May 25, 2017 Articles

The Pitfalls of Litigation Bonds

By Michal Rogson

If you haven’t heard of a “litigation bond,” you’re in good company. While some lawyers encounter this unique area of litigation practice immediately, many do not encounter it until the right case comes along. But ignorance of the nature and procedure of litigation bonds is a significant drawback. If your lawsuit does require such a bond, you will likely have very little time to procure it. And your client will be looking to you for guidance. Furthermore, knowing when a bond can be required—or may be utilized even when not required—can be of strategic value. This article will enable you to address your bond needs knowledgeably and efficiently.

 

What Is a Litigation Bond?
First, a basic understanding of litigation bonds is helpful. A litigation bond is a type of surety bond that serves as a third-party guarantee for the condition stated in the bond. While “surety” is a subset of insurance, surety bonds are not insurance policies. Instead, they are guarantees that if the primary party does not fulfill its obligation under the bond, the surety will fulfill that obligation and will then seek recovery/indemnification from the primary party. Thus, the primary party (your client) continues to retain liability, even once the bond is filed. The key to qualifying for a surety bond, therefore, is to ensure that your client is able to satisfy whatever obligation is being bonded, so that its indemnity will qualify it for the necessary bond. Such bonds are usually required when the court is asked to take an action that may be necessary to maintain the status quo but that can result in damage to the other party. The law seeks to balance the equities by requiring a bond to offset any damages that may be suffered should the court’s action ultimately prove unjustified. This has given rise to bond requirements when seeking stays of execution of a judgment pending appeal, writs, or injunctions.

What Do Appeal, Writ, and Injunction Bonds Achieve?

Appeal bonds. The most common litigation bond is the “appeal” or “supersedeas” bond. All state and federal courts will ordinarily require an appeal bond in order to stay execution of a money judgment for the duration of the appeal. The bond guarantees payment of the judgment, while protecting both parties. If the appeal fails, the bond can make the judgment creditor whole, placing it in the same position it would have been had the appeal not occurred. If the appeal is successful, posting a bond in lieu of up-front payment obviates the need to attempt to recover funds already paid out to the judgment creditor. The bond requirement further discourages judgment debtors from filing frivolous appeals in hopes of using the delay to render themselves judgment proof, as they will have to guarantee coverage of the bond obligation. The appeal bond is therefore an excellent tool for maintaining the status quo for the duration of the appeal.

Writ and injunction bonds. While the appeal bond requirement typically occurs after most of the litigation story has transpired, an extensive array of other bond requirements can arise over the course of the litigation itself. These can generally be divided into two categories—injunction and writ bonds. Injunction bonds include the bonds necessary to obtain preliminary injunctions, temporary restraining orders, temporary protection orders, or appointments of receivers. The most common writ bonds include writs of attachment, possession, sequestration, replevin, and claim and delivery, although every jurisdiction has its own unique array of interim protections that could require the posting of a surety bond. Any situation in which one party seeks an order enjoining another party from taking an action it would otherwise have the legal right to take, or requiring the other party to take an action it would not ordinarily be obliged to take, will typically require the posting of a bond to cover the damage that may result from such an order. Similarly, an order allowing one party to take or retain possession of something it may not have an absolute right to will require the posting of a bond to cover the damages to the other party that may result from such an order.

The effective use of these types of interim protections can be critical in a litigation strategy. For example, stopping the use of improperly appropriated data is the first step in litigating a breach of a noncompete clause. Similarly, repossessing machinery that is the subject of a breach of the payment contract prevents devaluation or damage during the course of litigation. But to obtain either of these results, the court is likely to require your client to provide a bond to protect the adversely impacted party. The court will want the bond to ensure that, should your client lose at trial, the other party can be returned to the position it would have been in had the injunction or writ not issued—the status quo.

What Is the Client’s Exposure?
The bond is not an insurance policy where the client pays a premium and is absolved of further liability. Instead, the client remains liable for the full amount of the bond (its “penal sum”). With appeal bonds, the exposure is typically the judgment amount plus costs and interest on appeal. With writ and injunction bonds, the exposure is determined by the amount of bond ordered by the court. The considerations for each are distinct.

Appeal bonds. The first question to ask when considering an appeal bond is: should we even file such a bond? If your client is judgment proof, there is little point to filing a bond that stays execution. It is also likely that the client will not qualify because, for an appeal bond, sureties often require full collateral—which most judgment-proof clients cannot post. The rationale for the collateral requirement is clear: if the appeal is lost, the client is expected to pay the judgment with interest and costs on appeal. The surety will want to ensure that the client is able to do so. While some clients can establish sufficient liquid net worth to get approved without full collateral, the average judgment creditor cannot. And almost all states require that the bond cover not just the judgment amount, but also an additional amount for postjudgment interest and costs on appeal. Some states codify that “additional amount,” e.g., California requires a bond for 150 percent of the judgment amount. Cal. Civ. Proc. Code § 917.1. Other states simply indicate that the bond must cover interest and costs without specifying what amount must be factored in. See, e.g.Tex. R. App. Proc. 24.2(a)(1). Where not otherwise stated by statute, the current standard in the surety industry is to factor in an additional 25 percent, so your client will need to qualify for (and potentially collateralize) a bond for 125 percent of the judgment amount. Therefore, the first conversation you should have with your client is how it intends to pay the judgment, and whether it can collateralize 125 percent of the judgment amount.

