Court Opinion

ID: 4713741
Source: CourtListenerOpinion
Date Created: 2021-08-12 00:39:56.37678+00
Date Added: 2024-06-11T08:07:19.240485
License: Public Domain

*611¶35 (concurring in the dissent) — I agree with the majority that there is no language in the performance bond that requires Colorado Structures, Inc. (Structures) to “formally” declare a default or terminate the subcontract as a condition precedent to Insurance Company of the West’s (West) liability under the bond. But I disagree with the majority’s holding that Structures had no legal obligation to declare a default at all. The majority dispenses with the declaration of default requirement after erroneously equating it with termination of the subcontract. In doing so, the majority renders superfluous key operative language of the performance bond. In my view, a declaration of default means notification that the principal is in breach of its contractual obligations. Such notice gives effect to the surety’s contractual right to intervene, complete the work, and minimize its liability for damages. I concur in the result on the issue of liability because I agree with the majority that Structures adequately notified West that Action Excavating and Paving, Inc. (Action) defaulted on its contractual obligations.20 Moreover, under well-established Washington law, even inadequate notice of the principal’s default relieves a surety of liability only to the extent of any resulting prejudice. Accordingly, I concur on the issue of liability.
Madsen, J.
¶36 As to the attorney fees, however, I dissent from the majority’s extension of Olympic Steamship Co. v. Centennial Insurance Co., 117 Wn.2d 37, 811 P.2d 673 (1991) to construction performance bonds. I agree with Chief Justice Alexander that there has been no showing that such contracts are “ ‘substantially different from other commercial contracts’ ” so as to justify a departure from the American rule on attorney fees. Dissent (Alexander, C.J.) at 609 (quoting Olympic S.S., 117 Wn.2d at 52). The extension of *612Olympic Steamship to construction performance bonds is inappropriate in view of the purpose and nature of the relationship created by a surety agreement, which is fundamentally different from a casualty insurance policy.
Declaration of Default
¶37 Performance bonds are a staple of the construction industry. One of the most commonly used forms of performance bonds is the American Institute of Architects’ (AIA) Form A311, which has been in use since 1958. Edward H. Cushman, Surety Bonds on Public and Private Construction Projects, 46 A.B.A.J. 649, 651 (1960). The A311 bond guarantees that the principal "shall promptly and faithfully perform” the contract, which is incorporated by reference. Suppl. Br. of Pet’r Ins. Co. of the W. (App. A). A surety’s performance obligations under the bond arise when (a) the principal (in this case, Action) defaults on its contractual obligations, (b) the obligee (Structures) declares a default, and (c) the obligee is not in default. When these three conditions occur, a surety has several options: it may remedy the default by, for example, financing the principal; complete the contract itself by arranging for another contractor to perform the principal’s obligations; or simply pay the obligee its damages, i.e., the costs of completion. U.S. Fid. & Guar. Co. v. Braspetro Oil Servs. Co., 369 F.3d 34, 66 (2d Cir. 2004) (quoting Granite Computer Leasing Corp. v. Travelers Indem. Co., 894 F.2d 547, 551 (2d Cir. 1990)). If the completion costs exceed the unpaid contract balance, the surety must pay the difference, up to the penal amount of the bond. The bond at issue in this case is an A311 bond.
¶38 Both parties recognize that the key operative language of the bond is:
Whenever Principal shall be, and declared by Obligee to be in default under the subcontract, the Obligee having performed Obligee’s obligations thereunder:
(1) Surety may promptly remedy the default... , or;
(2) Obligee after reasonable notice to Surety may, or Surety upon demand of Obligee may arrange for the performance of Principal’s obligation under the subcontract . . . ;
*613(3) The balance of the subcontract price, as defined below, shall be credited against the reasonable cost of completing performance of the subcontract.
2 Clerk’s Papers (CP) at 602.
¶39 The central dispute in this case is whether Structures “declared” Action “to be in default,” thus triggering the surety’s duty to perform its obligations under the subcontract. The surety contends that a declaration of default means termination of the subcontract. Structures argues that a declaration of default means notice that the principal is in material breach of the subcontract. The majority mistakenly adopts the surety’s interpretation, recognizes that the bond does not condition a surety’s liability on termination of the subcontract, and infers that the entire paragraph applies only when an obligee elects to terminate the subcontract. Since Structures did not terminate the principal’s right to complete the subcontract in this case, the majority concludes that the provisions in question are inapplicable. The majority thus fails to give effect to what is widely understood — not only by the parties here but in the construction industry generally — to be a central provision of the performance bond.
