California is just one of many states which allow employers to self-insure
workers compensation as long as the employer supports that self-insurance with
a surety bond or other form of security. This article discusses California workers
compensation self-insured bonds in the context of the employer's bankruptcy.
Statutory Background of Self-Insured Bonds
California law requires that every employer provide for payment of workers
compensation claims either by obtaining insurance or obtaining a certificate
to self-insure from the California Department of Industrial Relations (DIR).
Self-insured employers are required to deposit security in a prescribed amount
and acceptable form. The security deposit ensures payment of the self-insurer's
"incurred liabilities for the payment of compensation and the performance of
the obligations of employers imposed" under the workers compensation code.
Incurred liabilities for the payment of compensation are defined as:
the sum of an estimate of future compensation … plus an estimate of the
amount necessary to provide for the administration of claims, including
If a self-insured fails to pay workers compensation, the DIR may use the
self-insured's security "to administer and pay the employer's compensation obligations."
A self-insured employer may provide any combination of authorized forms of
security, so long as the DIR deems the deposit adequate. The DIR permits surety
bonds from admitted sureties on DIR-provided bond forms.
Extent of the Surety's Obligation
The DIR bond form provides that the surety's obligation:
shall cover and extend to all past, present, existing, and potential
liability of said principal as a self-insurer, to the extent of the penal
sum ¼without regard to specific injuries, date or dates of injuries, happenings
The surety's obligation under the bond may only be exonerated when the self-insurer
has substituted another deposit. ("Exoneration" here is synonymous with discharge
or a complete release compared to "termination" or "cancellation" where the
surety's liability is discontinued only on a going forward basis.) Thus, the
bond remains in force for any liability incurred as of the cancellation effective
date until new security is deposited, then the original surety's liability is
Short of exoneration, the bond may be terminated "in the manner provided
by law." Termination occurs in the event of (1) change in the principal's proprietorship,
(2) appointment of a receiver or trustee, or (3) the Certificate of Consent
to Self-Insure is revoked. Unlike exoneration, in these three circumstances,
the surety's obligations are terminated "save and except as to all past, present,
existing and potential liability of the principal...." A self-insurer incurs
"potential" liability on a workers compensation claim as soon as claim is made.
Under the DIR regulations, bond cancellation is an additional means for the
surety to terminate its liability. A surety can cancel its bond upon 30 days'
written notice. The self-insurer then has 30 days to obtain substitute security.
The DIR cannot exonerate the original surety from liability until it receives
such substitute security, despite the fact that the original bond is canceled.
California Code of Civil Procedure section 996.330 governs the surety's liability
after the cancellation effective date. That section provides:
If a surety cancels or withdraws from a bond:
- The bond remains in full force and effect for all liabilities incurred
before, and for acts, omissions, or causes existing or which arose before,
the cancellation or withdrawal. Legal proceedings may be had therefore,
in all respects as though there has been no cancellation or withdrawal.
- The surety is not liable for any act, default, or misconduct of the
principal or other breach of the condition of the bond that occurs after,
or for any liabilities on the bond that arise after, the cancellation or
- The cancellation or withdrawal does not effect the bond as to the remaining
sureties, or alter or change their liability in any respect.
Thus, cancellation stops the accrual of any liability under the bond arising
from an injury occurring after cancellation.
Sureties may argue that cancellation relieves them of liabilities that the
employer incurred prior to termination, so long as the employer's obligation to pay has not arisen. In fact,
the DIR cannot use the security deposit until it determines that the self-insured
has failed to pay. Thus, a surety will argue that a self-insured has an incurred
estimated future liability but no obligation to pay. Accordingly, sureties will
argue that a self-insured's failure to make payments after bond cancellation,
even for preexisting estimated future liabilities, constitutes default after cancellation for which the surety
is not liable.
Needless to say, the DIR will take a contrary position. The law is not clear
on this point, but the DIR's position has merit. Pursuant to the bond form and
applicable law, the surety bond covers the self-insured's total incurred workers
compensation liability, including estimated future liability for existing claims.
