The Surety Is Not Your Fiduciary
September 27, 2022
Every now and then a surety will be faced with an opposing party claiming that the surety owes it a “fiduciary duty,” usually it’s the principal or an indemnitor. Many times, they will latch on to the “attorney in fact” provision in an indemnity agreement or other rights that are granted to the surety in that agreement as justification for their contention. Accordingly, in this Surety Today Blog post we will consider the issue of fiduciary duties.
To establish a claim for breach of fiduciary duty, a plaintiff must typically prove the following elements: (1) a fiduciary relationship between plaintiff and defendant, (2) breach of the fiduciary duty by defendant, and (3) injury to plaintiff as a result of the breach. Navigant Consulting, Inc. v. Wilkinson, 508 F.3d 277, 283 (5th Cir. 2007). In the surety context, typically the deciding issue is whether a fiduciary duty can be shown to be owed by the surety.
The determination of whether a fiduciary duty exists cannot be made “by recourse to rigid formulas.” Scott v. Dime Sav. Bank of N.Y., FSB, 886 F. Supp. 1073, 1078 (S.D.N.Y. 1995). In assessing whether a fiduciary relationship exists a court must generally examine “whether one person has reposed trust or confidence in the integrity and fidelity of another who thereby gains a resulting superiority or influence over the first.” Teachers Ins. & Annuity Ass’n of Am. v. Wometco Enters., Inc., 833 F.Supp. 344, 349–50 (S.D.N.Y. 1993); Lasater v. Guttmann, 194 Md. App. 431, 456 (2010). In other words, “[a] fiduciary relation exists between two persons when one of them is under a duty to act for or to give advice for the benefit of another upon matters within the scope of the relation.” Restatement (Second) of Torts § 874, cmt. a). Stated differently, a fiduciary relationship is regarded as a special relationship of confidence or trust that may arise when one person has reposed a special confidence or trust in another who undertakes to act primarily for the benefit of the person in a particular endeavor such that the parties do not deal with each other on equal terms. In re Clark’s Estate, 467 Pa. 628, 359 A.2d 777, 781 (1976); Scheffler v. Adams and Reese, LLP, 06-1774 (La. 2/22/07), 950 So. 2d 641, 647-48)(“A fiduciary relationship, in turn, is a ‘special relationship’ of confidence or trust imposed by one in another who undertakes to act primarily for the benefit of the principal in a particular endeavor.”). A fiduciary relationship is characterized “by a unique degree of trust and confidence between the parties, one of whom has superior knowledge, skill or expertise and is under a duty to represent the interest of the other.” LaCroix v. U.S. Bank, N.A., No. CIV. 11-3236 DSD/JJK, 2012 WL 2357602, at *7 (D. Minn. June 20, 2012). Determining the existence of a fiduciary relationship requires a fact-specific inquiry. St. John’s Univ., N.Y. v. Bolton, 757 F. Supp. 2d 144, 166 (E.D.N.Y. 2010).
A fiduciary duty is an extraordinary one and is not lightly created. Casa Orlando Apartments, Ltd. v. Fed. Nat’l Mortg. Ass’n, 624 F.3d 185, 195 (5th Cir. 2010); In re Int’l Payment Grp., Inc., 733 F. App’x 98, 104 (4th Cir. 2018) (“[c]ourts impose fiduciary duties only in limited circumstances.”). Indeed, a fiduciary duty is the highest standard of duty implied by law. Lucas v. Fairbanks Capital Corp., 618 S.E.2d 488, 493 (W. Va. 2005) (citing Elmore v. State Farm. Mut. Auto. Ins. Co., 504 S.E.2d 893, 898 (W. Va. 1998)). A fiduciary duty requires the party to exercise the duty in equity and good conscience, and to act in good faith and with due regard to the interest of the one reposing the confidence. SSI Medical Services, Inc. v. Cox, 301 S.C. 493, 392 S.E.2d 789 (1990). As one court put it “a fiduciary must act with scrupulous fairness and good faith in his dealings with the other and refrain from using his position to the other’s detriment and his own advantage.” Young v. Kaye, 443 Pa. 335, 279 A.2d 759, 763 (1971). The fiduciary duty is so strict because the superior position of the fiduciary affords great opportunity for abuse of the confidence reposed. Id.