¶40 Under the performance bond, the principal and surety are “jointly and severally” liable for the principal’s failure to “promptly and faithfully perform” the subcontract. 2 CP at 602. Thus, the liability of the surety is coextensive with that of the principal. However, the surety’s liability for damages is limited by the terms of the bond. In this case, the bond restricts the surety’s liability for damages in two respects. First, the surety is liable up to the penal amount of the bond. Second, the surety may either cure the default itself, complete performance or pay the obligee for the costs of completion, depending on which option it deems most favorable to its interests. Under the majority’s interpretation, an obligee may elect never to declare a default, thus depriving a surety of its contractual right to intervene and minimize its liability for damages.
*614¶41 In my view, the surety’s contractual right to remedy a default obligates the obligee to declare a default so that the surety may decide whether to take action in order to minimize its damages. See Plowden & Roberts, Inc. v. Conway, 192 So. 2d 528 (Fla. Dist. Ct. App. 1966) (surety’s right to complete performance under the ALA A311 performance bond is an affirmative defense, entitling surety to reduction in damage award to the extent of prejudice resulting from lack of notice); accord Blackhawk Heating & Plumbing Co. v. Seaboard Sur. Co., 534 F. Supp. 309 (N.D. Ill. 1982); see also Arthur Adelbert Stearns, The Law of Suretyship § 239 (4th ed. 1934) (a surety’s liability may be offset by any damages resulting from the creditor’s failure to notify it of the principal’s default).
¶42 The majority incorrectly equates a declaration of default with a declaration of intent to terminate:
“If a principal is ‘in default under the subcontract’ when he or she has materially breached the subcontract, thereby permitting but not requiring the obligee to terminate the subcontract, an obligee ‘declares’ a principal to be in default when, having elected to treat the breach as ‘material,’ the obligee announces his or her intent to terminate the subcontract.”
Majority at 591 (quoting Colo. Structures, Inc. v. Ins. Co. of the W., 125 Wn. App. 907, 920, 106 P.3d 815 (2005)).
¶43 Contrary to the majority’s assertion, it does not logically follow that a declaration of default is a declaration of intent to terminate. A declaration of default is no more than notice that the obligor is in breach of the contract.
¶44 The performance bond does not define “default” or set forth a procedure for declaring a default. Although the performance bond does not define “default,” the subcontract, which is incorporated by reference, expressly provides that a default occurs when the subcontractor fails to perform the work in an efficient and skillful manner, fails to use enough properly skilled workers and supervision, fails to use proper materials and equipment and/or fails to carry *615on the work in a manner acceptable to the contractor, among other acts or inactions. CP at 605.21
¶45 The parties do not dispute that the principal here defaulted on its contractual obligations. The record amply demonstrates that Structures notified the surety of the principal’s contract breaches through numerous oral and written communications. This satisfies the performance bond’s declaration of default requirement.
¶46 The genesis of the majority’s error appears to be its reliance on L&A Contracting Co. v. Southern Concrete Services, Inc., 17 F.3d 106 (5th Cir. 1994). In L&A, the court effectively rewrote the language of the bond at issue, also a form A311 bond. In L&A, the bond claimant argued that “ ‘declared in default’ ” means any communication that “ ‘[made] it clear that [the principal] failed to fulfill a contract or duty.’ ” Id. at 110 (first alteration in original) (quoting Webster’s Ninth New Collegiate Dictionary). The L&A court disagreed, holding that the phrase unambiguously means a “clear, direct, and unequivocal” declaration that the principal has committed a material breach, that the obligee regards the subcontract as terminated, and that “the surety must immediately commence performing under the terms of its bond.” Id. at 111. The L&A court gave three reasons for rejecting the claimant’s contrary interpretation of default.
¶47 First, the court stated that in construction sur-etyship law, “default” has a particular meaning, i.e., “a (1) material breach or series of material breaches (2) of such magnitude that the obligee is justified in terminating the contract.” Id. at 110. In the court’s view, the claimant’s definition “impermissibly blurs the distinct concepts of ‘breach’ and ‘default.’ ” Id. In support, the court cites *616a law review article by James A. Knox entitled, What Constitutes a Default Sufficient to Justify Termination of the Contract: The Surety’s Perspective, Constr. Law (Summer 1981), which discusses the “confusion” that results when “ ‘the obligee claims default but does not terminate and yet demands action by the surety.’ ” Id. at 110 n.11 (emphasis omitted) (quoting Knox, supra, at 1).
