Can a Texas school district set its own financial standards for surety bond companies?

Plain-English summary

When a school district hires a contractor for a public construction job over $25,000, state law (article 5160) makes the contractor post performance and payment bonds backed by a surety company. Some districts worried that the surety, or the reinsurer standing behind part of the surety's risk, might be financially shaky and unable to pay if a claim came in, leaving the district holding the loss. The Texas Education Agency asked whether a district could protect itself by setting its own financial standards: could it insist that the surety be solvent enough to issue the bond without any reinsurance, and could it set minimum financial requirements for, or require Texas authorization of, the reinsurer?

The Attorney General concluded that districts cannot set their own solvency standards for sureties or reinsurers, but they do get one specific protection from the 1991 statutory amendments. Texas courts had long held that local officials have no discretion to judge a surety company's financial solvency; that job belongs to the experts at the insurance department, and a local official's approval of a properly executed bond is ministerial. The 1991 amendments to article 5160 and Insurance Code article 7.19-1 changed the picture only at the edges. They let local officials get capital-and-surplus figures from the Department of Insurance, and they let a political subdivision require a surety to reinsure the portion of risk exceeding ten percent of the surety's capital and surplus, with any such reinsurer required to be "duly authorized, accredited, or trusteed" to do business in Texas.

Reading those changes narrowly, the Attorney General gave three answers. First, a district may not require a surety to be solvent enough to issue bonds without reinsurance. Second, a district may reject a surety bond when the part of the risk above ten percent of the surety's capital and surplus is reinsured by a company not duly authorized, accredited, or trusteed in Texas, because article 7.19-1(b) requires that authorization. Third, a district may not set its own minimum financial standards for reinsurers. The opinion stressed that the Department of Insurance keeps primary responsibility for monitoring the financial condition of sureties and reinsurers, and it declined to read the amendments as silently handing districts broader power, especially since the Legislature had expressly given a few large political subdivisions that kind of authority by name (for example, in Local Government Code section 271.025(e)).

Currency note

This opinion was issued in 1992. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here. The public-works bond statute (former V.T.C.S. article 5160) was later recodified into chapter 2253 of the Government Code, and the surety-bond provisions formerly in Insurance Code article 7.19-1 have been recodified and amended, so confirm the current statutes, the dollar threshold, and the ten-percent rule before relying on anything described here.

Background and statutory framework

Article 5160, V.T.C.S., required any contractor entering a contract with a governmental entity, including a school district, for the construction, alteration, or repair of a public building or public work valued over $25,000 to execute a performance bond and a payment bond in the amount of the contract. V.T.C.S. art. 5160, subdiv. A. The 1991 amendment to article 5160 required each such bond to be executed by a corporate surety in accordance with section 1 of Insurance Code article 7.19-1; before the amendment, the statute required only that corporate sureties be "duly authorized to do business in this State." Both article 5160 and Insurance Code article 7.19-1 were amended in 1991. See Acts 1991, 72d Leg., ch. 242, §§ 11.28, 11.29, at 1067-68; Acts 1991, 72d Leg., 2d C.S., ch. 12, § 5.01, at 319.

Before its 1991 amendment, article 7.19-1 provided that whenever a bond was required, it could be executed by a surety company duly qualified to do business in the state, and that such execution "shall be in all respects a full and complete compliance with every law" requiring the bond, with all courts, public officers, and others required to accept such a bond when so executed. The courts uniformly held that this version of article 7.19-1 and its predecessor allowed local officials no discretion to determine the financial solvency of surety companies. See International Fidelity Insurance Co. v. Sheriff of Dallas County, 476 S.W.2d 115 (Tex. Civ. App.—Beaumont 1972, writ ref'd n.r.e.); Peeples v. Nagel, 137 S.W.2d 1064 (Tex. Civ. App.—Galveston 1940, writ dism'd). The reasoning was that local officials, however sincere, were ill-equipped to perform this function, which was for the experts employed by the commissioner of insurance; if the bonds were in proper form and properly executed, the local official's approval was ministerial, absent some fact justifying refusal. Lawyers Surety Corp. v. Rankin, 500 S.W.2d 181 (Tex. Civ. App.—Houston [14th Dist.] 1973, writ ref'd n.r.e.). The courts recognized that any deficiencies in this system could only be addressed by the Legislature.