Writ and injunction bonds. Unlike appeal bonds, the amount of an injunction or writ bond is based on the potential resulting damages and is therefore open to argument. As the moving attorney, you have several options. You can negotiate an amount with opposing counsel and stipulate to it before the court. Or you can choose to argue the appropriate amount, seeking to obtain a favorable result from the court. The amount of a writ or injunction bond typically is not found in a statute but rather is subject to the court’s discretion. The smaller the bond requirement, the easier it will be for your client to qualify. While collateral is not always required for this type of bond, it is still a fairly common requirement, particularly if your client’s credit or financials are not the best. So it is always worthwhile to anticipate and be prepared for such a requirement.

Obtaining the Bond
The first step in obtaining a litigation bond is determining your point of contact. You can reach out to a surety directly or utilize a surety agent (much like an insurance agent) who can guide you through the process. If you choose to use an agent, try to find one who handles such bonds regularly. While a local agent is helpful, proficiency with the type of bond you are seeking is much more advantageous than locale. Using a surety agent who is not familiar with litigation bonds can slow the process down significantly, something you can rarely afford in time-sensitive litigation. The second thing to ensure is that you are working with the most financially stable surety companies available. If the company you utilize ceases to exist before your appeal has concluded, its product becomes useless, and your client can be compromised. So be sure to check the S&P and Moody’s ratings of the sureties you’re potentially planning to use. One last thing to consider is flexibility in the type of collateral accepted. Most surety companies will accept cash collateral as well as irrevocable letters of credit from stable banks. Some surety companies will also accept the assignment of marketable securities accounts or deeds of trust to real property (typically residential only, sometimes also small commercial). The surety’s flexibility on collateral expands your client’s options should collateral be necessary.

How to Qualify
Once you’ve identified your point of contact and are prepared to reach out, you will want to maximize your client’s chances of being approved. Being prepared is the best method of doing so. With all types of litigation bonds, the surety will want to see that the client is able to cover the bond exposure being requested. You can compare it to qualifying for a loan. Admittedly, bonds are conditional, whereas loans are not. Nevertheless, the surety will seek to ascertain that if the condition is triggered, your client is able to cover whatever damages are awarded to the opposing party. The surety will want to look at the client’s financials. If the client is an entity, the surety will probably request audited financials. If the financials are not strong, be prepared to provide additional indemnitors. If there is a parent company, a relative, or any other interested party willing to provide indemnity or put up collateral, this may be a way of obtaining approval where your client alone could not. It is therefore worthwhile to explore all options that may aid in qualifying your client for the bond before you apply. Being prepared with this information up front can significantly speed up and smooth the process of obtaining the bond.

Steps for Exoneration
Now that you have successfully guided your client through the process of obtaining a litigation bond, your client will look to you for assistance when the time comes to exonerate the bond. The key to exoneration of any litigation bond is to ask whether the condition of the bond has been satisfied. Procedurally, the best thing to do is to reach out to the surety that issued the bond and ask it what it will require to exonerate the bond. If you are drafting a settlement agreement, stipulation, or court order, be sure to seek the surety’s approval of the language you plan to rely on to release the bond (or request its suggested language and simply incorporate it). Failing to do so may result in the surety’s rejecting the proposed language after you’ve had it executed—which will undoubtedly frustrate your client, who may be impatiently waiting for release of its collateral.

Appeal bonds. The condition of the appeal bond is that the judgment debtor will pay the judgment or any portion of it that is upheld on appeal. If the appeal results in reversal of the underlying judgment, proof of such reversal (and its finality) should serve to exonerate the bond. If the appeal results in anything other than a reversal (i.e., remand, partial affirmation, etc.), it would likely require either an order of the court to which the bond was remanded exonerating the bond or proof of satisfaction in order to establish that the bond can no longer be impacted by any further development relating to the judgment. The key is to assess what documents will establish definitively for the surety that its liability under the bond has been fully resolved. As stated above, it is always best to check with the surety in advance when possible.

Writ and injunction bonds. The condition of a writ or injunction bond is that the party obtaining the writ or injunction establishes with finality that it was entitled to the writ or injunction in question. Consequently, the termination of the writ or injunction does not, in and of itself, cancel the bond (a common misconception). If the writ or injunction is lifted over the course of the litigation, this may actually be a precursor to a subsequent finding that it was unjustified, in which case any damages incurred while the writ or injunction was in force would still be recoverable against the bond. Only a court order, a final judgment in the client’s favor, or a release from the protected party (e.g., in the context of a settlement agreement or stipulation before the court) can address the question of whether the condition has resolved, thereby exonerating the bond.

Payment from collateral. In the event that the appeal is unsuccessful or the writ or injunction was determined to be unjustified, and payment must be made to the opposing party, you can request that the surety satisfy the judgment or order from the assets taken as collateral. Otherwise, the surety will likely request proof that any obligation has been satisfied.

Conclusion
A basic understanding of litigation bonds can go a long way toward using them effectively and providing superior counsel to your client. Pursuing a litigation avenue that may require a bond for a client who has no way of obtaining one is impractical and can be a frustrating experience for counsel and client alike. Gaining familiarity and a comfort level with litigation bonds can also be a huge advantage, if you are prepared to be creative. While many litigation bonds are established by statute, there is nothing to prevent a litigator from proposing a bond specifically for the situation at hand and obtaining the court’s approval for the filing of such a bond. This is often an excellent litigation strategy, as it offsets any damages the opposing party may protest about, while creating an avenue for your client to achieve its desired ends. Therefore, it can often be a precursor to successful settlement negotiations. Litigation bonds are a little known tool that are often seen as a burden rather than an opportunity. The more familiar you become with the process, the better situated you are to utilize them to the full advantage of your clients.


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