Opinion ID: 1427999
Heading Depth: 4
Heading Rank: 2

Heading: Public Interest and Fiduciary Responsibility

Text: Our decisions observe that tort remedies are appropriate for breaches in the insurance policy context because insureds generally do not seek to obtain commercial advantages by purchasing policies; rather, they seek protection against calamity. (See Foley, supra, 47 Cal.3d at p. 684, 254 Cal.Rptr. 211, 765 P.2d 373; Egan, supra, 24 Cal.3d at p. 819, 169 Cal.Rptr. 691, 620 P.2d 141; Crisci v. Security Ins. Co., supra, 66 Cal.2d at p. 434, 58 Cal.Rptr. 13, 426 P.2d 173.) But while the typical insurance policy protects an insured against accidental and generally unforeseeable losses caused by a calamitous or catastrophic event such as disability, death, fire, or flood, the general purpose of a construction performance bond is to protect the creditor [the owner/obligee] against the danger that he will be unable to collect from the debtor [the general contractor/principal] for any failure in the performance of the contract. ( Regents of University of California v. Hartford Acc. & Indem. Co. (1978) 21 Cal.3d 624, 639, 147 Cal.Rptr. 486, 581 P.2d 197; see Schmitt v. Insurance Co. of North America, supra, 230 Cal.App.3d at p. 257, 281 Cal.Rptr. 261 [the surety, in essence, `merely lends its credit so as to guarantee payment in the event that the principal defaults' on its contract]; 1 Cal. Insurance Law, supra, § 1.01[4], p. 1-10 [same].) In requiring a performance bond, then, the obligee seeks the commercial advantage of obtaining a contract with the principal which provides additional financial security. (Shattuck, supra, 57 Ala. Law. at p. 246.) In Foley, supra, 47 Cal.3d 654, 254 Cal. Rptr. 211, 765 P.2d 373, this court indicated that insurance is a quasi-public service in the sense that individuals contract with insurance companies specifically in order to obtain protection from potential specified economic harm. ( Id. at p. 692, 254 Cal.Rptr. 211, 765 P.2d 373.) While our words, read in isolation, might suggest that suretyship could qualify as a quasipublic service because a bond may be viewed as offering a form of economic protection, the context of our discussion indicates otherwise. Foley emphasized that when an insurer in bad faith refuses to pay a claim or accept a settlement offer within policy limits, its insured cannot turn to the marketplace to find another insurance company willing to pay for losses already incurred. (47 Cal.3d at p. 692, 254 Cal.Rptr.2d 211, 765 P.2d 373; see Hunter, supra, 6 Cal.4th at p. 1181, 26 Cal.Rptr.2d 8, 864 P.2d 88.) Our discussion, however, distinguished that type of unique economic dilemma from the ordinary sort of situation in which breach of a commercial contract may have merely adverse financial significance to the nonbreaching party. [17] ( Foley, supra, 47 Cal.3d at p. 692, 254 Cal.Rptr. 211, 765 P.2d 373.) As another court put it, [a] contracting party's unjustified failure or refusal to perform is a breach of contract, and cannot be transmuted into tort liability by claiming that the breach detrimentally affected the promisee's business. ( Arntz Contracting Co. v. St. Paul Fire & Marine Ins. Co. (1996) 47 Cal. App.4th 464, 479, 54 Cal.Rptr.2d 888.) Although a construction surety's breach of the implied covenant might very well have financial significance for a performance bond obligee, the obligee does not face the same economic dilemma as an insured. In contrast to an insured who typically can look only to the insurer for recovery in the event of a covered loss, an obligee also has a right of recovery against the principal. That right is not a hollow one, for unlike insurance, which contemplates the certainty of losses, sureties do not write performance bonds for principals who appear unable to perform the primary obligation and whose assets are insufficient to meet the contingency of default. (Conners, supra, § 1.4, pp. 6-7; Cushman, Surety Bonds on Public and Private Construction Projects (June 1960) 46 A.B.A.J. 649, 652-653; see Leo, The Construction Contract Surety and Some Suretyship Defenses (1992-1993) 34 Wm. & Mary L.Rev. 1225, 1232 (Leo) [contract bonds, like loans, are written based on the financial integrity of the principal, premised on the idea that no losses should follow [fn. omitted]].) Accordingly, an obligee's right of recovery against a principal is, in most cases of default, a meaningful