The 1991 amendment to article 7.19-1 redesignated the prior language as subsection (a) and added subsection (b), which provides that if a bond is in an amount exceeding ten percent of the surety company's capital and surplus, the public entity may require, as a condition of accepting the bond, written certification that the surety has reinsured the portion of risk exceeding ten percent of its capital and surplus with one or more reinsurers "duly authorized, accredited, or trusteed to do business in this state." The amount reinsured by any reinsurer may not exceed ten percent of the reinsurer's capital and surplus, and the State Board of Insurance furnishes, on request, the allowed capital and surplus as of the last annual statutory financial statement for a surety or reinsurer authorized to do business in Texas.

The Attorney General concluded the 1991 amendments accomplished three things: they let local officials obtain capital-and-surplus information from the Department of Insurance; they effectively authorized political subdivisions to require corporate sureties to secure reinsurance for the portion of risk exceeding ten percent of the surety's capital and surplus; and they required such reinsurers to be duly authorized, accredited, or trusteed in Texas. But the primary responsibility for monitoring the financial condition of sureties and their reinsurers remained with the Department of Insurance. Given that continuing role, the Attorney General was reluctant to read the amendments as delegating greater authority to political subdivisions, particularly because the Legislature had expressly conferred authority to set financial criteria on some political subdivisions by name. See, e.g., Local Government Code § 271.025(e) (enacted in 1989, authorizing a county with a population of 2.2 million or more and certain special districts to impose such criteria). Accordingly, the Attorney General answered the first question (whether a district may require sureties solvent enough to issue bonds without reinsurance) in the negative; resolved the second by article 7.19-1(b), so a district may reject a surety bond whose portion exceeding ten percent of the surety's capital and surplus is underwritten by reinsurers not duly authorized, accredited, or trusteed in Texas; and answered the final question (whether a district may set minimum financial requirements for reinsurers) in the negative.

Common questions

Can a school district demand a surety strong enough to skip reinsurance?
No. The opinion concluded a district may not require corporate sureties to be solvent enough to issue bid, performance, or payment bonds without reinsurance. Judging a surety's solvency is the Department of Insurance's job, not the district's.

Can a district require the reinsurer to be authorized in Texas?
For the relevant portion of the risk, yes. Under article 7.19-1(b), a district may reject a bond when the part of the risk exceeding ten percent of the surety's capital and surplus is reinsured by a company that is not duly authorized, accredited, or trusteed to do business in Texas.

Can a district set its own minimum financial standards for reinsurers?
No. The opinion concluded districts may not impose financial standards on reinsurers beyond what article 7.19-1 permits.

Why do districts have so little say over surety finances?
Because Texas courts and the statutes place that oversight with the state insurance regulator. The opinion noted the Legislature gave a few specific large subdivisions added authority by name, which signaled it did not intend to give that authority to every district by implication.

Citations

• V.T.C.S. art. 5160 (public works payment and performance bonds)
• Insurance Code art. 7.19-1(a), (b)
• Local Government Code § 271.025(e)
• International Fidelity Insurance Co. v. Sheriff of Dallas County, 476 S.W.2d 115 (Tex. Civ. App.—Beaumont 1972, writ ref'd n.r.e.)
• Peeples v. Nagel, 137 S.W.2d 1064 (Tex. Civ. App.—Galveston 1940, writ dism'd)
• Lawyers Surety Corp. v. Rankin, 500 S.W.2d 181 (Tex. Civ. App.—Houston [14th Dist.] 1973, writ ref'd n.r.e.)

Source

• Landing page: https://www.texasattorneygeneral.gov/opinions/dan-morales/dm-0165
• Original PDF: https://www.texasattorneygeneral.gov/sites/default/files/opinion-files/opinion/1992/dm0165.pdf

Original opinion text

Best-effort transcription from a scanned PDF. Minor errors may remain. The linked PDF is authoritative.

