Opinion ID: 2640709
Heading Depth: 1
Heading Rank: 7

Heading: Olympic Steamship Attorney Fees

Text: ¶ 71 In extending Olympic Steamship to construction performance bonds, the majority fails to account for the critical differences between suretyship and insurance. Olympic Steamship fees are an equitable remedy, based on the special fiduciary relationship . . . existing between an insurer and insured. McGreevy v. Or. Mut. Ins. Co., 128 Wash.2d 26, 36, 904 P.2d 731 (1995). Accordingly, an insured has an enhanced duty to the insured which prevents it from putting its own interests before that of the insured's. The fiduciary nature of the relationship arises from the disparity in bargaining power that generally exists between an insurer and insured, and the insured's unique vulnerability when faced with a casualty loss. McGreevy, 128 Wash.2d at 36, 904 P.2d 731 (quoting Tank v. State Farm Fire & Cas. Co., 105 Wash.2d 381, 385-86, 715 P.2d 1133 (1986)). Neither characteristic is present in the relationship between a surety and obligee. In fact, imposing fiduciary obligations on a surety is fundamentally inconsistent with the nature and purpose of a suretyship agreement, as recognized by statute and common law. ¶ 72 I agree with Chief Justice Alexander that this court should not assume that the disparity of bargaining power characteristic of typical consumer insurance contracts exists in the context of construction suretyship. As discussed by the California Supreme Court in Cates Construction, Inc. v. Talbot Partners, 21 Cal.4th 28, 980 P.2d 407, 86 Cal.Rptr.2d 855 (1999), a disparity in bargaining power generally is absent in construction performance bonds, which are always entered into in a commercial setting. ¶ 73 In dismissing the thorough, well-reasoned analysis of the differences between performance bonds and insurance contracts set forth in Cates, the majority states that the decision does not address attorney fees, represents a minority position, and rests on a different statutory scheme. ¶ 74 The majority is correct that the primary issue in Cates is whether a surety may be liable in tort for damages resulting from a bad faith breach of contract, not whether a surety may be liable for attorney fees. The court addressed whether a surety agreement is sufficiently akin to an insurance policy to justify tort liability for a bad faith breach of contract, notwithstanding the general rule limiting a claimant to contractual damages. Here, the issue is whether a surety agreement is sufficiently akin to insurance to justify an exception to the American rule, requiring each party to bear its own litigation expenses. Both issues turn on whether there is a fiduciary or quasi-fiduciary relationship between the parties, and whether public policy compels an exception to the general rule. ¶ 75 Contrary to the majority, most courts addressing the issue have recognized that the obligee on a performance bond, the owner of a construction project, is not similar to an individual insured in terms of bargaining power and sophistication. See, e.g., Masterclean, Inc. v. Star Ins. Co., 347 S.C. 405, 556 S.E.2d 371, 375 (2001) (Inequities in bargaining power are largely absent in the surety context because the obligee, not the surety, usually dictates the bond requirements.); Blackfeet Tribe of Blackfeet Indian Reservation v. Blaze Constr., Inc., 108 F.Supp.2d 1122, 1142 (D.Mont.2000) (finding that the parties were not in inherently unequal bargaining positions); Cates, 21 Cal.4th at 53, 86 Cal.Rptr.2d 855, 980 P.2d 407 (concluding that [p]erformance . . . bonds do not reflect the . . . unequal bargaining power that [is] inherent in insurance policies); Great Am. Ins. Co. v. Gen. Builders, Inc., 113 Nev. 346, 355, 934 P.2d 257 (1997) (no inherent inequality in bargaining power between a performance bond obligee and a surety); Transamerica Premier Ins. Co. v. Brighton Sch. Dist. 27J, 940 P.2d 348, 353 (Colo.1997) (admitting that the parties to a suretyship contract are on equal footing when entering into the agreement); Great Am. Ins. Co. v. N. Austin Mun. Util. Dist. No. 1, 908 S.W.2d 415, 418 (Tex.1995) (noting that it is the obligee, not the surety, that controls the form of the bond and the terms of the incorporated contract). ¶ 76 These courts acknowledge that, unlike in the case of casualty insurance, in which a consumer accepts insurance on a take it or leave it basis, the obligee has the power to dictate the terms of the bond. As the California Supreme Court observed: If the obligee does not agree with the terms of the bond secured by the principal, it may consent to a modification of the underlying contract or may end bargaining altogether and seek a different principal whose financial resources and qualifications enable it to procure a bond with acceptable terms. (See generally, [Randall S. Udelman] Comment, Surety