Opinion ID: 475496
Heading Depth: 1
Heading Rank: 3

Heading: Effect of Modifications of Contract

Text: 20 The primary issue is whether the modifications of the bonded contract exonerate Reliance. As a general rule a surety will be discharged where the bonded contract is materially altered or changed without the surety's knowledge or consent. 72 C.J.S. Principal and Surety Sec. 124 (1951). See also Cal.Civ.Code Sec. 2819 (West 1985); Anstalt v. F.I.A. Ins. Co., 749 F.2d 175 (3d Cir.1984); Argonaut Ins. Co. v. Town of Cloverdale, 699 F.2d 417 (7th Cir.1983); Continental Bank & Trust Co. v. American Bonding Co., 605 F.2d 1049 (8th Cir.1979); Verdugo Highlands, Inc. v. Security Ins. Co., 240 Cal.App.2d 527, 49 Cal.Rptr. 736 (1966). In addition, where, as here, a compensated surety seeks exoneration, it must show that the alteration caused prejudice or damage. 72 C.J.S. Principal and Surety Sec. 124 (1951). See also Ramada Development Co. v. United States Fidelity and Guaranty Co., 626 F.2d 517 (6th Cir.1980) (rule in substantial number of jurisdictions requires surety to show some injury, loss or prejudice). Thus, Reliance must demonstrate that the modifications were material and that some prejudice resulted. 21 The parties dispute the effect of the modifications. The Academies argue that the net effect of the modifications was to benefit the Foundation. Although under the second modification the Foundation lost its right to receive $1,100,000 in television revenue, it was also relieved of its obligation to guarantee that amount in television revenue. The Academies argue that the third modification relieved the Foundation of a $1,267,355.63 payment to the airlines for transporting the cadets, midshipmen and supporting personnel. Yet, in exchange, the Foundation gave up its rights to only $350,000 in excess television revenue. Consequently, the Academies argue, the net effect was a $917,355.63 benefit to the Foundation. Reliance, however, contends that the $1,100,000 lost revenue from the second modification and the $350,000 lost revenue from the third modification coupled with the approximately $1,267,000 decrease in its obligation to the airlines resulted in a net loss of approximately $183,000. 22 Neither party is entirely correct. First, in monetary terms, the second modification has no net effect. The Foundation lost the rights to $1,100,000 in television revenues, but it was also relieved of its obligation to guarantee that amount. Second, the third modification did not relieve the Foundation of its obligation to pay the airlines. The language of the third modification clearly indicates that the Foundation remained liable for the costs of transportation. The third modification merely shifted from the Foundation to the Academies the immediate burden of providing funds for transportation. In exchange, the Foundation relinquished its sole remaining right of any significance under the contract--the right to receive the excess television revenues. 23 The Academies argue that this court should view the modifications of the contract only to the extent they modify the Foundation's obligation which was the subject of the bond in question--the obligation to cover the Academies' additional expenses for the football team. Because the modifications did not affect this obligation, the Academies argue that there was no material alteration of the bonded contract. This view is much too narrow. First, courts construe a bond and its underlying contract together. Pacific Employers Ins. Co. v. City of Berkeley, 158 Cal.App.3d 145, 150, 204 Cal.Rptr. 387, 390 (1984). Second, the bond specifically incorporated the contract. Reliance guaranteed the Foundation's obligation on the basis of the entire contract, not just a single provision. When the bond and its underlying contract are viewed together, it is clear that the modifications were both material and prejudicial. 24 Paragraph 2(a) funded the otherwise assetless Foundation with ticket, concession, and television proceeds. These funds provided the Foundation with a means to satisfy its obligations. As evidenced by the Foundation's February 18 letter promising to assign television proceeds, Reliance relied on the Foundation's funding as provided in the original contract. As the district court concluded, The impact of the third modification on the Foundation was that it was deprived of the excess television revenues on which it depended to meet its contractual obligations, including those secured by [the bond in question]. Absent the provision that the Foundation would receive the television proceeds, Reliance would likely have determined the risk was too great, and declined to issue the bonds. Had there been no third modification, the Foundation may have had funds available to cover its obligations under paragraph 2(c). The prejudice suffered by Reliance is the increased risk resulting from the modifications. As the Court of Appeals for the District of Columbia has stated: 25 A surety company is not a public utility. It may, for any or no reason, conclude not to furnish its bond with respect to a particular contract. When it has committed itself with respect to one contract, amendments which convert that agreement into a significantly different one should be brought to the attention of the surety so that it may exercise its own business judgment as to whether it wishes to continue its commitment. It is not for the parties to the contract to decide among themselves that their amendments are of no interest to the surety, at least when, as here, those amendments go beyond mere matters of form. 26 Reliance Ins. Co. v. Colbert, 365 F.2d 530, 534 (D.C.Cir.1966). We conclude that the district court correctly held that the modifications were material, at least one of which, the third, was prejudicial to its rights as surety.