Office of the Attorney General
State of Texas

DAN MORALES
ATTORNEY GENERAL

September 21, 1992

Mr. Skip Meno
Commissioner
Texas Education Agency
1701 North Congress Avenue
Austin, Texas 78701-1494

Opinion No. DM-165

Re: Whether a school district can require a corporate surety to be sufficiently solvent to issue bid, performance, or payment bonds without reinsurance, and related questions (RQ-98)

Dear Commissioner Meno:

You ask whether school districts in this state may require corporate sureties on bid bonds, payment bonds, and performance bonds to be sufficiently solvent under the Texas Insurance Code to issue these bonds without the necessity for reinsurance. If school districts may not require sufficient financial solvency without need for reinsurance, you ask whether school districts may require either (1) that a reinsurance company underwriting a bond be admitted and authorized to do business in Texas, or (2) that the reinsurer meet minimum financial standards set by the district. In light of recent changes in the laws governing the procurement and submission of bid bonds, payment bonds, and performance bonds on public improvement projects, we conclude that a school district may not establish minimum financial standards for reinsurance companies. However, because these laws require a reinsurance company underwriting any portion of a performance or payment bond which exceeds ten percent of a surety company's capital and surplus to be "duly authorized, accredited, or trusteed to do business in this state," a school district may reject any such bond which does not meet this requirement.

The answers to your questions are governed by article 5160, V.T.C.S., and section 7.19-1 of the Insurance Code. Both provisions were amended during the most recent session of the Texas Legislature. See Acts 1991, 72d Leg., ch. 242, §§ 11.28, 11.29, at 1067-68 (amending both); Acts 1991, 72d Leg., 2d C.S., ch. 12, § 5.01, at 319 (amending art. 7.19-1). Article 5160 requires any person or persons, firm, or corporation entering into a contract with a governmental entity, including a school district, for the construction, alteration, or repair of any public building or public work valued in excess of $25,000, to execute a performance bond and a payment bond in the amount of the contract. V.T.C.S. art. 5160, subdiv. A. The 1991 amendment to article 5160 requires each such bond to be executed by a corporate surety or sureties in accordance with section 1 of article 7.19-1 of the Insurance Code. Prior to the amendment, the statute provided only that such corporate sureties be "duly authorized to do business in this State."

Prior to its amendment in 1991, article 7.19-1 provided the following, in pertinent part:

      Whenever any bond . . . is, by law or the charter, ordinances, rules and regulations of a municipality, board, body, organization, court, judge or public officer, required or permitted to be made, given, tendered or filed, and whenever the performance of any act, duty or obligation, or the refraining from any act, is required or permitted to be guaranteed, such bond . . . may be executed by a surety company duly qualified to do business in this state; and such execution by such company of such bond . . . shall be in all respects a full and complete compliance with every law, charter, rule or regulation that such bond . . . shall be executed by one surety or by one or more sureties, or that such sureties shall be residents, or householders, or freeholders, or either, or both, or possess any other qualification, and all courts, judges, heads of departments, boards, bodies, municipalities, and public officers of every character shall accept and treat such bond . . . when so executed by such company, as conforming to, and fully and completely complying with, every requirement of every such law, charter, ordinance, rule, or regulation.

Ins. Code art. 7.19-1 (pre-1991 language) (emphasis added).

The courts uniformly held that this version of article 7.19-1 and its statutory predecessor allowed local officials no discretion to determine the financial solvency of surety companies. See International Fidelity Insurance Co. v. Sheriff of Dallas County, 476 S.W.2d 115 (Tex. Civ. App.—Beaumont 1972, writ ref'd n.r.e.); Peeples v. Nagel, 137 S.W.2d 1064 (Tex. Civ. App.—Galveston 1940, writ dism'd). The courts reasoned that local officials, no matter how sincere, were ill-equipped to perform this function and that these matters were for the determination of experts employed by the commissioner of insurance. International Fidelity Insurance Co. Consequently, if the bonds were in proper form and properly executed, approval by the local official was ministerial, absent some fact that would justify a refusal to approve. Lawyers Surety Corp. v. Rankin, 500 S.W.2d 181 (Tex. Civ. App.—Houston [14th Dist.] 1973, writ ref'd n.r.e.). The courts were not unsympathetic to the dilemma of local governments, but conceded that any deficiencies in this system could only be addressed by the legislature. International Fidelity Insurance Co.

Your questions are prompted by the concerns expressed by some school districts that state law provides little control over the financial condition of companies that reinsure portions of the risk undertaken by surety companies executing performance and payment bonds under article 5160. It is suggested that state laws do not require reinsurers of surety companies to be licensed in Texas and do not prescribe minimum capital and surplus requirements for reinsurers. Consequently, there is great concern that reinsurers may be incapable of paying claims on surety bonds offered to school districts and that the school districts themselves will be required to pay any such losses.