Contractors: Are Sureties Becoming General Liability Insurers? (1990) 22 Ariz. St. L.J. 469, 484.) Hence, obligees generally possess ample bargaining power to negotiate for favorable bond terms. Cates, 21 Cal.4th at 52, 86 Cal.Rptr.2d 855, 980 P.2d 407. ¶ 77 In the majority's view, the California court's reasoning is belied by the use of form contracts in construction suretyship, which is a convincing reason to infer a disparity in bargaining power between sureties and obligees. Yet, as the majority notes, the form bonds are drafted by an uninterested third party, the American Institute of Architects. Even more importantly, the obligee, not the surety, controls the terms and conditions of the bonded contract. Indeed, the surety has no input into the terms and conditions of the bonded contract, which defines the nature and extent of its performance obligations. See Great Am. Ins. Co., 908 S.W.2d at 415 (noting that surety has no control over the contract documents that define its liability). Thus, a performance bond does not involve the elements of adhesion and inequality of bargaining power characteristic of a typical insurance policy. ¶ 78 Moreover, a surety's nonperformance does not raise the same public policy concerns implicated when an insurance company fails to compensate a policyholder for losses covered by a casualty insurance policy. An obligee faced with the default of its subcontractor is not in the uniquely dependent or vulnerable situation of an insured that has experienced an unforeseen calamity. The majority likens a construction performance bond to a fire insurance policy that promises immediate cash for food, shelter and clothing, or disability insurance that replaces a lost income stream. However, the purpose of a performance bond is not to protect an obligee from potential property damage or other unforeseen losses. And unlike in the case of a typical consumer insurance claim, an obligee does not depend on a prompt pay-out to satisfy basic necessities of life. Rather, an obligee relies on the surety for additional security to ensure the fulfillment of a commercial contract. A surety's breach threatens to create no different a dilemma than that posed by the principal's default on the underlying construction contract. Cates, 21 Cal.4th at 55, 86 Cal.Rptr.2d 855, 980 P.2d 407. ¶ 79 The majority overstates an obligee's reliance on a surety's prompt payment of a claim. Other courts have noted that an obligee, unlike the victim of an unforeseen calamity, can cover its losses when faced with the surety's nonperformance. Cates, 21 Cal.4th at 53, 86 Cal.Rptr.2d 855, 980 P.2d 407. While an insured can look only to the insurer for help, an obligee on a surety bond has recourse against the principal as well as the surety, including all available contractual remedies. Upon the principal's default, the obligee may withhold the balance of the contract price and hire another contractor to perform the work if the surety refuses to do so. The facts of this case belie the majority's assertion that the primary benefit of a performance bond is lost when the surety forces an obligee to litigate the issue of coverage. The obligee completed the project and then successfully sued the surety for damages, winning an award for the full penal amount of the bond. The obligee thus gained the principal benefit of the performance bond: compensation for its contractual damages notwithstanding the subcontractor's financial insolvency. ¶ 80 The purpose of a construction performance bond is different from the purpose of a casualty insurance policy. An obligee does not obtain a performance bond to avoid litigation with the principal or to guarantee immediate liquid resources to weather the effects of an emergency. Majority at 1139. A performance bond protects the obligee from financial losses resulting from the principal's failure to fulfill its contractual obligations. The surety lends its credit to guarantee payment in the event the principal defaults on its contract: the obligee relies on the performance bond as additional financial security to protect itself from financial loss in the event of the principal's financial insolvency. A surety may provide an immediate infusion of cash to prevent a more costly default, but it is generally not contractually required to do so. On the contrary, a surety usually may elect to do nothing, leave completion of the contract to the obligee, and then compensate the obligee for its damages. See article by Patrick E. Hartingan & Andrew J. Ruck, Completion of Contract by the Owner, in ABA, Bond Default Manual, supra, at 159-60. Unlike a typical claim on a casualty insurance policy, a performance bond claim is essentially a claim for contractual damages. ¶ 81 As recognized by the United States Supreme Court, a performance bond claim involves plain and simple commercial