¶48 Second, the court considered it “impractical” and “commercially absurd” to define a “declaration of default” as something less than express, unequivocal declaration that the surety must immediately begin performance because sureties face tort liability for prematurely interfering in the principal’s affairs and “would be reluctant to enter into otherwise profitable contracts” without a “clear rule for notices of default.” Id. at 110-11.
¶49 Third, the L&A court considered that an express declaration of default is necessary to fulfill the purpose of the notice of default provision, which is to avoid the common law rule that a surety is not entitled to notice when the time for its performance is due.
¶50 Because the obligee did not satisfy the “clear rule” announced by the L&A court, the surety was discharged from any liability under the performance bond.
¶51 L&A’s reasoning is deeply flawed and should be soundly rejected by this court. First, L&A erred in reasoning that “default” must mean a material breach justifying termination rather than the failure to fulfill a contractual obligation. The subcontract itself defines “default,” and the meaning of “default” must also be read in light of the purpose of the bond, which is to guarantee the “prompt and faithful” performance of the subcontract. Obviously, a subcontract has not been promptly and faithfully performed when the principal has breached its contractual obligations, whether the breach is serious enough to justify termination or not. “[I]t is axiomatic that the very purpose of a performance bond is ‘to assure completion of the contract.’ ” U.S. Fid. & Guar. Co., 369 F.3d at 67 (holding that a surety must pay all the costs of completion, not simply those incurred *617after a declaration of default) (quoting Pearlman v. Reliance Ins. Co., 371 U.S. 132, 140, 83 S. Ct. 232, 9 L. Ed. 2d 190 (1962)); see also Surety Information Office, The Information Source on Surety Bonds in Construction, http://www .sio.org/private/iprivatel.html (last visited July 31, 2007) (A performance bond “protect [s] the owner from financial loss should the contractor fail to perform the contract in accordance with its terms and conditions.”).
¶52 Moreover, it is not the role of the court to rewrite the bond language to save a surety from any “confusion” that may result when its obligations are uncertain. See Joint Admin. Bd. of Plumbing & Pipefitting Indus, v. Fallon, 89 Wn.2d 90, 94, 569 P.2d 1144 (1977) (“if the language of the bond is ambiguous, the bond is construed in favor of liability of the surety”). Nothing in the form A311 bond requires an obligee to terminate a subcontract as a condition precedent to the surety’s performance obligations. Am-Haul Carting, Inc. v. Contractors Cas. & Sur. Co., 33 F. Supp. 2d 235, 242 (S.D.N.Y. 1998) (declaration of default, not termination of the subcontract, triggers a surety’s obligations under a performance bond). Rather, the bond permits an obligee to allow a principal to continue performing following breach rather than terminating the subcontract. In such circumstances, the surety may step in and take any of a number of actions, such as financing the principal or otherwise facilitating its performance, and it may do so under a reservation of rights if there is a legitimate dispute as to whether the principal is in default. A surety that wishes to avoid any “confusion” arising when an obligee does not follow through and terminate a subcontract following a declaration of default may elect to use form A312, which unlike form A311, expressly conditions a surety’s performance obligations on the termination of the subcontractor’s right to complete the contract. ABA, Bond Default Manual 185 (Ex. 5.4, ¶ 12.3) (Richard H. Wisner ed., 1987).
¶53 The L&A court is also incorrect in stating that a “clear rule” is necessary to save a surety from tort liability *618for interference with the principal’s business relationship. There is no basis for the court’s statement. Once a surety has notice of a potential claim, it is privileged to intervene and protect its interests without liability for tortious interference. Gerstner Elec., Inc. v. Am. Ins. Co., 520 F.2d 790, 794-95 (8th Cir. 1975) (holding that a surety, after becoming aware of a single claim for labor and materials by a subcontractor, acted reasonably by directing the owner to withhold further payments from the contractor even though contractor had not been declared in default by the owner); Zoby v. Am. Fid. Co., 242 F.2d 76, 79 (4th Cir. 1957) (“Where the alleged interferer is a financially interested party, and such interest motivates its conduct, it cannot be said that [the interferer] is an officious or malicious meddler,” finding no actionable interference where surety recommended to the obligee that it complete the contract with another contractor.). Here, the language of the performance bond itself provides that a surety “may promptly remedy the default” upon a declaration of default, authorizing the surety’s interference in the principal’s affairs. 2 CP at 602. Moreover, the indemnity agreement between the principal and surety gives the surety “the right, at its option and in its sole discretion ... to take possession of all or any part of the work under the contract covered by the Bonds and to complete or arrange for the completion of the same” in the event of the principal’s default, which the agreement defines as “any ... breach of or refusal or inability to perform” the bonded contract. 2 CP at 305, 304 (emphasis added). A surety need not wait until the obligee has actually terminated the contract before intervening. Rather, the surety has an express contractual right to cure a default before it results in termination of the subcontract.
