Surety Case Law Note: Sureties Do Not Owe Tort Duty of Good Faith In Indiana
April 25, 2023
In this Surety Today Blog post we consider a Case Law Note addressing the issue of whether a surety is subject to a tort duty of good faith to the obligee under Indiana law. Spoiler Alert: the answer is no! The case is:
POSTERITY SCHOLAR HOUSE, LP v. FCCI INS. CO., 205 N.E.3d 1018 (Ind. Ct. App. 2023)
This case follows closely on the heels of the Eastern Steel Constructors, Inc. v. Int’l Fid. Ins. Co., case from Pennsylvania in which the appellate court held that the Pennsylvania insurance bad faith statute did not apply to sureties. On March 1, 2023, in the Posterity Scholar House case, a case of first impression in Indiana, the appellate court held that the common law tort duty of good faith in performing an insurance contract that an insurer owes to its insured does not apply to the surety/obligee relationship, even though suretyship is regulated as a class of insurance under the Indiana Insurance Code. The court noted that there are fundamental differences between insurance and suretyship. Most notably, the relationship between a surety and its bond obligee does not reflect the “special relationship” on which a bad faith claim in the insurance context was recognized for insurers in Indiana.
The facts – An owner hired a general contractor to construct two apartment buildings. The general contractor was required to obtain performance and payment bonds for the project. FCCI Ins. Co., provided the bonds. When the general contractor allegedly defaulted on the construction contract, the obligee/owner filed a claim under the performance bond, demanding that FCCI complete performance of alleged defective or incomplete work on the construction project. The owner also filed a series of claims under the payment bond, demanding that FCCI pay the general contractor’s unpaid subcontractors.
FCCI denied the performance bond claim after its investigation revealed that the owner, not the general contractor, was the party in default of the construction contract. FCCI also denied the payment bond claims due to the owner’s alleged failure to provide certain information required by the bond. However, FCCI indicated that it would reconsider all of the bond claims if the owner provided additional information.
The owner sued the surety company for breach of contract and tortious bad faith in its handling of the bond claims. FCCI moved for partial summary judgment as to the bad faith claim. The trial court granted FCCI’s motion. In challenging the trial court’s grant of FCCI’s motion for partial summary judgment, the owner argued that a surety owes its bond obligee a common law duty of good faith by extension of the duty an insurer owes its insured. The court noted that this was a matter of first impression under Indiana law and is one on which other states are divided. The court observed that states that extend an insurer’s common law duty of good faith to the surety-obligee relationship tend to rely heavily on the inclusion of sureties in their states’ regulatory schemes governing insurance. States holding a contrary view champion the fundamental differences between suretyship and insurance. See, e.g., Cates Constr., Inc. v. Talbot Partners, 21 Cal.4th 28, 86 Cal.Rptr.2d 855, 980 P.2d 407 (1999); Great Am. Ins. Co. v. N. Austin Mun. Util. Dist. No. 1, 908 S.W.2d 415 (Tex. 1995).
In analyzing Indiana law, the court noted that an insurer’s duty of good faith was based on the “unique character” of insurance policies and the “special relationship” between insurer and insured. The special relationship between insurer and insured imposes on the insurer a duty of good faith dealing because of the arms-length contractual relationship between the two parties, the fiduciary nature of the contract, and the potentially adversarial nature of first-party claims that may occur as a result of the contractual relationship between the parties. The noted that the fiduciary nature of the relationship arises from an insurer’s duty to defend an insured against third party liability claims. The adversarial nature of the relationship is marked by an insured’s vulnerability when, in the face of calamity, the insured makes a first-party coverage claim.
The court noted that the Indiana Supreme Court long ago distinguished between suretyship and insurance, noting that “there is a very wide difference between the two kinds of contracts.” Meyer v. Bldg. & Realty Serv. Co., 209 Ind. 125, 133, 196 N.E. 250, 253-54 (1935).; Ind. Univ. v. Ind. Bonding & Sur. Co., 416 N.E.2d 1275, 1285 n.6 (Ind. Ct. App. 1981) (“[T]he essential nature of the promises differ.”). The court noted that insurance involves a bilateral contract by which one party (the insured) shifts its risk of loss to another party (the insurer). “Suretyship is a tripartite arrangement in which one party (the surety) guarantees that a second party (the principal) will perform its contractual obligations to a third party (the obligee). If the principal defaults on its obligations, the obligee may call upon the surety for performance, after which the surety may seek indemnification from the principal. Thus, the principal retains the risk of loss.” The court, quoting Bruner & O’Connor, stated “[a] surety bond is a financial credit product, not an insurance indemnity product.” 4A Philip L. Bruner & Patrick J. O’Connor, Jr., Construction Law § 12:7 (2022).
The court continued by observing “[i]t is true that from the obligee’s standpoint … a surety bond may be thought of as ‘insurance’ against a default by the principal. However, this extra level of protection is really no different from that afforded to a beneficiary under a letter of credit or other similar credit arrangement. The obligee’s perceptions of what it is acquiring when it purchases a surety bond do not alter the underlying nature of the transaction. Suretyship is a form of credit enhancement rather than a type of risk financing, e.g., insurance.”
The owner claimed that suretyship and insurance should be treated in the same manner because the Indiana General Assembly included surety bonds as a class of insurance under the Indiana Insurance Code, which broadly defines “[i]nsurance” as that which “grant[s] indemnity or security against loss for a consideration”. The court, aligned itself with the states that disregard statutory inclusion as a basis for liability, and held that an insurer’s common law duty of good faith arises not because insurance is a regulated industry, but from the “special relationship” between insurer and insured, which does not exist between surety and obligee. The court noted that 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. Moreover, whereas an insured can look only to its insurer for recourse in the wake of a loss, a bond obligee has a remedy against its principal as well as its surety.
The court held that “we find the relationship between a surety and its bond obligee does not reflect the ‘special relationship’” and therefore “conclude that the common law duty of good faith that an insurer owes its insured does not extend to the surety-obligee relationship in the context of performance and payment bonds on a construction project.” Accordingly, the summary judgment in favor of FCCI was upheld.
It is always good to see a court get the issue of the distinction between suretyship and insurance correct and to see that bad faith exposure did not extend to suretyship. This case is especially helpful in its recognition of suretyship as a credit transaction.
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (410-659-1321 or mstover@wcslaw.com) or any member of the Surety and Fidelity Practice Group.