litigation. F.D. Rich Co. v. United States, 417 U.S. 116, 130, 94 S.Ct. 2157, 40 L.Ed.2d 703 (1974). Accordingly, in F.D. Rich Co., the Court held that attorney fees may not generally be awarded to successful claimants on the surety bonds required of government contractors under 40 U.S.C. §§ 207a-270e (the Miller Act), which protects those who supply labor and materials to a contractor on a federal project. The Supreme Court rejected the argument that a claimant would not be made whole absent an attorney fee award, noting that the argument merely restates one of the oft-repeated criticisms of the American Rule. F.D. Rich, Co., 417 U.S. at 128, 94 S.Ct. 2157. The Court observed that under a well-established exception to the American rule, attorneys' fees may be awarded to a successful party when his opponent has acted in bad faith, vexatiously, wantonly, or for oppressive reasons. Id. at 129, 94 S.Ct. 2157. Absent an applicable exception, however, the Court held that the American rule should govern surety bond claims: Miller Act suits are plain and simple commercial litigation. In effect then, we are being asked to go the last mile in this case, to judicially obviate the American Rule in the context of everyday commercial litigation, where the policies which underlie the limited judicially created departures from the rule are inapplicable. This we are unprepared to do. The perspectives of the profession, the consumers of legal services, and other interested groups should be weighed in any decision to substantially undercut the application of the American Rule in such litigation. Id. at 130-31, 94 S.Ct. 2157. ¶ 82 The majority improvidently overrides the prevailing system of contractual attorney fee provisions in construction contracts, which we recently acknowledged in Cosmopolitan Engineering Group, Inc. v. Ondeo Degremont, Inc., 159 Wash.2d 292, 303, 149 P.3d 666 (2006). There, we concluded that the legislature did not intend to supplant the American rule or contractual attorney fee provisions when it authorized the recovery of attorney fees by successful claimants on the surety bond required of registered contractors. We held that the statutory attorney fee provision authorizes an award of attorney fees only against the surety, not the contractor, and only up to the penal amount of the bond. We noted that countervailing considerations support limiting attorney fee awards to the penal amount of the bond, such as the availability and cost of surety bonds. Cosmopolitan Eng'g, 159 Wash.2d at 304-05, 149 P.3d 666. We also observed that [p]arties to a construction contract can, and often do, include an attorney fee provision in their contracts. Id. at 303, 149 P.3d 666. Indeed, in this case, the subcontract expressly provides for attorney fees, a fact which the majority ignores. [3] In assuming the risk of the principal's default, the surety agreed that it would be liable for attorney fees arising from the costs of litigation, but only up to the penal amount of the bond. The majority offers no persuasive reason for supplanting the American rule or the parties' contract and fails to take into account the likely adverse consequences on the cost and availability of performance bonds. ¶ 83 The majority states that absent liability for attorney fees, a surety lacks sufficient incentive to fulfill its contractual obligations. In support, the majority quotes the dissenting justice's view in Cates that the value of a performance bond is `deeply undermined if sureties can regularly choose to ignore their obligations.' Majority at 1138 n. 13. The dissent observed that the purpose of a bond is to ensure `timely, dependable performance of the construction contract,' and the obligee `depend[s] upon the surety's good faith performance of these duties.' Id. (quoting Cates, 21 Cal.4th at 65-66, 86 Cal. Rptr.2d 855, 980 P.2d 407 (Mosk, J., dissenting)). As the majority elsewhere observes, however, Cates involves the availability of tort damages for a surety's bad faith breach of contract. Thus, Justice Mosk's remarks presume the existence of bad faith, which in itself would be sufficient to support an award of attorney fees under existing law. See McGreevy, 128 Wash.2d at 37, 904 P.2d 731 (noting that the existence of bad faith alone would support the invocation of the court's equitable powers to award attorney fees). The majority's broad new extension of Olympic Steamship is unwarranted because a surety already risks liability for attorney fees with a bad faith refusal to pay. ¶ 84 Given that neither the disparity in bargaining power nor the unique vulnerability of the insured characteristic of a typical consumer insurance contract is present in the commercial context of a construction performance bond, the rationale supporting Olympic Steamship does not apply. In fact, imposing an enhanced duty on sureties is fundamentally