¶54 Finally, the essential purpose of the notice requirement is to give effect to the surety’s contractual right to intervene and minimize its liability for damages. This purpose is well served by interpreting “declared in default” as notice of the principal’s breach of its contractual obligations. It is less well served by equating declaration of *619default with termination of the subcontract because a surety may have no opportunity to intervene and cure a default before it results in a more costly termination.
¶55 L&A’s holding that the failure to declare a default discharges a surety’s liability is also inconsistent with the well-established law of this state. A contract of suretyship is construed in accordance with the laws of the State. Ramsey & G. Constr. Co. v. Vincennes Bridge Co., 283 U.S. 796, 51 S. Ct. 484, 75 L. Ed. 1420 (1931). The surety’s representation that L&A is “settled law” is wishful thinking, at best. There has long been a “strong divergence of opinion” as to whether the failure to comply with a notice requirement when a bond expressly conditions liability on notice discharges a surety’s liability. S. Sur. Co. v. MacMillan Co., 58 F.2d 541, 545 (10th Cir. 1932). One line of cases strictly enforces such express notice requirements while another line of cases holds that violation of a notice requirement exonerates a surety only to the extent of resulting prejudice even when notice is an express condition precedent to liability under the performance bond. Id. at 545. Washington courts have consistently followed the latter rule. Cmty. Bldg. Co v. Md. Cas. Co., 8 F.2d 678 (9th Cir. 1925) (collecting Washington cases); see, e.g., Lazelle v. Empire State Sur. Co., 58 Wash. 589, 592, 109 P. 195 (1910) (“[T]he surety cannot complain when it can show no loss or substantial damage by reason of the failure to receive notice, in the exact and technical language of the contract, or make it appear that its failure to receive notice has prevented it from taking proper steps for its protection.”); Denny v. Spurr, 38 Wash. 347, 352, 80 P. 541 (1905) (a compensated surety “can insist only on those forfeiture clauses of its contract the failure to comply with which probably inflicts upon it a loss”); Heffernan v. U.S. Fid. & Guar. Co., 37 Wash. 477, 481, 79 P. 1095 (1905) (“yet when the notice serves its purpose as well when given after the prescribed time as it does before — that is, when it is equally effective in protecting the surety from loss — it is inequitable, and a manifest abuse of the purposes of this provision of the bond, to hold that the mere technical *620variance shall relieve the obligor entirely”). Thus, while L&A may reflect Florida law, it is inconsistent with well-established Washington precedents.
¶56 Although the majority correctly rejects the central holding of L&A, it errs in adopting its interpretation of “declaration of default” as a declaration of intent to terminate the subcontract. Contrary to L&A, “declared in default” is not unambiguous and, thus, should be interpreted in favor of liability of the insured. Here, the numerous oral and written communications notifying the surety that the principal had defaulted on its contractual obligations, giving rise to a potential claim, satisfied the declaration of default requirement. In adopting a narrow definition of “declared in default,” the majority repeats the error it recognizes elsewhere in L&A of failing to give effect to the language of the bond in light of recognized principles of contract interpretation as applied to suretyship. The result is that the majority renders inoperative a key provision defining the surety’s contractual rights and obligations, including the right to receive notice of the principal’s default so that it may intervene and minimize its liability for damages.
Olympic Steamship Attorney Fees
¶57 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 Wn.2d 26, 36, 904 P.2d 731 (1995). Accordingly, an insurer 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. Id. *621at 36 (quoting Tank v. State Farm Fire & Cas. Co., 105 Wn.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.
¶58 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) (plurality opinion), a disparity in bargaining power generally is absent in construction performance bonds, which are always entered into in a commercial setting.
