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Performance Bonds , Indemnity Agreements and Contractor’s Spouses

Building contractors often have to provide performance bonds to owners. Do their spouses understand they are cosigning for those bonds and may lose their homes and personal assets when obtaining the bond?

Contractors’ spouses’ risk on bonded projects

You may have heard of the problem of a spouse who gets stuck with a tax liability for unpaid taxes or an incorrect or false tax return. Here’s a similar problem for innocent, or at least uninformed, spouses, who are married to contractors. I’m a board certified construction lawyer, and I’m saddened to see spouses learning for the first time, at the end of a project, that they are jointly and severally, personally liable for claims arising out of construction projects.

How It Happens

It starts when your husband or wife owns a construction company. On a big job, or a public job, the owner may require a payment or performance bond to guarantee the contractor’s work. The bond is a promise by a financially responsible institution to guarantee that if the builder fails to perform, the bonding company will pay the owner for the cost to complete the job (subject to many caveats). The company that issues the bond, called the “surety”, charges the builder a premium for the bond, just like insurance. Unlike most insurance, the surety will also usually require the individual owners of the builder to sign an “indemnity agreement.” The agreement means that if the surety has to pay the owner, the surety can collect whatever it paid from the builder, individually. This is true regardless of whether the builder is a corporation. The entire point of the indemnity agreement is to (lawfully) defeat the defense that the company’s owners are not individually liable.

How does this affect the builder’s spouse?

Of course, individuals have defenses too, and sureties have been around the block a few thousand times. They know that an individual owner of a contracting company, if married, would claim his or her assets are marital property, and marital property is typically not liable for one spouse’s business debts. The fix: the surety insists that the contractor’s spouse co-sign the indemnity agreement. This results in the spouse being jointly liable with the company-owning spouse for the duty to repay the surety, if the surety ever has to pay the owner for a breach by the contractor. (That’s a long and complex sentence, but it’s the key issue: if owner collects from surety, surety collects from family of the owners of contracting company). The owner’s claim against the surety may be for hundreds of thousands or millions of dollars, and will typically include the bonding company’s attorneys’ fees. The surety also typically gets to recover its attorneys’ fees from the construction company owners. This exposure may present financial ruin for the builder’s spouse and family.

What to look out for

There is nothing dishonest or illegal about this chain of events. It is simply an intelligent way to structure a transaction from the surety’s viewpoint. However I suspect it presents a huge and nasty surprise to a lot of spouses who have no involvement in the contracting company’s business, have no idea that the company or a job is in trouble, and discover to their dismay that their comfortable lives have just been financially ruined. I attended a mediation recently where the contractor (call it Smith & Jones Construction) had million dollar problems on a job, maybe or maybe not the builder’s fault. Regardless the attorneys’ fees were in six figures to defend the surety. The builder was bankrupt; the builder’s insurance company denied coverage; the surety litigated the case for three years; and I suspect there was a very hard negotiation among the insurer, the surety and Mrs. Smith and Mrs. Jones’ lawyers over how much of the low 7 figure tab each was going to pay. The starting point for the problem, and the red flag, should have been when Mrs, Smith and Mrs. Jones were asked, probably by their spouses, to sign an “indemnity agreement.” Maybe they read and understood it; maybe, like many  documents passed between spouses, they just signed it.

For a contractor’s spouse, being asked to sign an indemnity agreement should be a red flag event like signing a tax return or cosigning a bank loan or equipment lease. It means that the defenses that the individual shareholders aren’t liable for company debts, and marital property isn’t reachable to pay the spouse’s individual debts, are out the window.

Why would anyone sign such an agreement? What’s the fix?

The problem for the spouse is , without the indemnity agreement, there will be no bond; without a bond, the contractor doesn’t get the job; without the job, the family doesn’t eat. I think every spouse of a contractor who does bonded work ought to think carefully about whether getting bonded work is worth the risk; and alternatively, consult with a very well qualified asset protection lawyer to get advice on how to structure the family’s property ownership, in a legal way, to trump the surety’s ability to pursue martial assets.