inconsistent with the conditional nature of the surety's obligation, as well as the surety's competing duties to the principal as recognized by both statutory and common law. ¶ 85 As noted by the majority, we awarded Olympic Steamship attorney fees to a successful claimant on a fidelity bond in Estate of Jordan v. Hartford Accident & Indemnity Co., 120 Wash.2d 490, 844 P.2d 403 (1993). However, we did so without examining the differences between fidelity bonds and other forms of insurance because the issue was not before us. In McGreevy, we recognized that there are essential differences between a fidelity bond and various insurance coverages, while concluding that fidelity bonds fall within the scope of insurance contracts covered by Olympic Steamship. McGreevy, 128 Wash.2d at 33, 904 P.2d 731. Indeed, it is generally recognized that fidelity bonds, which indemnify employers for financial losses resulting from the dishonest or fraudulent acts of an employee, resemble a traditional contract of insurance. Cates, 21 Cal.4th at 46, 86 Cal.Rptr.2d 855, 980 P.2d 407. ¶ 86 The majority discerns no material distinction between fidelity bonds and surety bonds. However, a fidelity bond is a two-party contract while a surety bond is a three-party contract. The materiality of this distinction is that in the one-on-one relationship created by a fidelity bond, the insurer owes a duty only to the obligee, not to the third party whose actions give rise to a claim. In contrast, in a surety relationship, a surety owes competing duties to the obligee and the principal, arising from the fact that the principal is the primary obligor on the bond and must indemnify the surety for any damages it pays on the principal's behalf. ¶ 87 In the one-on-one relationship created by a fidelity bond, it is appropriate to impose an enhanced duty on the insurer in view of its undivided duty of loyalty to the obligee. McGreevy, 128 Wash.2d at 36, 904 P.2d 731 (an insurer's enhanced duty precludes it from putting its own financial interests before that of the insured). But such an enhanced duty is fundamentally inconsistent with the role of a surety, who stands in the shoes of its principal and may assert any defense that the principal has against the obligee. See Stearns, supra, § 102. In a surety agreement, the rights, remedies and defenses of a surety cannot be disassociated from those of the principal. When a surety contests its liability, it is protecting not only its own interests but those of the principal. In fact, by statute a surety is barred from submitting to a default judgment when notified that the principal has a valid defense. RCW 19.72.090. And a surety may forfeit its right to indemnification by prejudicing any defenses the principal may have against the obligee or by making payments when the principal is not liable. See Restatement of Security § 108(5) (1941); Stearns, supra, § 284. Imposing an enhanced duty on the surety toward the obligee is inconsistent with the surety's statutory and common law obligations to the principal. ¶ 88 To the extent that the policy of Olympic Steamship is to encourage the prompt payment of claims, its application to suretyship contravenes a surety's statutory right to require the bond obligee to look to the principal before holding the surety liable. In recognition of the conditional nature of the surety's obligation, RCW 19.72.100 allows a surety to require a bond obligee to sue the principal on the contract before the surety is liable, while RCW 19.72.101 discharges a surety of liability if the bond obligee fails to proceed against the principal in a timely manner. [4] See Amick v. Baugh, 66 Wash.2d 298, 308, 402 P.2d 342 (1965) (explaining that RCW 19.72.100 and .101 codify the  Pain v. Packard  suretyship rule (13 Johns. R. 174 (N.Y.Sup.Ct.1816)), which allows a surety to convert itself into a guarantor of collection). The law applies equally to compensated and uncompensated sureties. RCW 19.72.900; RCW 48.28.050. [5] ¶ 89 The policy of discouraging a surety from contesting its liability is also inconsistent with the surety's contractual and equitable rights to indemnification, because if a surety pays a doubtful claim, it may forfeit its right to indemnification. ¶ 90 In view of the surety's divided loyalty to the obligee and the principal, the fiduciary or quasi-fiduciary relationship existing in the one-on-one relationship between insurer and insured in the context of casualty insurance, including a fidelity bond, does not exist between a surety and obligee. A surety's duty to the obligee is no greater than its duty to the principal. Because a surety has no enhanced duty toward the obligee, Olympic Steamship does not apply. ¶ 91 The extension of Olympic Steamship to surety contracts will have the inequitable effect of imposing liability for attorney fees on principals who