Surety Case Law Note: Upholding a Surety’s Right to Settle a Principal’s Affirmative Claims
August 16, 2022
In this Surety Today blog post we will provide a Case Law Note to consider the issue of the surety’s right to settle a principal’s claims.
PICKARD & BUTTERS CONSTR., INC. V. COUNTY OF SANTA CRUZ, No. H046816, 2020 WL 7554084, at *1–5 (Cal. Ct. App. Dec. 21, 2020), review denied (Mar. 17, 2021)
In this case, the Principal entered into a construction contract with the County of Santa Cruz and the surety issued payment and performance bonds. As consideration for those and other bonds issued on its behalf, the Principal and others executed a general indemnity agreement in favor of the surety. As is typical, the GAI permitted the surety to demand collateral security on the bonds upon a notice of claim or lawsuit asserting liability. The GAI also assigned the Principal’s rights under the bonded contracts to the surety upon the Principal’s default. The GAI defined default as including failure to deposit collateral security upon demand. In addition, the GAI also authorized the surety “to decide and determine in its sole discretion whether any claim, liability, suit or judgment made or brought against the surety on any Bond shall or shall not be paid, compromised, resisted, defended, tried or appealed, and surety’s decision shall be final, binding and conclusive upon Principal.” In connection with such rights, the GAI authorized the Surety to act as the Principal’s attorney-in-fact to execute any release required to reach a claim settlement.
Over a period of 3 years, the Surety investigated and paid over 100 claims totaling nearly $1.4 million, including $605,371 to resolve 29 bond claims on the Santa Cruz County project. The Surety made a written demand for collateral security in 2016 to the Principal in the amount of $1.4 million. The Principal did not post collateral or respond in writing to the demand. The Surety sued the Principal for breach of the indemnity agreement and reimbursement.
At the same time, disputes between the Principal and Santa Cruz County arose over change orders and delays. The County denied the Principal’s claim for $894,075 and the Principal filed suit in the Santa Cruz County Superior Court. Just before trial in that case the County attempted to settle with the Principal, but the Principal refused. The County then approached the Surety regarding settlement. The Surety intervened in the Principal/Santa Cruz litigation and then entered into a settlement with the County, the day before the trial date. The Surety then filed a motion to enforce the settlement in that litigation.
The Surety argued in its motion that the settlement agreement should be enforced and the lawsuit dismissed because the Principal was in default under the Indemnity Agreement and failed to comply with the Surety’s demand for collateral. The Surety noted that the indemnity agreement assigned the Principal’s rights against the County and gave the Surety the right to settle the lawsuit.
The Principal opposed the Motion to enforce settlement and argued that the Surety had materially breached the indemnity agreement by acting in bad faith by paying indemnity claims over the Principal’s objections; refusing to intervene at the outset of the case against the County; and intervening and settling the instant case secretly after the Principal incurred trial preparation costs. The Principal also argued that the court should find the indemnity agreement unenforceable under the equitable doctrine of laches because the Surety sat on its rights for over three years during which time the Principal incurred several hundred thousand dollars in litigation expenses related to multiple projects. The Principal further contended that the settlement was unjust because it was less than half of what the Principal was prepared to prove at trial.
The trial court found that the Principal was in default under the Indemnity Agreement by failing to pay amounts claimed by its subcontractors and others on the Santa Cruz County project and failure to respond to the collateral demand. In addition, the trial court found that the Assignment clause of the Indemnity Agreement was valid and that all of the Principal’s rights and claims against the County were assigned to the Surety and the Surety was therefore entitled to pursue and settle the claims as the “Attorney-in-Fact” in its “sole discretion.”
The lawsuit filed by the Surety against the Principal was still pending and the trial court noted that enforcement of the settlement agreement, and dismissal of the County litigation, did not prejudice or foreclose any bad faith breach of contract claim that the Principal may want to assert in the Surety litigation. Accordingly, the trial court upheld the settlement. The appellate court affirmed the ruling on appeal. Although the settlement was upheld and the Principal’s case against the County was dismissed, the Surety may still have to face the alleged bad faith arguments in the Surety/Principal litigation.
I had an identical case here in Maryland where the surety settled the Principal’s claims in litigation involving a local government agency over the objection of the Principal. The court upheld the surety’s right to settle the case and noted any bad faith claims could be addressed in the dispute between the Principal and Surety. The Principal then raised bad faith in the case between the Principal and Surety. Maryland imposes a reasonableness standard on the surety’s settlement of claims in general and we had to go back and prove that the settlement of the claims was reasonable and that the payments made by the surety were reasonable. We ultimately prevailed. But, sometimes even though you have the right to settle a principal’s claims under the Indemnity Agreement, you have to consider the costs and repercussions of doing so.
If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (firstname.lastname@example.org) or any member of the Surety and Fidelity Practice Group.
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