ferry-Morse Seed Co. v. Food Corn, Inc., 729 F.2d 589, 593 (8th Cir. 1984). A preliminary injunction maybe issued through the exercise of a court’s “equitable discretion.” eBay Inc. v. MercExchange, L.L.C., 547 U.S. 388, 391 (2006).
In considering injunctive relief, the court must weigh four factors:(1) the probability or likelihood of success on the merits of claim; (2) the threat of irreparable harm or injury to the movant absent preliminary relief; (3) the balance of equities, weighing the harm suffered by the movant against the harm to the non-movants that would result from issuing an injunction; and (4) the public interest. Dataphase Sys., Inc. v. C L Sys., Inc., 640 F.2d 109, 113 (8th Cir. 1981). The moving party bears the burden to establish that a preliminary injunction is appropriate by a clear showing that they are entitled to such relief. Mazurek v. Armstrong, 520 U.S. 968, 972 (1997) (per curiam).
Although none of the Dataphase factors are determinative, probability of success is “the most significant.” Carson v. Simon, 978 F.3d 1051, 1059 (8th Cir. 2020). Furthermore, a plaintiff is not required to establish with absolute certainty that irreparable harm will occur, but it must show that “irreparable injury is likely in absence of an injunction.” Winter, 555 U.S. at 22. Failure to show irreparable harm is an “independently sufficient basis upon which to deny a preliminary injunction.” Sessler v. City of Davenport, 990 F.3d 1150, 1156 (8th Cir. 2021).
Court’s Analysis
The Surety argued that it was entitled to a preliminary injunction based on the clear provisions in the Indemnity Agreement, which is further supported by its common law right of exoneration and quia timet. The Indemnitors contended that equity favored the denial of the motion.
As noted above, the “likelihood of success on the merits” is the most important of the factors and “it should receive substantial weight in the court’s analysis.” Cigna Corp. v. Bricker, 103 F.4th 1336, 1343 (8th Cir. 2024). A movant must establish there is a “fair chance” of success on the merits of its claim. The Surety’s claim, in part, was for specific performance requiring the Indemnitors to post cash collateral, allow the company to inspect the financial records, and pay for its attorney’s fees in connection with enforcement of the contract. Specific performance of a contract serves to effectuate the purpose for which a contract is made and is to be granted only in extraordinary, unusual cases in which irreparable harm will result in its absence, not as a matter of grace. UE Local 893/IUP v. State, 997 N.W.2d 1, 12 (Iowa 2023). The Surety argues that the requirement for the Indemnitors to deposit collateral upon demand by the company is clearly and expressly provided for in the Indemnity Agreement. Furthermore, the Surety maintained that the inadequacy of a remedy at law is explicitly stated in the Indemnity Agreement, which provided:
Indemnitors acknowledge that their duty to deposit collateral under this Paragraph is specifically enforceable because [Surety] lacks an adequate remedy at law and their failure to deposit collateral with [Surety] as required by this Paragraph will cause irreparable harm as to justify injunctive relief compelling the deposit of collateral.
The United States Court of Appeals for the Eighth Circuit, which includes Iowa, has not addressed collateral security provisions in an indemnity agreement, however, district courts within the Circuit have enforced them. See Safeco Ins. Co. of Am. v. Lake Asphalt Paving & Co., 807 F. Supp. 2d 820, 826–27 (E.D. Mo. 2011); Merchs. Bonding Co. (Mut.) v. Ark. Constr. Sols., LLC, CASE NO. 5:18-CV-05078, 2019 WL 452767, at *5 (W.D. Ark. Feb. 5, 2019).
The Indemnitors argued that the Surety did not have an existing obligation and any obligations owed by the Indemnitors to the Surety is contingent on success by the obligee in its lawsuit against the Surety. They noted that the Surety took the position that the obligee was not entitled to call on the bonds in the litigation with the obligee. The Indemnitors further contended that the subdivision was subsequently foreclosed upon by the lender and their obligation under the bonds would not arise because the property will “almost certainly be sold to another developer.” The court dismissed this argument noting that the Indemnitors misconceive of the issue in the request for injunctive relief, the question for the court on the likelihood of success on the merits is not whether the obligee is likely to succeed against the surety in a separate case, rather it is the Surety’s chances against the Indemnitors on its claims under the Indemnity Agreement. The Indemnity Agreement expressly contemplates that the Indemnitors would be obligated to indemnify, exonerate, and hold harmless the surety “from and against any actual or anticipated Liability & Loss.” Moreover, the court noted that the Indemnity Agreement requires the Indemnitors to deposit collateral “immediately” upon demand in an amount that:
(a) Surety deems necessary in its sole discretion at the time of the demand to protect itself from actual or anticipated Liability & Loss; (b) an amount Surety determines is sufficient to collateralize or pay any outstanding Bond obligations and all outstanding liability in connection with any Bond, including the aggregate penal sums of any Bonds where Principals and Indemnitors are unable to produce the full and complete discharge of Surety from its Bonds upon demand; and (c) all other amounts payable to Surety according to the terms and conditions of this Agreement or Other Surety Agreements.
