Surety Case Law Note: Surety Can Pay Claims When Principal Goes Into Bankruptcy – Oh Joy!
March 12, 2024
In this Surety Today: The Blog post we consider a Case Law Note addressing the issue of the surety’s obligation to address bond claims when its principal has filed for bankruptcy protection. The secondary issue of whether the surety could seek indemnification from the individual indemnitors of the bankrupt principal, while the bankruptcy was pending, was, in effect, deferred. The case is:
MIG EAST, LLC V. SELECTIVE INSURANCE COMPANY OF AMERICA (IN RE MIG E., LLC), No. 23-51096 (Adv. No.: 23-04492), 2024 WL 332225, (Bankr. E.D. Mich. Jan. 29, 2024)
This case concerns a dispute between a surety and its bankrupt principal, MIG East, LLC (“MIG”), a Detroit-based construction services company. In 2020, MIG undertook a project as a construction manager (presumably at risk) that required it to provide a $11 million in payment and performance bonds each. MIG later acknowledged that the bonded project was significantly underbid, and it ran into difficulties paying subcontractors. These difficulties resulted in over $1,337,000 in claims being asserted against the surety.
MIG filed for bankruptcy protection under Subchapter V of Chapter 11 in December 2023. As a debtor in possession, MIG was operating through a joint venture with Roncelli Construction (“MIG-CELLI”). With the infusion of money from MIG-CELLI and the individual guarantors, MIG intends to file a plan of reorganization that proposes to repay one hundred percent of the subcontractors’ claims over three to five years. During the pendency of the bankruptcy, the surety was pursuing MIG’s individual indemnitors (who were not in bankruptcy) for indemnity and reimbursement in federal court. Litigation was also pending from some of the payment bond claimants against the surety. MIG filed an adversary proceeding in the bankruptcy against the surety asking the Court for a temporary restraining order and preliminary injunction that would: (1) stay the surety’s federal district court litigation seeking reimbursement of bond claim payments from MIG’s individual guarantors, (2) hold that any claims against the surety should be handled in the bankruptcy case; and (3) prohibit the surety from paying any bond claim during the pendency of the bankruptcy.
MIG argued in its motion that claims against the surety should be set as of the petition date, because allowing pre-petition claims to be continually adjusted post-petition creates a “moving target” that inhibits MIG’s ability to reorganize. MIG further argued that if the surety obtains a judgment against the individual guarantors, it would be akin to obtaining indemnification from MIG, because funding in the case will come, in part, from the guarantors. MIG took the illogical position that the surety was attempting to “profit” from payment of claims and has a competitive advantage over the other unsecured creditors. It further contended that the number of suits arising from bond claims was potentially unwieldy and that all claims should be handled by the bankruptcy court, which would decrease the potential for inconsistent decisions from different courts.
The court analyzed MIG’s arguments through the familiar factors required for injunctive relief. In addressing the requirement of “irreparable harm” the court held that no such harm would be suffered by MIG if the surety is permitted to pay bond claims. The court noted, “[t]he universe of potential bankruptcy claims arising from the bond is fixed at 94: if Selective pays a claim, that subcontractor’s proof of claim will simply be transferred to Selective without any administrative burden on MIG. . . . If MIG determines Selective improperly paid any bond claim, the transferred proof of claim remains subject to MIG’s objection.” As to the suggestion that the surety would somehow profit at MIG’s expense from paying bond claims, the court stated, “[t]he Court’s research has found no support for this contention. Instead, it is far more likely that the opposite is true. Like any insurance company, a surety that arbitrarily pays claims surely has a bleak future. The Court finds Selective has a financial incentive to thoroughly vet all bond claims, and deny them if appropriate.” The court further noted that with the surety leading the litigation defense any burden to MIG would be minimized and noted that the bankruptcy court was not the best forum for such claim litigation.
The court pointed to the nature of, and public policy behind, surety bonds to support its denial of injunctive relief. Observing that sureties have an independent obligation to pay bond claims, and that subcontractors who have performed the requisite work under the contract have done so with the expectation that the surety would pay them if the contractor did not promptly do so, the Court held that such subcontractors and suppliers should not have to wait years for the bankruptcy to be completed to receive their promised full payment. The court also noted that the project owner would be at risk of foreclosure because of the pending liens the unpaid subcontractors filed against the property if the surety was not required to promptly honor its bonds. Thus, the court concluded that public policy favors allowing the prompt payment of construction claims. This holding is generally in accord with most jurisdictions.
Prior to the court’s ruling on the motion, the surety pragmatically agreed to a voluntary stay of its federal district court litigation against the individual indemnitors of MIG, to allow MIG time to file a plan of reorganization. The court skirted the issue of whether it should stay the indemnification action against non-debtor third parties, noting that MIG could include a request to extend this stay in any motion to extend the deadline to file a plan. There is a split among jurisdictions whether, under what circumstances and to what extent a bankruptcy court can control external litigation between two third parties such as that between a surety and non-debtor individual indemnitors. Finally, the court held that the surety was not prohibited from paying bond claims during MIG’s bankruptcy, but any payment was limited to reimbursement for amounts due as of the petition date.
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.
