Opinion ID: 1427999
Heading Depth: 4
Heading Rank: 3

Heading: Consequences of Allowing Tort, Recovery

Text: In Transamerica Premier v. Brighton School, supra, 940 P.2d 348, the Colorado Supreme Court held that subjecting sureties to tort liability for breach of the implied covenant compels commercial sureties to handle claims responsibly. (940 P.2d at p. 353.) The court also determined that, when a commercial surety withholds payment of an obligee's claim in bad faith, contract damages do not compensate for the surety's misconduct and have no deterrent effect to prevent such misconduct in the future. ( Ibid.; see also Dodge v. Fidelity & Deposit Co. of Md. (1989) 161 Ariz. 344, 778 P.2d 1240, 1242-1243.) For the reasons set forth below, we are not convinced that tort remedies are necessary to achieve such objectives. Unlike insureds, obligees possess ample bargaining power to negotiate terms that encourage timely performance of bond obligations and that provide for attorneys' fees and interest when breaches occur. (Shattuck, supra, 57 Ala. Law. at p. 246; Conners, supra, § 1.5, p. 8; Transamerica Premier v. Brighton School, supra, 940 P.2d 348, 354 (dis. opn. of Kourlis, J.).) Obligees may also require a liquidated damages provision to discourage nonperformance by sureties. Accordingly, tort remedies appear largely unnecessary to induce a surety's performance or to fully compensate for a surety's breach of the covenant of good faith. [21] Moreover, it is generally recognized that a primary purpose of a performance bond is to protect the obligee against the risk of the principal's default on the construction contract. (See Regents of University of California v. Hartford Acc. & Indem. Co., supra, 21 Cal.3d at p. 639, 147 Cal.Rptr. 486, 581 P.2d 197.) Where, as here, a bond is given to guarantee faithful performance of a construction contract, then contract remedies, which compensate for all damages within the contemplation of the parties at the time of contracting or at least reasonably foreseeable by them at that time (Civ.Code, § 3300), provide adequate compensation for breach of the bond. [22] Nor are we persuaded that tort recovery is necessary to deter misconduct by sureties. As noted, owners and developers involved in construction wield sufficient bargaining power to demand contractual provisions for interest, attorney's fees and liquidated damages. More importantly, the Insurance Code subjects sureties to substantial administrative sanctions and penalties for violations of the Unfair Trade Practices Act (Ins. Code, § 790 et seq.). Those sanctions include maximum civil penalties of $5,000 for each act or $10,000 for each willful act in violation of Insurance Code section 790.03, subdivision (h) (Ins.Code, § 790.035), and the issuance of cease and desist orders to enjoin further violations ( id., § 790.05). Willful violations of cease-and-desist orders may result in an additional penalty of $55,000, while repeated violations may result in the suspension or revocation of a surety's license for up to a year. ( Id., § 790.07.) In considering the potential consequences of allowing tort remedies in the performance bond context, we are mindful of cases and commentary indicating that, for whatever benefits might accrue from permitting such remedies, harmful economic effects appear at least as likely to occur. Unlike insurance relationships, which involve the interests of only two parties, the surety relationship is a tripartite one implicating the separate legal interests of the principal, the obligee and the surety. When contract disputes arise between an obligee and a principal as to whether the principal is in default, it may prove difficult for the surety to determine which party is in the right and whether its own performance is due under the bond. As one text explains: There is no simple scenario for a performance bond dispute. Most often a dispute will involve claims, counterclaims, charges, and countercharges. Seldom will any one party be altogether in the right. Often the parties are in a defensive posture when bond claims begin to surface. Usually, the project is behind schedule. Generally, prior to the time the surety is officially called upon to perform, lines have been drawn and personalities have clashed. It is no wonder that performance bond claims are fertile fields for surety litigators. (Cushman & Stamm, Handling Fidelity and Surety Claims (1984) Performance Bonds, § 6.4, p. 168.) As the foregoing suggests, construction disputes may be complicated enough to resolve when all three parties are on a level playing field. But it is rational to assume that making tort remedies available may encourage obligees to allege a principal's default more readily than they would in the absence of such remedies. It is also reasonable to conclude that allowing obligees to wield the club of tort and punitive damages may make it easier to pressure sureties into paying questionable default claims, or paying more on properly disputed claims, because the sureties will be reluctant to risk the outcome of a tort action. (See Moradi-Shalal v. Fireman's Fund Ins. Companies, supra, 46 Cal.3d at p. 301, 250 Cal.Rptr. 116, 758 P.2d 58 [noting similar concerns in the context of third party actions against insurers]; cf. U.S. ex rel. Ehmcke Sheet Metal Works v. Wausau Ins. Cos. (E.D.Cal.1991) 755 F.Supp. 906, 910-911 [finding the potential for unwarranted settlement demands and inflated settlements in the context of tortious breach actions premised upon federal Miller Act surety bonds].) Thus, permitting obligees to sue sureties in tort may allow obligees to gain additional leverage with sureties that principals do not have in contract disputes. With such increased leverage, obligees will have sufficient power to detrimentally affect the interests of principals when disagreements arise during construction. Claims of default by the obligee may impair the principal's ability to secure bonding on other projects (see, e.g., Arntz Contracting Co. v. St. Paul Fire & Marine Ins. Co., supra, 47 Cal.App.4th at p. 479, 54 Cal.Rptr.2d 888), thus automatically disqualifying the principal from bidding on all public projects and many private ones. Moreover, indemnity agreements executed by principals often give sureties the right to pursue them for reimbursement of any loss, including legal expenses and the costs of investigation. In efforts to avoid bad faith liability, sureties may strive to find bond coverage for obligees while, at the same time, charging their investigation costs to the principal. Accordingly, even if the surety's investigation ultimately leads to the conclusion that the principal is not in default, the faultless principal may still suffer adverse consequences. These considerations, which have no parallel in disputes involving insurance policies, weigh against the recognition of extracontractual liability in the performance bond context. Finally, allowing tort recovery in the construction bond context may open the door to increased (and sometimes successive) litigation, which in turn may increase the cost of obtaining bonds. For example, in K-W Industries v. National Sur. Corp. (1988) 231 Mont. 461, 754 P.2d 502, the subcontractor first sued in federal court on a payment bond under the Miller Act and then sued in Montana state court alleging violations of statutory prohibitions against bad faith insurance practices. But even if obligees bring their contract and tort actions in one suit, increased litigation and settlement costs are inevitable. Those costs ultimately would be passed on by contractors to obligees (see U.S. ex rel. Ehmcke Sheet Metal Works v. Wausau Ins. Co., supra, 755 F.Supp. at pp. 910-911) and may contribute to the unaffordability of bonds.