Surety Recovery Trends, Tips and Tools

Transcription

1 Surety Recovery Trends, Tips and Tools Todd C. Kazlow Kazlow & Fields LLC 8100 Sandpiper Circle, Suite 204 Baltimore, MD (410)

2 Todd C. Kazlow is President of Kazlow & Fields LLC of Baltimore, Maryland. Established in 2001, K&F pursues recovery and collection and performs asset investigations for sureties in all 50 states. He has been licensed to practice law and been involved in the surety business for over 29 years with 17 of those years as an in-house attorney for top 5 sureties. His last position prior to establishing K&F was as Assistant Vice President for Surety Claim of The St. Paul Fire & Marine Insurance Company (now known as Travelers). Mr. Kazlow has authored several articles and spoken to many industry groups about surety claim and recovery topics. He obtained his B.A. from the University of Maryland, College Park and his J.D. from The New England School of Law in Boston, MA.

3 Surety Recovery Trends, Tips and Tools Table of Contents I. Introduction...55 II. Trends in Surety...55 A. The Economy...55 B. Surety Losses...55 III. Tips for Recovering Surety Losses...56 IV. Tools Available to the Surety...57 V. Conclusion...58 Surety Recovery Trends, Tips and Tools Kazlow 53

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5 Surety Recovery Trends, Tips and Tools I. Introduction This paper will describe some new trends in the economy which will help predict the near future loss ratios of the surety industry. It is hoped that such a discussion will assist surety claim professionals in their preparation for the task of recovering losses incurred. The paper will also outline some helpful tips to maximize the surety s recovery while identifying some very helpful tools in carrying out recovery duties. The tools available to both in-house and outside counsel are ever changing and becoming more complex to master. A basic understanding of the tools available will give the practitioner the ability to know when it is appropriate to put those tools to use in the pursuit of the surety s recovery. When discussing surety recovery it is instructive to review the past and attempt to predict the future. The surety bonding industry was fairly easy to predict prior to this century as the industry entered and exited various loss cycles. (See, 2012 State of the Industry Report, The Vertex Companies, p. 48). From 1988 through 1999 the industry had only one year, 1986, when it suffered a loss. Starting in 2000 the industry began to suffer loss ratios well above 40 percent, which is considered the break even line. Since 2006, the industry has performed extraordinarily well according to the Vertex report cited herein. II. Trends in Surety A. The Economy One must view the entire U.S. economy in order to properly predict the overall state of the U.S. surety industry marked a change in the U.S. economy and many believe that these changes will be good and bad for the surety bond market. Bankruptcy filings were down 12.7 percent from 2011 and bankruptcy filings have fallen 28 of the last 31 months. In contrast, the rate of increase of filings was 87 percent from 2007 to On a national level, home prices rose in 2012 from $81.05 per square foot to $86.42 in In the southern U.S., prices rose 11 percent from 2011 to 2012 while that region experienced its largest increase in December of 2012 when prices jumped 8.3 percent. Housing is a leading indicator of an economic recovery and is crucial to surety recovery since a very large percentage of recovery dollars are the result of the sale or liquidation of the real property owned by the indemnitors. When the U.S. housing bubble burst in 2006 it wiped out a tremendous amount of the equity that indemnitors use to partially reimburse sureties for losses. This factor has had a negative effect on surety recovery since that time. Housing prices appear to be stabilizing across the country as inventory is down 16.5 percent from the 3 rd quarter of Actually, 2012 ended with an 11 year low of housing inventory as banks have finally slowed the foreclosure rate. This bodes well for surety s in the future but for now equity levels remain very low. B. Surety Losses Due to the economic meltdown experienced in 2006, surety losses for commercial and miscellaneous bonds began to increase in 2008 and peaked around Losses and claims on commercial/miscellaneous bonds have now receded and are back at normal historical levels. Because of low loss ratios on contract surety bonds (payment and performance bonds), the surety industry performed extremely well from 2007 to 2012 (See, Vertex report). The surety industry has lost less than 10 percent of its revenue since 2008, while overall construction revenue has compressed by nearly one third. Surety Recovery Trends, Tips and Tools Kazlow 55