In most jurisdictions certain relationships have generally been held to be fiduciary in nature as a matter of law, such as the relationship between a trustee and beneficiary, guardian and ward, attorney and client, executors or administrators and creditors, legatees, or distributes, principal and agent, partners, and joint venturers. Leedom v. Palmer, 274 Pa. 22, 117 A. 410, 412 (1922). It is easy to see in the typical fiduciary relationship why a high and strict duty is imposed. These are relationships where the skilled and knowledgeable party is charged with protecting and safeguarding the interests of the other party and that other party, because it does not have such skill and knowledge, must justifiably rely on the other.
However, fiduciary duties are not necessarily confined to any specific association of parties. The duty can arise when the circumstances make it certain that the parties do not deal on equal terms, but on the one side there is an overmastering influence, or, on the other, weakness, dependence, or trust, justifiably reposed. Indeed, the Connecticut Supreme Court has purposefully left open the definition of a fiduciary so that new situations and factual scenarios are not excluded. Konover Development Corp. v. Zeller, 228 Conn. 206, 222–23, 635 A.2d 798, (1994), quoting Harper v. Adametz, 142 Conn. 218, 225, 113 A.2d 136 (1955). Similarly, Texas courts provide that confidential relationships may arise when the parties have dealt with each other in such a manner for a long period of time that one party is justified in expecting the other to act in its best interest. Ins. Co. of N. Am. v. Morris, 981 S.W.2d 667, 674–75 (Tex. 1998).
While fiduciary duties may arise in the course of a business relationship, a mere contractual association by itself does not generally give rise to a fiduciary duty. eToll, Inc. v. Elias Savion Advertising, Inc., 811 A.2d 10, 23 (Pa. Super. 2002); Steele v. Isikoff, 130 F. Supp. 2d 23, 36 (D.D.C. 2000)(“As a general rule, the mere existence of a contract does not create a fiduciary duty.”); Ponder v. Chase Home Fin., LLC, 666 F. Supp. 2d 45, 49 (D.D.C. 2009)(debtor-creditor relationship is ordinarily not a fiduciary relationship.). Moreover, “[m]ere subjective trust does not … transform arm’s-length dealing into a fiduciary relationship.” Schlumberger Tech. Corp. v. Swanson, 959 S.W. 2d 171, 177 (Tex. 1997).
So how does this general law of fiduciary duties relate in the context of suretyship? Our research reveals that the vast majority of courts that have considered the issue, have held that a surety owes no fiduciary duty to its principal or indemnitors. See National Union Fire Ins. Co. v. Turtur, 892 F.2d 199, 207 (2d Cir. 1989) (“[I]n general, a surety does not owe a fiduciary duty to its principal.”); Ins. Co. of N. Am., 981 S.W.2d at 674–75 (Tex. 1998); Bruce v. Martin, No. 87 CIV. 7737 (RWS), 1993 WL 148904, at *5–6 (S.D.N.Y. Apr. 30, 1993); In re McNeil, 22 B.R. 408, 413–14 (Bankr. E.D. Tenn. 1982); Associated Indem. Corp. v. CAT Contracting, Inc., 964 S.W.2d 276, 287–88 (Tex. 1998); Northwestern Nat’l Ins. Co. of Milwaukee v. Barney, 1988 WL 215411, at *7 (N.D. Ohio Nov.23, 1988) (stating that “a surety does not owe a fiduciary duty to its principals” under Ohio law); Hartford Fire Ins. Co. v. CMC Const. Co., No. 3:06-CV-11, 2010 WL 3338581, at *15–16 (E.D. Tenn. Aug. 24, 2010); Far W. Ins. Co. v. J. Metro Excavating, Inc., No. 2:07-CV-11-PRC, 2008 WL 859182, at *11 (N.D. Ind. Mar. 28, 2008); Abbott v. Equity Grp., Inc., No. 86-4186, 1990 WL 3152, at *5 (E.D. La. Jan. 5, 1990), amended, No. 86-4186, 1990 WL 32979 (E.D. La. Mar. 20, 1990) (“In general, a surety does not owe a fiduciary duty to its principal….”) (internal citations omitted); U.S. Specialty Ins. Co. v. Strategic Planning Assocs., LLC, No. CV 18-7741, 2019 WL 296864, at *4 (E.D. La. Jan. 23, 2019); Associated Indem. Corp. v. CAT Contracting, Inc., 964 S.W.2d 276, 287-88 (Tex. 1998); Sonoma Springs Ltd. P’ship v. Fid. & Deposit Co. of Maryland, 409 F. Supp. 3d 946, 955 (D. Nev. 2019); Insurance Co. of West v. Gibson Tile Co., Inc., 122 Nev. 455, 134 P.3d 698, 702 (2006). In reaching this conclusion, courts have expressed a variety of reasons. For example, in Travelers Prop. & Cas. Ins. Co. v. Triton Marine Const. Corp., 473 F. Supp. 2d 321, 332–33 (D. Conn. 2007), the court observed that the surety and principal operated as entities in a commercial relationship. Their relationship could not be described as one exhibiting “a unique degree of trust and confidence,” and the surety—who under the indemnity agreement had the exclusive right to determine whether any claims on the bond should be paid, settled, defended or appealed—was not “under a duty to represent the interest” of its principal. Id. at 322, 528 A.2d 1123.
