To be sure, there is some risk on the surety as well. The surety has good faith obligations to both the contractor and the owner, and when a declaration of default by the owner is challenged by the contractor, those twin obligations require a bit of a balancing act. Often the contractor's challenge will arise from its suspension or abandonment due to nonpayment for work that the contractor considers a change and the owner considers within the original scope of work. The surety must investigate and decide which party's position is more plausible. Most indemnity agreements will prescribe the standard that the surety will apply when judging between the two positions (“reasonableness” being the usual touchstone), but judging wrongly can have consequences – particularly given the legal principle that the performance bond surety has all of the rights and defenses that the contractor has. Refusing to invoke those defenses when they are likely winners may end up depriving a surety of reimbursement.
So can going overboard on the amount spent in defending against an owner's claim. In Gulf Ins. Co. v. AMSCO, Inc., 153 N.H. 28, 41 (2005), our Supreme Court noted that “an indemnity agreement is not a blank check; it does not entitle the surety company to reimbursement for legal expenses which are unreasonable or unnecessary. To hold otherwise would allow [a surety] to retain counsel and to charge attorney's fees against the indemnitor even when the surety company does not require a separate legal defense to protect its interests.” The Court affirmed a lower court decision that a surety was not entitled to be indemnified by the contractor for the costs of hiring separate counsel where it could have tendered the defense of the owner's claims to the contractor.
Every case is different, but in general the factors considered by the courts when ruling on a surety's right to be reimbursed for attorneys' fees include “the amount of risk to which the surety was exposed; whether the principal was solvent; whether the surety has called on the principal to deposit with it funds to cover the potential liability; whether the principal on demand by the surety to deposit with it the amount of the claim has refused to do so; whether the principal was notified of the action and given opportunity to defend for itself and the surety; whether the principal hired the attorney for both himself and the surety; whether the principal notified the surety of the hiring of the attorney; the competency of the attorney hired by the principal; the diligence displayed by the principal and his attorney in the defense; whether there is a conflict of interest between the parties; the attitude and cooperativeness of the surety; and the amount charged and diligence of the attorney hired by the surety.” Id. at 37-38.
Tendering the defense of an owner's claims to the contractor does not mean that the surety will incur no indemnifiable expenses. The surety will still monitor the litigation, and could step in if the defense is going poorly. It may even end up assisting in financing the defense if the contractor's resources wane. But in my experience, tendering the defense usually makes sense – for both contractor and surety.