would otherwise not be liable in the absence of a contractual attorney fee provision. This is because the surety has an implied (and usually, as here, an express) contractual right to indemnification for any costs it incurs as a result of the principal's default. Stearns, supra, § 280 (a surety has an implied contractual right to indemnification from principal for any payment made to the creditor). Applying Olympic Steamship fees to litigation arising from performance bond claims may be unjust to the principal, who must ultimately pay the attorney fees, yet has no control over the surety's decision to honor the claim. ¶ 92 The majority compounds its error by permitting an award of attorney fees against the surety in excess of the penal amount of the bond. The performance bond expressly limits the surety's liability to the penal amount: in no event shall the aggregate liability of the Surety exceed the amount of this bond. CP at 602. Construing similar language, the California Supreme Court held that the penal amount caps the surety's liability for attorney fees as well as other damages. `[U]nder the rule that a surety on a bond is not liable beyond the penalty named therein, the surety is not liable for attorney's fees in excess of the penalty named.' Hartford Accident & Indem. Co. v. Indus. Accident Com., 216 Cal. 40, 50, 13 P.2d 699 (1932) (quoting 50 C.J.S. § 149, at 92); see also T & R Painting Constr., Inc. v. St. Paul Fire & Marine Ins. Co., 23 Cal.App.4th 738, 29 Cal. Rptr.2d 199, 203 (1994) (holding that obligee may recover attorney fees as provided in subcontract so long as total recovery does not exceed penal amount of the bond); Lawrence Tractor Co. v. Carlisle Ins. Co., 202 Cal.App.3d 949, 249 Cal.Rptr. 150, 153 (1988) (holding that recovery of attorney fees is limited to penal amount of the bond absent contractual provision to the contrary); In re Guardianship of Davison, 31 Wash.App. 480, 642 P.2d 1259 (1982) (noting that the general rule limits a surety's liability for attorney fees to penal sum of the bond); Basic Refractories v. Bright, 72 Nev. 183, 298 P.2d 810, 818 (1956) (holding that the obligee may recover attorney fees as an element of damages only up to the limit of the penal amount of the bond). ¶ 93 As the California Supreme Court observed, The general rule has always been that plaintiff cannot recover more than the penalty of the bond. An attorney's fee is a part of the loss sustained by an obligee when compelled to sue on a bond. In other words, it partakes of the nature of the damages sustained, and the agreement to pay same makes it a part of such damages. But the bond does not provide for protection against damages beyond the amount of the penalty. As to such damages in excess of the penalty, the obligee must stand the loss himself or at least look elsewhere than to the surety. Hartford Accident, 13 P.2d at 703 (citations omitted) (quoting Hartford Fire Ins. Co. v. Casey, 196 Mo.App. 291, 191 S.W. 1072, 1076 (1917)). Of course, in the case of a bad faith refusal to pay, a surety may be liable for attorney fees above the penal amount, as a penalty for its own misconduct, rather than as compensation for the principal's default. See United States ex rel. Yonker Constr. Co. v. W. Contracting Corp., 935 F.2d 936 (8th Cir.1991) (upholding award of attorney fees based on surety's bad faith breach of contract). Alternately, attorney fees above the penal amount may be appropriate when a statute expressly allows attorney fees for a surety's breach of the performance contract. See, e.g., Great Am. Ins., 908 S.W.2d at 427-28 (surety liable above the penal amount for its own contractual breach, under statute allowing attorney fees for successful claimants on a contract); David Boland, Inc. v. Trans Coastal Roofing Co., 851 So.2d 724, 727 (Fla. 2003) (surety liable for attorney fees in excess of penal amount under statute allowing recovery of attorney fees by successful claimant in action against insurers, including sureties). In the absence of a bad faith refusal to pay, however, the surety should not be penalized for exercising its statutory and common law right to vigorously contest liability. ¶ 94 Statutory surety bonds expressly limit a surety's liability to the penal amount of the bond, including liability for attorney fees. See Cosmopolitan Eng'g, 159 Wash.2d 292, 149 P.3d 666 (construing RCW 18.27.040, governing mandatory contractor's surety bond); Davison, 31 Wash.App. at 482, 642 P.2d 1259 (construing RCW 19.72.109, .180 as applied to guardianship surety bonds required under RCW 11.88.100). The majority gives no reason for providing more protection to the obligees of private surety bonds than exists for the obligees of statutory surety bonds, which protect ordinary consumers as well as particularly vulnerable individuals who have been entrusted to the care of a guardian.