JUNE 2013 BAD FAITH CASES: PENNSYLVANIA DISTRICT COURT FINDS SURETY OWES NO FIDUCIARY DUTY TO POLICYHOLDER; GIST OF THE ACTION DOCTRINE BARS BAD FAITH CLAIMS (Western District)
The court was presented with a question of whether a surety is a fiduciary, as well as whether a breach of surety contract could result in a bad faith claim.
Plaintiff is a Pittsburgh-based construction company that primarily deals in large-scale public construction projects for school districts, state universities and agencies, municipalities, and other public entities. It is common practice in the construction industry for general contractors to purchase surety bonds when undertaking large-scale projects. A surety bond guarantees the general contractor’s performance of the work and its payments of subcontractors and suppliers, and act to reduce the risks inherent in logistically complicated projects. Typically, only the project owners, subcontractors, and suppliers are entitled to make claims and receive payment under the bond, although the general contractor obtains and pays the premium due on the bond.
This case arises out of three surety bonds provided to plaintiff by the carrier for two separate projects. The first two bonds were issued for plaintiff’s contract with a Pennsylvania school district (“the school district”) and the remaining bond was for plaintiff’s contract with the Ohio Turnpike Commission (“the OTC”) for re-construction of two service plazas along the turnpike.
The school district project began and continued without incident from August 2010 through April 2012. Then, in mid-April 2012, the school district approved a $554,702 invoice from plaintiff, but failed to issue payment. On April 26, Travelers sent a letter to the school district, demanding payment on the project for “the entire amount of the contract funds remaining in the custody of [the school district], including any and all estimates earned by [plaintiff] but unpaid at this time.”
Six weeks later no payments had been made by the carrier or the school district, resulting in the subcontractors on the project not being paid. Plaintiff alleges at this time the carrier met with the subcontractors privately and informed them that the project was going to be terminated. This allegedly caused the subcontractors to slow down, stop working, and submit inflated and premature claims against plaintiff. This led to the shutdown of the school district project on June 11, 2012.
The surety bonds issued in connection with the school district project, a performance bond and a payment bond, had a combined value of $19,297,000, the full value of the school district contract. Under the performance bond, the carrier guaranteed plaintiff’s performance in the event that plaintiff defaulted in its obligation, but if the school district defaulted, the carrier was not obligated to guarantee plaintiff’s performance.
The payment bond provided that the carrier would “have no obligation to [the subcontractors, suppliers, laborers, and other claimants]” until they “have given notice to [the carrier and the school district] stating a claim [for payment] is being made under this bond.” After receiving a properly submitted claim, the carrier is responsible for promptly paying or arranging for payment of any undisputed amounts at its own expense.
In its complaint, plaintiff alleged the carrier breached its fiduciary duty to plaintiff as its surety on the school district project, and that the carrier acted in bad faith by refusing to pay plaintiff’s subcontractors as required under the terms of the bond agreements. The carrier claims it owed no fiduciary duty to plaintiff and Pennsylvania does not recognize a tort-based bad faith claim by a principal against a surety.
The second contract for the OTC project was also bonded by the carrier for the full contract price of $9,930,730. Six months into the project, plaintiff fired a subcontractor on the project. The subcontractor then filed a lien against the project, which under Ohio law allowed OTC to withhold payment from plaintiff until plaintiff obtained a lien-over bond to guarantee payment of the claim.
At this point, plaintiff had terminated its bond relationship with the carrier, but the OTC project bond remained intact. The carrier, however, refused to issue the lien-over bond, alleging the contract bond did not require it to issue lien-over bonds, that plaintiff should seek the bond from its new surety, and that the contract bond required OTC to release payment. OTC continued to refuse payment on the project until plaintiff procured the lien-over bond, and the carrier refused to issue the lien-over bond until May 2012, at which point OTC terminated the contract.
Plaintiff’s contract bond for the OTC project guaranteed plaintiff’s performance of the work as well as plaintiff’s payment of “all lawful claims of subcontractors, material suppliers and laborers” in the event of plaintiff’s default. The bond stated its purpose was to “benefit any subcontractor, material supplier or laborer having a just claim, as well as for [the OTC].” Plaintiff claims the carrier breached its fiduciary duty as plaintiff’s surety, and acted in bad faith in refusing to issue the lien-over bonds as allegedly required by the contract bond.
In response to plaintiff’s complaint, the carrier filed a motion to dismiss. The court first faced the choice of law issue presented by the diversity of the parties. Applying Pennsylvania’s “most significant relationship” forum test, the court found Pennsylvania law applicable for the school district issues because both parties were Pennsylvania entities, the parties established minimum contacts with Pennsylvania, and no other state was involved.
The court also applied Pennsylvania law to the OTC claims because there were no relevant differences between the substantive law of the two states. Neither Ohio nor Pennsylvania has specifically held whether a principal may bring a breach of fiduciary duty or common law bad faith claim against a surety, requiring the district court to predict how the state supreme courts would rule.
On the breach of fiduciary duty claim, the court predicted the Pennsylvania Supreme Court would not impose fiduciary duties on a surety. A fiduciary duty exists “whenever one person has reposed a special confidence in another to the extent that the parties do not deal with each other on equal terms.” This may be shown by demonstrating the existence of a relationship normally considered to be fiduciary in nature, such as attorney and client or principal and agent, or by establishing a “disparity in position between the parties.”
Pennsylvania case law views surety bonds as “commercial guarantee instruments rather than policies of insurance,” stating specifically, “suretyship is not insurance.” Furthermore, imposing a fiduciary relationship between parties to a contact is the exception rather than the rule.
Finally, the split loyalties the surety maintains in a surety bond contract between the principal and the owner of the project are not indicative of a fiduciary relationship. Thus, the court predicted the Pennsylvania High Court would hold that as a matter of law, a surety does not owe a fiduciary duty to its principal.
Furthermore, the court found no “overmastering influence” on the part of the surety to establish a fiduciary relationship in this specific circumstance, and dismissed the breach of fiduciary duty claims.
In determining the tort bad faith claims, the court applied the gist of the action doctrine. The gist of the action doctrine prevents a plaintiff from bringing a contract claim under the guise of a tort claim to avoid a bar on certain claims. Under Pennsylvania law, “tort actions lie for breaches of duties imposed by law as a matter of social policy, while contract actions lie only for breaches of duties imposed by mutual consensus agreements between particular individuals.”
Thus, the gist of the action doctrine bars tort claims “(1) arising solely from a contract between the parties; (2) where the duties allegedly breached were created and grounded in the contract itself; (3) where the liability stems from a contract; or (4) where the tort claim essentially duplicates a breach of contract claim or the success of which is wholly dependent on the terms of a contract.”
The court found the gist of the action doctrine barred both claims of bad faith against the carrier arising out of the school district project and the OTC project. Pursuant to plaintiff’s complaint, the carrier’s conduct was allegedly tortious because of perceived rights and duties set forth in the bond agreements.
Furthermore, there was a dispute as to whether or not plaintiff defaulted on the school district project and whether the bond for the OTC project required the carrier to issue lien-over bonds. Thus, the true question in plaintiff’s alleged tort claims is whether the carrier breached its contractual duties. Therefore, the court dismissed the plaintiff’s bad faith claims with prejudice.