right. In addition, an obligee may contract with others in the marketplace to obtain completion of its construction project and thereafter recover the reasonable cost of completion against the principal and the surety. (Cf. Bacigalupi v. Phoenix Bldg. etc. Co. (1910) 14 Cal.App. 632, 637, 112 P. 892.) In effect, then, a surety's breach of the implied covenant threatens to create no different a dilemma than that posed by the principal's default on the underlying construction contract. Moreover, it is common for construction contracts to contain terms that protect an owner's construction funds. Owners and contractors generally structure their contracts to provide for installment payments to the contractor as the work progresses, typically as the work reaches specified stages of completion. [18] (See generally, 11 Cal.Jur.3d, Building and Construction Contracts, § 37, p. 54.) This payment system adds incentive for the contractor to complete the work and reduces the risk of nonperformance for the owner. A percentage of funds held until completion of all of the work is called retainage and is intended both to reduce the risk of nonperformance by the contractor and to assure the completion of the work in accordance with the contract terms. (Leo, supra, 34 Wm. & Mary L.Rev. at p. 1238.) Progress payments and retainage serve to reduce both the owner's and the surety's risk. ( Ibid. ) Thus, if an owner avoids overpaying the contractor as the project progresses, then the owner should have funds available to apply toward completion of the project in the event of the contractor's default. [19] Indeed, when the surety, pursuant to a bond, undertakes to complete the project itself or expends funds to enable another contractor to do so, the surety is entitled to reimbursement from the retainage. (See Leatherby Ins. Co. v. City of Tustin, supra, 76 Cal.App.3d at p. 685, 143 Cal. Rptr. 153.) Likewise, if the surety fails to perform under the bond, the owner/obligee may, on its own, look to the marketplace to find a replacement contractor and use the unexpended sums to pay for that contractor's services. Even if, then, the original contractor defaults because of insolvency, an owner typically should have in its possession contract funds that roughly approximate the value of the uncompleted work. Consequently, it should not be common for an owner to confront the sort of economic dilemma that an insured faces after a catastrophic loss or accident, or for an owner to be particularly vulnerable to a surety's inaction. [20] Contrary to Talbot's assertions, there is little basis for concluding that the relationship between a surety and an obligee is fiduciary or quasi-fiduciary in nature. Although a performance bond serves to shift the risk of the principal's nonperformance from the obligee to the surety, the conditional nature of the surety's obligations and its right to assert the defenses of the principal distinguish the surety-obligee relationship from the insurer-insured relationship. The fact that insurance regulations exempt sureties from many of the fair claims settlement standards applicable to issuers of insurance policies is consistent with and supports the conclusion that a surety does not stand in a fiduciary or quasi-fiduciary position with respect to an obligee. (Cal.Code Regs., tit. 10, § 2695.1, subd. (c); e.g., compare Cal.Code Regs., tit. 10, § 2695 subds. (f), (g) with id., § 2695.10 [a surety is not obligated to notify an obligee of potential time-bar defenses and is not barred from making settlement offers that are unreasonably low].) Additionally, a principal basis for recognizing tort liability in the context of liability insurance, i.e., the insurer's assumption of the insured's defense and of settlement negotiations of third party claims ( Crisci v. Security Ins. Co., supra, 66 Cal.2d at p. 432, fn. 3, 58 Cal.Rptr. 13, 426 P.2d 173; see Comunale v. Traders & General Ins. Co., supra, 50 Cal.2d at p. 660, 328 P.2d 198), is not transferable to the performance bond setting. In contrast to a liability insurer, a surety bears no responsibility to defend an obligee against third party claims and has no right to represent the obligee's interests by virtue of the surety bond. Thus, to the extent such responsibilities give rise to fiduciary or quasi-fiduciary obligations in the liability insurance setting, their absence in surety arrangements supports a different result.