The 1991 amendment of article 7.19-1 addresses several of these concerns. The amendment redesignated the above-quoted language as subsection (a), added a new subsection (b), and inserted the words "except as provided by Subsection (b) of this section" before the first italicized phrase above. Subsection (b) provides the following in pertinent part:

      (b) If any bond . . . is in an amount in excess of 10 percent of the surety company's capital and surplus, the municipality, board, body, organization, court, judge, or public officer may require, as a condition to accepting the bond . . . written certification that the surety company has reinsured the portion of the risk that exceeds 10 percent of the surety company's capital and surplus with one or more reinsurers who are duly authorized, accredited, or trusteed[1] to do business in this state. For the purposes of this subsection, the amount reinsured by any reinsurer may not exceed 10 percent of the reinsurer's capital and surplus. The State Board of Insurance shall furnish, on request, the amount of the allowed capital and surplus as of the date of the last annual statutory financial statement for a surety company or reinsurer authorized and admitted to do business in this state.

Ins. Code art. 7.19-1(b) (footnote added).

The 1991 amendments to articles 5160 and 7.19-1 accomplish several things. First, they authorize local officials to obtain information from the Department of Insurance regarding the condition of the surety company's capital and surplus for purposes of determining whether to consider requiring the surety company to obtain reinsurance. Second, article 7.19-1 effectively authorizes political subdivisions to require that corporate sureties secure reinsurance for the portion of any risk that exceeds ten percent of the surety company's capital and surplus. Third, article 7.19-1 requires reinsurers to be "duly authorized, accredited, or trusteed to do business in this state."

Although the recent changes in article 5160 and 7.19-1 delegate some control to local officials, the primary responsibility for monitoring the financial condition of surety companies furnishing bonds under article 5160, and now reinsurers underwriting such bonds, remains with the Department of Insurance. In view of the department's continuing role in the process, particularly where reinsurers are concerned, we are reluctant to conclude that political subdivisions are delegated greater authority to regulate surety companies submitting bonds under article 5160 or their reinsurers. Furthermore, since the legislature has expressly conferred on some political subdivisions the authority to establish financial criteria for surety companies providing performance and payment bonds, see, e.g., Local Government Code section 271.025(e) (enacted in 1989, authorizing a county with a population of 2.2 million or more and certain special districts to impose such criteria), we do not interpret the 1991 amendments to article 5160 and article 7.19-1 as impliedly conferring such authority on other political subdivisions with regard to reinsurers.

Accordingly, your first question, whether a school district may require corporate sureties to be sufficiently solvent to issue bonds without reinsurance, may be answered in the negative. Your second question, whether school districts may require reinsurance companies to be admitted and authorized to do business in Texas, is resolved by subsection (b) of article 7.19-1. School districts may reject surety bonds, any portion of which exceeds ten percent of the surety company's capital and surplus, that are underwritten by reinsurers that are not duly authorized, accredited, or trusteed to do business in this state. Your final inquiry, whether school districts may establish minimum financial requirements for reinsurers, is answered in the negative.

                             SUMMARY

      Surety companies furnishing bid bonds, performance bonds, and payment bonds under article 5160, V.T.C.S., must be duly authorized to do business in Texas. Ins. Code art. 7.19-1(a). School districts may require corporate sureties to obtain reinsurance for any portion of the risk that exceeds ten percent of the surety's capital and surplus. Reinsurers of such bonds must be "duly authorized, accredited, or trusteed" to do business in Texas. Id. art. 7.19-1(b). A school district may reject a surety bond which does not meet these requirements. School districts may not forbid surety companies from obtaining reinsurance in accordance with article 7.19-1, or establish minimum financial standards for reinsurers underwriting such bonds beyond those permitted by article 7.19-1.

                                            DAN MORALES
                                            Attorney General of Texas

WILL PRYOR
First Assistant Attorney General

MARY KELLER
Deputy Assistant Attorney General

RENEA HICKS
Special Assistant Attorney General

MADELEINE B. JOHNSON
Chair, Opinion Committee

Prepared by Steve Aragón
Assistant Attorney General

[1] Although the 1991 legislation deleted from article 5160 the requirement that a corporate surety be duly authorized to do business in Texas, subsection (a) of article 7.19-1 retains this qualification.