6 The reduction of construction revenue was primarily experienced in the private sector and government stimulus programs kept surety premiums afloat and kept loss ratios low. This is expected to change as federal spending decreases and private sector construction fails to fill the void. In fact the Vertex Report forecasts an undesirable combination of shrinking public construction spending and contractor balance sheet deterioration (which) will ultimately catch up to many sureties (See, Vertex Report at p.57). Another industry publication recently predicted the following for the surety bonding industry in 2012: Frequency and severity (losses) will increase, especially in smaller end of market but in line with historic norms. Non-residential trades will be hit hardest. Stricter underwriting standards but easier access to credit for small/minority/set aside contractors will be experienced. See, Construction Executive Magazine, 10 th Annual Contractors Guide to Surety Bonding, November In fact surety s may be entering a perfect storm when one considers that equity in real property will remain low and losses are poised to increase. These conditions make it all the more imperative for the surety, and its counsel, to proceed proactively and intelligently when pursuing recovery. III. Tips for Recovering Surety Losses One way to proactively pursue surety recovery is to perform a comprehensive cost/benefit analysis no later than at the time of the posting of the loss reserve by the surety. In order to do so properly, the surety must efficiently and accurately identify the assets, if any, of the indemnitors and especially those that are not liquid and subject to hiding. The next section on Tools will provide information on how to identify those assets. It has been suggested that collateral, or an asset of the indemnitors, can be The Big Seducer (See, Bond Default Manual, Duncan L. Clore, Richard E. Towle, Michael J. Sugar, Jr., editors 3 rd ed., 2005 American Bar Association at p.161). It is very easy for the surety to over value assets and/or collateral pledged to the surety or to be liquidated by the indemnitors with the proceeds going to the surety. Hard assets like real property are the most promising assets that are used to reimburse the surety. Funds held by indemnitors in bank accounts are difficult to identify and are rarely seized by the surety. Services that offer to locate bank accounts are suspect, especially in light of recent statutes that create very high degrees of banking and financial privacy. Experience shows that debtors do not keep large sums of funds in bank accounts titled in their names and easily accessed by creditors/sureties. The most effective way to find, attach and access funds in such accounts is to obtain a judgment against the indemnitors and proceed with a shot gun bank garnishment. A comprehensive asset search, done internally or by an external vendor, will likely reveal several financial institutions that the indemnitors interact with frequently. Once those institutions are identified, the surety practitioner should issue a bank account garnishment on those institutions. It is recommended that recovery counsel forward the garnishment to at least 5-7 institutions that are most likely to have such funds. Depending on the situation, the surety may or may not be aware of the employment status of the indemnitors. Some may continue to work at the bonded principal while others, or non involved spouses, may be employed by non principal companies. Employment searches are not easy to conduct but should be attempted because wage garnishment is a very effective method of recovering surety losses. Some states (Pennsylvania) do not allow wages to be garnished. Counsel should quickly research the jurisdiction where the indemnitors employer resides and determine if a wage garnishment is allowed once a judgment is obtained against the indemnitor. As indicated earlier, real property is one of the largest sources of surety recovery often available to the surety. However, the equity, ownership and condition of such property may have changed dramatically from 56 Fidelity and Surety Roundtable May 2013