In Reginella Const. Co. v. Travelers Cas. & Sur. Co. of Am., 949 F. Supp. 2d 599, 610–14 (W.D. Pa. 2013), the federal Western District of Pennsylvania court stated that underlying economics of suretyship weigh against “transmuting a surety into a fiduciary.” First, the court noted that a surety bond is a financial credit product, not an insurance contract. Second, the surety has a contractual relationship with two parties that often have conflicting interests, namely the obligee on the bond and the principal, which causes the surety to balance these interests when responding to claims. Third, the parties to a surety contract are typically commercially sophisticated, have relatively equal bargaining power and ample access to legal and technical advice. Fourth, the pricing of the premium by the surety is not based upon the risk of fortuitous loss (as is the case in insurance contracts), but rather on the assumption that the principal will reimburse the surety in the event of the principal’s default and surety’s corresponding loss. Fifth, the principal purchases the bond from the surety not for its own benefit, but for the benefit of its customer, the obligee. Sixth, the principal must usually agree to indemnify the surety if claims are filed, which is the reverse of an insurance contract, where the insurer agrees to indemnify the principal who owns the policy. See U.S. ex rel. SimplexGrinnell, L.P. v. Aegis Ins. Co., 2009 WL 90233, at *3–4 (M.D. Pa. 2009); see also Bruner and O’Connor, §§ 10:201, 12:7.
The Reginella Court concluded that surety bond agreements are standard commercial contracts and imposing a fiduciary relationship between parties to a contract is the exception rather than the rule. It stated “[p]erhaps most importantly, the principal-surety relationship is riddled with conflicting interests and split loyalties, which fiduciaryship by definition forbids.” Id. at 612; McCarrell v. Cumberland County Employees Ret. Bd., 547 A.2d 1293, 1296 (1988). In other words, there can be no justifiable expectation that a fiduciary relationship exists because of the tripartite nature of suretyship and the indemnity obligation to keep the surety whole.
Surety bonds present the surety with a significant risk of financial loss if its principal were to fall short of its contractual obligations. The Reginella Court stated that:
[s]pecifically, these bonds required Travelers to pay claims filed by Reginella’s subcontractors as well as all of the costs necessary to complete the projects if Reginella defaulted. Although the agreements arguably positioned Travelers to do substantial harm to Reginella’s business interests if it were to act in bad faith, they do not go so far as to give Travelers an unfettered ability to exert complete control over the relationship without incurring any risk to its own interests.
Id. at 613-614.
The court continued, “[t]o the extent that Reginella predicates its fiduciary duty claims on the magnitude of the damage it allegedly suffered at Travelers’s hands, it is incorrect. As Pennsylvania law makes clear, it is the disparity in position between the parties and not the depth of the damage suffered that gives rise to an overmastering influence and fiduciary relationship.” Id.; eToll, 811 A.2d at 23. In a contractual relationship, this disparity involves much more than one party’s reliance on the other’s performance. This scheme of risk allocation is the essence of suretyship and is standard practice in the construction industry. Id.
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.