Penalty, Flag on the Play – But Not For Sureties!
September 10, 2024
In this Surety Today: The Blog post we discuss the sureties’ potential exposure to penalties and punitive damages. Well, the first week of the 2024/2025 NFL Football Season is in the books and man were there a lot of penalties! It is to be expected, somewhat, because teams are shaking off the rust and most starters don’t play in the preseason. But looking specifically at my Baltimore Ravens – come on man, you have to be able to line up correctly! You get paid millions of dollars and you can’t stand in a line — 5 illegal formation calls? But, I digress. One of my partners reached out to me over the weekend looking for some research on the issue of a surety’s exposure to penalties. Once I searched my files and sent him information, I thought this topic might also be a good refresher for the surety world. And a blog post was born. You should save this article because it is a great resource for addressing this issue.
The common-law principle is that a surety ordinarily is not liable for penalties imposed by law on a person covered by the bond. Butler v. United Pacific Ins.Co., 265 Or. 473, 474-75, 509 P.2d 1184 (1973)(citing with approval Restatement (First) of Security § 181 (1941)). The rationale for the rule is that the purpose of a penalty – i.e., to deter disfavored conduct and to punish – is ill-served when the person who engaged in the conduct does not have to pay the penalty. This rule should apply to any statutory liability designed to serve as a penalty rather than as compensation for losses arising directly from the breach of the duties secured by the bond. Consequently, treble damages and similar forms of penalties for nonpayment of wages or violation of prevailing wage laws generally are not recoverable from a construction bond. See 19 ALR 5th 900 (1994) (collecting representative cases and so observing).
The general principle of suretyship, as originally stated in the 1941 Restatement (First), now expressly applies to statutorily required bonds. Under the Restatement (Third) of Suretyship & Guaranty § 73 (1996), “[w]hen the secondary obligation is a legally mandated bond, that obligation does not include any penalties imposed on the principal obligor for failure to fulfill the underlying obligation unless the secondary obligation so provides.” The commentary to the Restatement explains:
a. General principle. When a secondary obligor issues a legally mandated bond, the secondary obligor assumes liability for losses resulting from the failure of the principal obligor to fulfill its underlying obligation. Sometimes the law also imposes a penalty on the principal obligor for failure to fulfill that obligation. Such a penalty, however, is typically considered punitive rather than compensatory. * * *
Id. at § 73 comment a.
In North Marion School Dist. No. 15 v. Acstar Ins. Co., 343 Or. 305, 314-316, 169 P.3d 1224, 1228-30 (Or. 2007), the court reviewed the history of the general rule and the Restatements in addressing a claim for “penalty wages” under Oregon’s wage statute (ORS 652.150(1)) and noted that the penalty wages are the kind of penalty for which a surety ordinarily is not liable and are to be assessed against the employer for an employer’s willful failure to pay a terminated employee earned wages on time. The court noted that such penalty was designed “to spur an employer to the payment of wages when they are due” and is punitive, not compensatory, in nature. Accordingly, the court held that the surety was not liable under its payment bond for the penalties. In the Butler case noted above, the issue involved whether a surety on a statutorily required automobile dealer’s bond was liable for punitive damages assessed against the dealer in a civil action. The statute at issue permitted a plaintiff to recover from the bond “any loss or damage” suffered due to an automobile dealer’s fraud; it did not expressly or in other clear terms authorize recovery of punitive damages. The court noted that the legislature had not included the surety liability to encompass penalties such as punitive damages and the court would not do so unless the legislature had, in clear and unambiguous terms, so provided by statute. The court therefore held that the surety was not liable for those amounts.
In Dean v. Seco Elec. Co., 35 Ohio St.3d 203, 206-207, 519 N.E.2d 837, 840-41 (Ohio 1988), the court stated the general principle as to punitive damages are not recoverable against a surety unless the act of the principal was authorized, participated in, or ratified by the surety. See Vicario v. Jenkins (1958), 108 Ohio App. 49, 9 O.O.2d 111, 155 N.E.2d 488; Cahill v. Fid. & Cas. Co. (1930), 37 Ohio App. 444, 175 N.E. 39; Restatement of the Law, Security (1941), Sections 195 and 198; Annotation, Liability of Surety on Private Bond for Punitive Damages (1980), 2 A.L.R. 4th 1254. In the Dean case, F & D was acting in no other capacity than as a surety. It did not authorize, participate in, or ratify the failure of the principal, to pay prevailing wages. It had no control or influence over Seco and there was no allegation that F & D was guilty of actual malice, fraud, or oppression. Thus, the court held that “[i]mposition of the statutory penalty upon sureties such as F & D would thus not serve the purpose of the statute that the General Assembly intended: to penalize past occurrences and deter future incidences of employers not paying prevailing wages. We therefore conclude that absent an agreement to the contrary, a surety is not liable for a penalty assessed against its principal for the wrongful acts of the principal where there has been no showing that the surety ratified the principal’s wrongful acts or that the surety is guilty of actual malice, fraud, or oppression.”
