Surety Case Law Note: The Right To Settle And The Duty Of Good Faith And Fair Dealing
May 28, 2024
In this Surety Today: The Blog post we consider a Case Law Note addressing the issue of the intersection between the surety’s right to settle claims in the GIA and the duty of good faith and fair dealing under Washington State law.
The case is:
TRAVELERS CAS. & SUR. CO. OF AM. v. FLAWLESS WALLS LLC, NO. 2:22-CV-0178-TOR,
2024 WL 71706, AT *1–6 (E.D. WASH. JAN. 5, 2024)
In this case the surety’s principal was a subcontractor to the obligee general contractor. After the surety had originally denied the obligee’s performance bond claim and elected to litigate the matter, the surety ultimately settled the claim with the obligee while cross motions for summary judgment were pending. After settlement, the surety then filed a motion for summary judgment against its indemnitors seeking reimbursement for the settlement payment and its costs and attorney’s fees. As a defense, the indemnitors argued that the surety breached its duty of good faith and fair dealing under the indemnity agreement because it had originally elected to litigate the matter and had opposed the obligee’s motion for summary judgment.
The facts are these: Traveler’s Casualty and Surety Company (“Travelers”) was the surety, Jackson Contractor Group, Inc. (“Jackson”) was the obligee and Flawless Walls, Inc. (“Flawless”) was the principal. The GIA between Flawless and Travelers contained the typical claims settlement clause:
Company shall have the right, in its sole discretion, to determine for itself, and Indemnitor whether any claim, demand or suit brought against Company or any Indemnitor in connection with or relating to any Bond shall be paid, compromised, settled, tried, defended or appealed, and its determination shall be final, binding and conclusive upon the Indemnitors. Company shall be entitled to immediate reimbursement for any and all Loss incurred under the belief it was necessary or expedient to make such payments.
On May 11, 2021, Jackson provided Flawless with a Notice of Supplementation of work due to what it characterized as Flawless’ inability to meet the agreed upon schedule. However, Flawless maintained that any failure to meet deadlines was due to Jackson’s mismanagement and changing of construction plans. The subcontract was subsequently terminated on August 26, 2021, and Jackson asserted that Flawless had given notice that it was going out of business and ceased all work on the Subcontract.
Flawless asserts that the subcontract was mutually dissolved on August 13, 2021, with the expectation that Flawless would complete certain remaining projects and the subcontract would be extinguished. As a condition for this agreement, Flawless would not receive payment for the work completed.
On March 25, 2022, Jackson sent a demand for payment under the performance bond to Travelers, claiming losses in the amount of $753.154.40, which Travelers denied. Jackson then filed suit against Flawless and Travelers. Later in the case Jackson filed a motion for partial summary judgment. Travelers filed a cross-motion for summary judgment. Thereafter, Travelers and Jackson reached a settlement of the claims for the payment of $325,000, in exchange for a full release of the bonds. The settlement agreement, also contained a provision that released any claims Flawless may raise in connection with the action, including the underlying subcontract with Jackson. Flawless and Travelers disagreed as to whether Travelers was exposed to liability under the bonds at all. Flawless asserted that it performed under the subcontract, and that Travelers had agreed that Jackson’s claim lacked merit under the performance bond. Travelers asserted that its settlement with Jackson was within the bounds of the indemnity agreement and “necessary and expedient” to resolve Jackson’s claim.
Travelers filed a complaint against Flawless seeking indemnity for the loss incurred settling the bond claim with Jackson, plus attorney’s fees and related costs. Travelers later filed a motion for summary judgment in its case against Flawless, arguing that the language of the GAI was clear in granting Travelers the ability to settle all claims it deemed necessary or expedient. Flawless responded, arguing in part that Travelers breached its duty of good faith and fair dealing in the settlement, as evidence existed that Jackson’s claims had no merit, and therefore it was not “necessary or expedient” to settle the claim.
The Court applied Washington State law and under that law it is recognized that every contract contains an implied duty of good faith and fair dealing. Citing Colorado Structures. This covenant requires parties to “cooperate with each other so that each may obtain the full benefit of performance.” The duty of good faith arises when the contract in question gives one party discretionary authority to determine a term therein, which the settlement clause of the bond clearly does. According to Flawless, Travelers did not negotiate the settlement with Jackson in good faith because the underlying claim lacked merit, and therefore they are relieved from indemnifying Travelers. In part, Flawless supported this position on the premise that Travelers had previously taken the position in its denial of the claim and in the litigation that Jackson’s claim had no merit.
Flawless contended that it fully performed under the Subcontract and that Jackson had failed to satisfy the conditions precedent in the performance bond. Travelers raised those positions in its defense of Jackson’s claims. The court noted that after Travelers had the benefit of its investigation, considering Flawless’ positions and reviewing the evidence, Travelers chose to litigate the claim, rather than settling initially, and defended Flawless in response to Jackson’s Motion for Summary Judgment, taking the position that Flawless had performed its duty under the subcontract. Travelers placed the blame on Jackson for creating delays in the project and pointed to the fact that Jackson never declared Flawless in default or sought to terminate the subcontract for cause, both conditions precedent to accessing the performance bond. The court further noted that Flawless produced evidence, including statements of position that Flawless provided to Travelers that describe a rocky and tenuous working relationship with Jackson, in which Flawless still managed to substantially perform, which the court believed raised questions of material fact as to whether Flawless “would have fared better without the settlement.” Travelers adopted and relied on many of these arguments both in its initial correspondence denying Jackson’s claim and in its Cross-Motion for Summary Judgment in the underlying suit.
The court upheld the settlement clause in the GIA, noting that the specific provision had been upheld by courts in other jurisdictions. However, the Court did find that questions of fact remained as to whether Travelers breached a duty of good faith to Defendants in settling the underlying lawsuit with Jackson. The court stated that “[g]ood faith limits the authority of a party retaining discretion to interpret contract terms; it does not provide a blank check for that party to define terms however it chooses.” Scribner v. Worldcom, Inc., 249 F.3d 902, 910 (9th Cir. 2001). The court held that “in considering all facts in the light most favorable to Defendants, the Court cannot determine if Travelers, in good faith, made a ‘necessary or expedient,’ settlement given Traveler’s position regarding Flawless in its initial dealing with Jackson.” Thus, the court concluded “as it stands the Court cannot definitively say if the settlement for $325,000 was done in good faith such that each party receives the ‘full benefit of performance.’”
I do not agree with this decision, but we do not want to read too much into this decision because it was on summary judgment and the court was bound to give the opposition the benefit of the doubt. The problem I have with this opinion is that it does not mention that “expediency and necessity” might include considering the costs of litigation and attorney’s fees, reassessment of the case after viewing the claimant’s summary judgment motion, discovery in the case, evaluating the witnesses, the amount of the settlement versus the potential damages in an adverse verdict, etc. This opinion would seem to lock a surety into its initial assessments. In addition, courts generally should favor and encourage settlements. The settlement in this case was for less than the demand and about half of the bond penal sum and does not seem excessive or in bad faith. The court does not do a good job of explaining the requirements under Washington State law for finding “bad faith.” Also, there was scant discussion of case law in other jurisdictions on the point that there should not be a finding of breach of the duty of good faith and fair dealing when a party is exercising its express rights under the GIA.
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.
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