The purpose of that security is to protect the state from bearing the burden
of those injuries already incurred, but unaccrued. It would, therefore, be counter
to public policy and the statutory scheme to allow a surety to escape already
incurred liability by terminating its bond before the principal's payment actually
In fact, California's bond form is referred to as a "last surety on" form
because the surety is arguably obligated thereunder until replaced.4 No California case specifically addresses this issue, but one New York court
held in dicta that the surety is obligated to pay any past, present, or future
liabilities that arose while its bond was effective, even if the principal's
default does not occur until after bond termination.5
The DIR's position on this issue is significant because it resolves any dispute
regarding liability arising out of a self-insurer's security deposit. A surety
can only appeal the DIR's decision by filing a petition for writ of mandate.6
An Employer's Bankruptcy
Even when a corporation is in a Chapter 11 bankruptcy reorganization, it
will probably pay its workers compensation obligations without interruption
in order to continue in business. Thus, bankruptcy will not necessarily impact
the surety's bond exposure. The surety's obligation to pay does not arise unless
the employer fails to pay.
Nonetheless, most sureties prefer not to continue their bond exposure if
their principal is in bankruptcy. In that regard, a surety's ability to terminate
a bond is arguably not jeopardized. Bankruptcy imposes an automatic stay, which
would prevent the surety from canceling the bond; however, there are very good
arguments for granting the surety relief from the automatic stay.
Bankruptcy Code section 362(d)(1) provides that upon request of a party in
interest and after hearing, a bankruptcy court "shall" grant relief from the
automatic stay of Bankruptcy Code section 362(a), "for cause." Such "cause"
exists as a matter of law where a creditor seeks relief to terminate an agreement
that the debtor is prohibited from assuming or assigning.7
A creditor seeking relief on this basis has the initial burden of producing
evidence sufficient to establish a prima facie case that the debtor may not
assume or assign the agreement.8 Once the
creditor establishes a prima facie case, however, the burden shifts to the debtor
to prove that the creditor is not entitled to relief.9 An employer is prohibited from assuming or assigning a surety bond absent the
creditor's consent because such a bond is a "financial accommodation." The Ninth
Circuit defines "financial accommodation" as "the extension of money or credit
to accommodate another."10
A workers compensation self-insured surety bond, is an extension of credit
in the form of an agreement to stand for the debt of another.11 When the surety has not consented to provide post-petition financing, the surety
is entitled to relief from the automatic stay to terminate the surety bond.
In these situations, unless the bankruptcy court grants retroactive relief,
the surety will arguably have been forced, without its consent, to provide post-petition
financing. A court can remedy such prejudice by annulling the automatic stay,
allowing the surety to terminate the bond as of the Bankruptcy Petition Date.
Bankruptcy courts have "wide latitude" in determining the scope of relief, including
granting that relief retroactively.12
Surety's Recourse upon Making Payment
Upon making payment, the surety is entitled to statutory and contractual
indemnity from the employer. Admittedly, such indemnity is of dubious value.
One 1996 Ninth Circuit Court of Appeals decision, Industrial
Commission of Arizona v Camilli, 94 F3d 1330 (9th Cir 1996), certiorari
denied 519 U.S. 1113 (1997), found that an employer's reimbursement obligation
to the Industrial Commission of Arizona for workers compensation benefits which
the commission paid was in the nature of an excise tax and, therefore, was non-dischargeable
under Bankruptcy Code section 523(a)(1)(A) and 507(a)(8)(E). There are a number
of later lower court cases that have refused to follow Camilli.13 Thus, while possible, it seems remote that an employer's indebtedness to its
surety could be non-dischargeable.
The Surety's Priority Rights in the Employer's Bankruptcy
A surety is statutorily entitled to the same priority over the principal's
other creditors as is are employees entitled to workers compensation. However,
the Bankruptcy Code does not give such an employee priority because payment
of pre-petition injury claims provide no benefit to the estate.14 On the other hand, post-petition injury claims are entitled to priority.15
The Surety's Subrogation Rights
The surety is subrogated to any claims it pays.16 No cases address whether a surety paying post-petition injury claims is entitled
to the priority workers' claims enjoy in bankruptcy. Two cases hold that state
trust funds guaranteeing post-petition claims are entitled to priority.17 A surety would arguably be entitled to the same priority.