7 the time when the surety bond principal account was originally underwritten by the surety. Underwriting information and data obtained at the time the bonds were written is often unverified at such time and is not reflective of the value of the property when the principal causes the surety a loss. Market conditions change, the property may have been transferred and the property may have been subsequently encumbered by mortgages, liens, etc. Valuations of property can be obtained by local real estate professionals and estimates can be deduced by comprehensive on line searches (see next section). It is critical to value available property as early as possible in order to determine how much money the surety is willing to devote to the recovery of proceeds from such assets. This is the key ingredient when performing the cost benefit analysis referred to earlier. Sureties do not want to pursue reimbursement if the potential recovery yield is too low. Sureties are in a business and are not generally impressed with winning if that means that a judgment is obtained without the possibility of a net recovery. In the current environment sureties should be willing to be very creative when structuring settlements with the indemnitors/debtors. Because property values and equity is low, the surety will have to be patient about the speed and rate of recovery. It may be necessary in these times to structure deals that require monthly payments, secured by real property, with balloon payments that can be renegotiated at a later date when the real estate market conditions improve and equity is increased. Sureties do not want to take title to property but skilled counsel can secure the proper mortgages, etc. to protect the surety in the long term. The last tip is for both the surety and counsel to consider creative fee arrangements in the pursuit of recovery. In some cases, the traditional hourly legal fee arrangement may be preferable for both attorney and client. But other circumstances require alternative fee arrangements such as contingency, fixed fee or blended rates. Alternative fee arrangements are gaining favor among large purchasers of legal services. Each surety recovery situation is different and demands that all potential fee arrangements be explored before the recovery endeavor is undertaken by local counsel. IV. Tools Available to the Surety The only way to properly perform a reliable cost benefit analysis, as described above, is to obtain accurate information about the potential for recovery. In the last twenty years the tools available to the surety and counsel have increased substantially. The internet, public data bases, private data bases and social media have largely contributed to the ability of the surety to learn about the indemnitors financial status. One would think that this plethora of information would make the surety s job easier. In fact, the availability of this information can overwhelm the surety claim professional and its counsel. Locating and subscribing to these data bases is the easy part; understanding how to efficiently and effectively use them is an art as much as a science. Once can easily be inundated with the amount of information available. The skill is in skillfully sifting through this information to identify key information which will lead to a maximum recovery. Anyone who has conducted this type of an investigation knows that many hours can be wasted going down the wrong path. That is not to say that amateurs can t effectively navigate the internet to learn of key information and facts about the indemnitors/debtors. The following information can and should be obtained as soon as possible: Real Property Ownership, including transfers over the past 5-10 years Credit Reports Judgments and Liens Past and current litigation Bankruptcy filings Surety Recovery Trends, Tips and Tools Kazlow 57

8 UCC searches Financial Relationship with institutions Ownership, relationships with companies other than the principal One of the first things a surety should obtain is the credit report of each indemnitor. One report from at least two of the three credit bureaus should be reviewed. Such reports are a good starting point and show a current snap shot of the monthly cash expenditures and lifestyle of each debtor. The report can also show debt service to mortgage companies and other financial institutions such as auto lenders, credit card companies, etc. While some information on the report, such as employment, can be stale or inaccurate, most of the information is reliable and can lead to other inquiries. It must be noted that the surety, as a creditor, can only access and pull a credit report for an indemnitor if it has a permissible purpose under the Fair Credit Reporting Act (FCRA), 15 U.S.C. Sec 1681, Sec 604 (3) (A). If the surety has posted a loss reserve or has incurred a loss and/or expense, then it would have a permissible purpose to pull a credit report. A small sampling of on-line resources includes the following: Accurint, Dun & Bradstreet, Hoover s, Intelius, LexisNexis, PACER (federal court database), Facebook, Federal Inmate Locator, LinkedIn, and Zillow. Becoming familiar with these resources takes time and patience but using as many tools as possible in an efficient manner yields the most useful information. V. Conclusion As the surety industry enters into a new cycle, it is important for industry professionals to be aware of the most up to date means and methods for identifying and securing the maximum recovery of loss and expense incurred. Funds realized from the sale or refinancing of real property are usually the best source of pure salvage for the surety. The pursuit of cash in bank accounts is not normally productive while the search for a debtor s current employment can yield very positive results if a wage garnishment can be legally obtained. The expeditious and efficient use of new on-line tools is required in order to identify potential recovery when a surety performs a cost benefit analysis prior to embarking on a potentially expensive journey to secure a judgment against the indemnitors. Care must also be given to the ever changing and complex statutes governing credit reporting and debtor privacy. 58 Fidelity and Surety Roundtable May 2013