In C & I Steel, LLC v. Travelers Cas. and Sur. Co. Of America, 70 Mass. App. Ct. 653, 658-59, 876 N.E. 2d 442, 446-47 (Mass. App. Ct. 2007), the court addressed a claim for punitive damages under a payment bond and held that such damages were not recoverable against the surety. The court noted that the terms of the bond did not cover punitive damages, and such damages were for punishment, not for “labor, materials and equipment.” The court observed that the “purpose of punitive damages has been described as punishment and deterrence rather than compensation of an injured party”. It stated, “[t]o conclude that the bond encompassed punitive damages would be to rewrite the agreement Travelers made with Peabody and to risk diluting through punitive awards to a few subcontractors and materialmen the “security to [all] subcontractors and materialmen on public works, . . . that the bond is designed to afford.” The court did note a caveat to its ruling stating, “[o]ur conclusion does not mean that Travelers is immune from punitive damages for any misdeeds of its own. . . . It simply means that Travelers did not undertake in the bond to pay for the misdeeds of others.” The Travelers court cited to the following cases in support of its conclusion: Bull v. Albright, 254 Ala. 29, 32, 47 So.2d 266 (1950) (surety not liable for punitive damages); Rogers v. Speros Constr. Co., Inc., 119 Ariz. 289, 293, 580 P.2d 750 (1978) (liability of surety on bond limited by statute and terms of bond); Edmonds v. Western Sur. Co., 962 P.2d 323, 326 (Colo.Ct.App.1998) (general rule that surety bond mandated by statute does not include penalties imposed on principal); Ames v. Commissioner of Motor Vehicles, 267 Conn. 524, 536, 839 A.2d 1250 (2004) (punitive damages not recoverable against surety bond); American Home Assur. Co. v. Larkin Gen. Hosp., Ltd., 593 So.2d 195, 198 (Fla.1992) (surety’s liability limited by terms of bond); Guardianship of Smith, 211 Kan. 397, 402, 507 P.2d 189 (1973) (general rule that surety is not liable for punitive or exemplary damages as public policy requires that payment rest on party committing the wrong); Growbarger v. United States Fid. & Guar. Co., 126 Ky. 118, 102 S.W. 873, 875–876 (Ct.App.1907) (surety not liable for punitive damages of principal); United States Fid. & Guar. Co., v. Mississippi, 254 Miss. 812, 818, 182 So.2d 919 (1966) (surety not liable for punitive damages); Yesel v. Watson, 58 N.D. 524, 226 N.W. 624, 626 (1929) (surety not answerable for punitive damages recoverable against wrongdoer); Troyer v. Horvath, 13 Ohio App.3d 155, 157, 468 N.E.2d 351 (1983) (punitive damages not recoverable from surety); Stumpf v. Pederson, 180 Okla. 408, 70 P.2d 101, 103 (1937) (surety not liable for punitive damages); Pennsylvania Turnpike Commn. v. United States Fid. & Guar. Co., 412 Pa. 222, 230–231, 194 A.2d 423 (1963) (decisions uniformly hold that liability of surety limited to actual damages sustained); Dawson v. Reliance Ins. Co., 482 S.W.2d 882, 882 (Tex.Civ.App.1972) (surety not liable for exemplary damages under bond); Coates v. United States Fid. & Guar. Co., 525 S.W.2d 654 (Mo. App. 1975)(statutory penalty for the subcontractor’s failure to pay the employees’ wages did not apply to surety because it was penal in character and the court gave it a strict construction, limiting it to only cases where an employer-employee relationship existed); Rogers v. Speros Constr. Co., 119 Ariz. 289, 580 P.2d 750 (1978)(statute limited the recovery of treble damages to actions against “an employer or former employer,” the court found that the surety was not obligated to pay any penalty imposed on the employer for violation of the prevailing wage law); State, ex rel. Nichols, v. Safeco Ins. Co., 100 N.M. 440, 671 P.2d 1151 (1983), the court held that a bond obligating the surety to pay “for all just claims for labor performed and materials and supplies furnished” did not obligate the surety to pay for any punitive damages assessed against the contractor).
While the case law is overwhelmingly in unison on this issue in finding that the surety is not liable for penalties and punitive damages, the surety must keep in mind that the language of specific statutes and bonds must be considered, as must the specific actions of the surety in each case.
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (410-659-1321/mstover@wcslaw.com) or any member of the Surety and Fidelity Practice Group.