Surety Bond

• A surety bond is a promise from a surety bond company to third parties engaged in business with you, the bonded contractor. The promise is that the surety company will pay the third party if you don’t perform as agreed. As a general rule, a surety company’s promise, as represented by the bond, doesn't get discharged when you file bankruptcy; accordingly, the surety company must pay all valid claims arising prior to your bankruptcy filing. Unlike the surety company’s obligation to the third party, the dischargeability of your obligation to the surety company will depend on circumstances such as your chosen bankruptcy chapter.
  
  

Bankruptcy

• As a contractor, you may file Chapter 7, Chapter 13 or Chapter 11 bankruptcy, depending on your business’ form and your future plans for the business. For example, any type of business may file a Chapter 7; however, Chapter 7 generally requires you to close your business and liquidate its assets. Moreover, partnerships and corporations don’t qualify for a discharge under Chapter 7. Chapter 13 bankruptcy involves keeping most of your assets while repaying some or all of your debts through a court-approved three-to-five-year payment plan. However, corporations and partnerships don't qualify for Chapter 13. Chapter 11, which is a popular option for businesses, involves keeping the business going while repaying debts according to a plan both your creditors and the bankruptcy court approves. Corporations and partnerships, as well as other filers, may seek a discharge in a Chapter 11 bankruptcy.
  
  

Indemnification

• Prior to issuing you a surety bond, the surety company likely required you to sign an indemnification agreement. According to the Black’s Law Dictionary, to indemnify means “to reimburse (another) for a loss suffered because of a third party’s or one's own act or default.” This indemnification agreement means that if the surety company had to pay on a bond, you must reimburse it for the amount paid, plus attorney’s fees and other associated expenses. Some surety companies also require a contracting company's owners and their spouses to sign indemnification agreements as an added precaution. This means that if your contracting business files bankruptcy and discharges its debt to the surety company, the surety company may pursue other parties who signed the agreement.
  
  

Subrogation

• The bankruptcy court generally will recognize your surety company’s subrogation rights in spite of your bankruptcy. The surety company generally has the right to subrogate itself to your rights once it pays claims against you. This means it can step into your shoes and take advantage of any benefit you’re entitled to under a construction contract. For example, a surety may have a right to retainage, which is the percentage of a construction contract’s value that third parties sometimes hold back until you complete the work as agreed. Since you have a right to those funds upon completing the project, the surety company can step in and take them.
  
  

Warning

• The laws concerning contractor liability, suretyship and bankruptcy are complex. Accordingly, for legal advice, you should consult a licensed attorney in your state.