¶59 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.
¶60 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.
¶61 Contrary to the majority, most courts addressing the issue have recognized that the obligee on a performance *622bond, 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 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 (concluding that “[pjerformance . . . 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).
¶62 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.
*623¶63 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 AIA. 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 418 (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.
¶64 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 payout 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.
¶65 The majority overstates an obligee’s reliance on a surety’s prompt payment of a claim. Other courts have *624noted that an obligee, unlike the victim of an unforeseen calamity, can “cover” its losses when faced with the surety’s nonperformance. Id. at 53. 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.
¶66 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 603. 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 obli-gee for its damages. See Patrick E. Hartingan & Andrew J. Ruck, Completion of Contract by the Owner, in ABA, Bond Default Manual, supra, at 159-60. Unlike a typical *625claim on a casualty insurance policy, a performance bond claim is essentially a claim for contractual damages.
¶67 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. §§ 270a-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. 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. 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.
¶68 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 Wn.2d 292, 303, 149 P.3d 666 (2006). There, we *626concluded 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 Wn.2d at 304-05. 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. Indeed, in this case, the subcontract expressly provides for attorney fees, a fact which the majority ignores.22 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.
¶69 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 601 n.13 (quoting Cates, 21 Cal. 4th at 65-66 (Mosk, J., dissenting)). 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. *627(quoting Cates, 21 Cal. 4th at 65-66 (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 Wn.2d at 37 (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.
¶70 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.
¶71 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 Wn.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 Wn.2d at 33 n.5. 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.
*628¶72 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.
¶73 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 Wn.2d at 36 (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.
¶74 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 *629require 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.23 See Amick v. Baugh, 66 Wn.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 48.28.050.24
¶75 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.
¶76 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.
¶77 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 *630here, 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.
¶78 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.” 2 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 Comm’n, 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 Wn. 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, Inc. 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).
*631¶79 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. Yonkers 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.
¶80 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 Wn.2d 292 (construing RCW 18.27.040, governing mandatory contractor’s surety bond); Davison, 31 Wn. App. at 482 (construing *632RCW 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.
Conclusion
¶81 I concur that West was not relieved of its liability on the performance bond by Structures’ failure to terminate Action’s right to complete the subcontract. The phrase “declared in default” required Structures to notify West that Action was in breach of its contractual obligations, but it did not require Structures to terminate the subcontract as a condition precedent to West’s liability.
¶82 I dissent from the majority’s holding that West is liable for Olympic Steamship attorney fees. Olympic Steamship fees are based on the special fiduciary relationship between an insurer and insured, which does not exist in the commercial context of construction suretyship. West’s liability for attorney fees is governed by the American rule and by the contract, which in this case provides recovery of attorney fees up to the full penal amount of the bond.
Fairhurst, J., concurs with Madsen, J.

 The majority confusingly holds that “by the plain terms of the bond the obligee was not required to formally declare the principal in default and that, regardless, adequate notice of default was given to the surety.” Majority at 586. The majority does not explain what constitutes “adequate” notice, or why notice is even relevant if the bond does not require it. The majority’s mixed message on the issue of notice leaves a central issue of the case unresolved.

 In contrast, another widely used performance bond, form A312, specifically requires written notice at the surety’s address, as set forth in the bond contract, at least 20 days in advance of a declaration of default, and defines default as “[f lailure of the Contractor, which has neither been remedied nor waived, to perform or otherwise to comply with the terms of the Construction Contract.” ABA, Bond Default Manual 185,187 (Ex. 5.4, ¶ 12.3) (Richard S. Wisner ed., 1987).

 "Section 19. Attorney’s Fees. In the event either party institutes suit in Court... against the other party, or against the surety of such party, in connection with any dispute or matter arising under the Subcontract, the Contractor shall be entitled to recover reasonable attorney’s fees, expert witness fees and expenses, and costs relating to such suit.” CP at 608 (emphasis added).

 A surety may waive these statutory rights by contractual agreement. See Amick v. Baugh, 66 Wn.2d 298, 305, 402 P.2d 342 (1965).

 RCW 19.72.900 provides: “This chapter applies to all sureties, regardless of whether the sureties are compensated or uncompensated.” RCW 48.28.050 provides: “A surety insurer may be released from its liability on the same terms and conditions as are provided by law for the release of individuals as sureties.”