Further, the court observed that the Indemnity Agreement also provides that Indemnitors are required to deposit the collateral as demanded “regardless of whether they dispute their liability for any Liability & Loss or potential Liability & Loss or assert any defenses to the validity or enforcement of this Agreement.” Quoting from another court, “the entire purpose of a contract is to provide security to a surety in the event of a third party’s claim for damages, that lack of security cannot be adequately remedied by a money judgment months or years down the road.” Merchs. Bonding Co., 2019 WL 452767, at *5 and “even if damages might be available to a surety in the future, the surety bargained for a collateral security clause to protect it from risk of liability as part of the contract. Lake Asphalt Paving & Co., 807 F. Supp. 2d at 827. “The protection provided by a collateral security provision would be impaired if the surety had to suffer even a temporary loss after a principal’s failure to perform.” In Travelers Cas. & Surety Co. v. Ockerlund, No. 04 C 3963, 2004 WL 1794915, at *5 (N.D. Ill. Aug. 6, 2004) the court concluded that case law and the Restatement “make clear that, for a surety in this situation, it is not simply an issue of a monetary loss; rather, it is an issue of impairing a surety’s expectation and requiring it to suffer any loss, even if only temporary, associated with the performance of a primary obligor’s duty”.
The court in this case also noted that its conclusion has been reached by courts around the country when considering whether a surety make seek specific performance of a collateral security clause. Citing Safeco Ins. Co. of Am. v. Schwab, 739 F.2d 431, 433 (9th Cir. 1984); Ohio Cas. Ins. Co. v. Fratarcangelo, 7 F. Supp. 3d 206, 214 (D. Conn. 2014); First Nat’l Ins. Co. of Am. v. Sappah Bros., Inc., 771 F. Supp. 2d 569, 574 (E.D. N.C. 2011); Liberty Mut. Ins. Co. v. Aventura Eng’g & Const., 534 F. Supp. 2d 1290, 1321 (S.D. Fla. 2008).
As to the factor of “irreparable harm” the surety argued that without an injunction it will suffer irreparable harm by virtue of the fact that it will not be able to avail itself of its contractual rights and enjoy the benefits of its bargain with Indemnitors. As part of the Indemnity Agreement, the Surety bargained for a specific security arrangement, wherein the Indemnitors agreed to post collateral security upon demand. The Indemnitors also assented to cover pending claims brought on the Bonds, as well as any potential liabilities and losses as defined in the Indemnity Agreement. Without enforcement of the collateral security provision, the Surety contended that it will forfeit its contract rights and suffer irreparable harm from its loss.
The Indemnitors responded that there was no irreparable harm because the Surety was only seeking indemnity for “a potential judgment” that had not been issued and may never be. The court rejected the Indemnitors’ position because the Indemnity Agreement provides the Surety with not only a right to indemnity for a final judgment on the bonds, but also imposes other obligations on the Indemnitors such as posting of cash collateral upon demand to protect the Surety from future potential loss. Other courts have similarly found that a surety in the same position has an immediate and irreparable risk of injury if specific performance of a collateral security clause is not enforced. See Am. Motorists Ins. Co. v. United Furnace Co., Inc., 876 F.2d 293, 302 (2d Cir. 1989); Westfield Ins. Co. v. Rainey Contracting, LLC, 179 F. Supp. 3d 798, 801–02 (E.D. Tenn. 2016); XL Specialty Ins. Co. v. Bighorn Constr. & Reclamation LLC, Civil No. 21-3068-BAH, 2022 WL 2105925, at *10 (D. Md. June 10, 2022); Great Am. Ins. Co. v. SRS, Inc., Civil No. 3:11-cv-00970, 2011 WL 6754072, at *8 (M.D. Tenn. Dec. 23, 2011).
Furthermore, the court stated “the purpose of a collateral security provision (and the benefits derived from its bargain) is that a surety will not have to compete with other unsecured creditors regarding the assets of a principal.” Citing Am. Motorists Ins. Co. v. Pa. Beads Corp., 983 F. Supp. 437, 441 (S.D. N.Y. 1997); Great Am. Ins. Co. v. Global Team Elec., LLC, 3:20-cv-00218-RJC-DSC, 2020 WL 2527034, at *6 (W.D. N.C. May 18, 2020).
Under the “balance of the equities” factor the question is whether the likely harm suffered by the movant in the absence of preliminary relief exceeds the likely harm to the non-movant if an injunction is issued. The Surety argued that compelling the Indemnitors to deposit collateral security will not cause them substantial harm, but will only require them to perform their contractual obligations and that it would be prejudiced without specific performance because it will never be able to exercise its collateral security rights under the Indemnity Agreement. An injunction ordering specific performance by the Indemnitors will simply put all of the parties to the Indemnity Agreement in a position for which they bargained. The Indemnitors argue that they would suffer substantially more harm from an injunction than would be suffered by the Surety because if they do not have the cash on hand to post as collateral, the Surety will “request the Court enjoin their fundamental liberties to sell, transfer, and dispose of their own property, or in the alternative, place a lien on all assets in which Indemnitors own or have an interest.” Some of the Indemnitors also pointed to alleged fraud perpetrated upon them by some of their co-indemnitors which induced them to agree to indemnification. The court held that the Indemnitors’ position regarding the balance of equities was wholly unpersuasive. “The Court cannot accept their position that it would be inequitable to issue an injunction ordering them to comply with provisions in a contract of unchallenged validity to which the Indemnitors undisputedly agreed.”
The final consideration involves the “public interest” factor. The court noted that the Eighth Circuit has repeatedly recognized that enforcement of contracts serves the public interest. Accordingly, the public interest favors judicial enforcement of contracts according to their own terms and predictability is equally important in equity proceedings as in law. Permitting parties to disclaim their contractual obligations will not promote the reliability of future contracts and would undermine the surety industry.
The court granted the Surety’s motion for preliminary injunction. This case provides a good road map to enforcing a collateral demand through a preliminary injunction under Iowa and Eighth Circuit law.
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (410-659-1321/mstover@wcslaw.com) or any member of the Surety and Fidelity Practice Group.