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Surety Does Not Have Special Relationship with Its Principal or Owe a Fiduciary Duty; Tort Claim Rejected
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February 12, 2007
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(A revised version of this article will appear in The Construction Lawyer, Volume 27, No. 1, Winter 2007, published by the American Bar Association's Forum on the Construction Industry.)
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Thelen Reid Brown Raysman & Steiner LLP
Based on a set of drawn-out but familiar facts, the Nevada Supreme Court has affirmed several fundamental concepts of surety law in favor of the surety.
A general contractor required a subcontractor to procure surety bonds in connection with its work on an airport project. The subcontractor, as bond principal, executed a "General Indemnity Agreement" with the surety, and in 1997 the surety issued a payment and performance bond in connection with the subcontractor's work on the project.
In 1998 and 1999, two suppliers sued the subcontractor and the surety for non-payment of amounts due. The subcontractor claimed that it could not pay the claims without receiving funds from the general contractor. Thereafter, the subcontractor received the funds from general contractor, placed the funds into a special account under the control of the subcontractor's counsel, and then transferred the funds, with the consent of the parties, to an account supervised by the trial court.
In 2000, the surety sued the subcontractor to enforce the indemnity provisions of the indemnity agreement. In particular, the surety asserted its right under the indemnity agreement to imposition of a "joint trust" over any funds received by the subcontractor from general contractor to be held to satisfy payment bond claimants. In that action, the subcontractor counterclaimed that the surety had breached an oral agreement to provide further bonds and that the subcontractor could not take on additional, profitable work as a result.
In 2001, the subcontractor settled with both suppliers, apparently without the consent of the surety, which moved to set aside the supplier settlement agreements on the grounds that funds received from general contractor should have been placed into a trust account held jointly by the surety and the subcontractor. The trial court denied the motion, but the surety pressed on with its indemnity claim, seeking attorney fees and costs incurred in its attempts to enforce the indemnity agreement.
In 2003, the trial court signed an order that approved the supplier settlements, ordered the subcontractor's counterclaim to a jury trial and effectively dismissed the surety's indemnity claims. One of the trial court's jury instructions stated that a surety owes its principal a fiduciary duty. The jury found for the subcontractor, awarding compensatory damages of $1,585,000 and punitive damages of $4,270,552.
On appeal, the Nevada Supreme Court reversed and remanded. Insurance Co. of the West v. Gibson Tile Co., 134 P.3d 698 (Nev. 2006). The Supreme Court found, among other things, that the trial court erred when it denied the surety an opportunity to pursue its indemnity claims. On this point, the court said:
We have recognized that "[s]ureties, unlike insurers, profit solely from the premiums they collect. Indemnification rights guard against potential losses, help reduce the surety's risk, and keep premiums relatively low.". Further, we have noted that "the right to subrogation distinguishes suretyship from insurance, and such right is considered by the surety in arriving at the amount of bond premiums.". Therefore, a surety is entitled, under a GIA [general indemnity agreement], to indemnity for costs incurred in defending an action brought against it on a bond, regardless of whether any payment is ultimately made by the surety.
The subcontractor had alleged a tort claim against the surety for breach of the implied covenant of good faith and fair dealing. The Nevada Supreme Court held that the surety-principal relationship is not one of those "rare and exceptional cases" of a "special relationship. characterized by elements of public interest, adhesion and fiduciary responsibility" that is necessary to support such a tort claim. Therefore, the subcontractor as bond principal had no claim against the surety for tortious breach of the implied covenant of good faith and fair dealing under Nevada law, and the trial court erred when it instructed the jury on fiduciary duties arising from a special relationship.
Because the surety and the subcontractor did not enter into a valid and enforceable contract to provide additional bonding, the Nevada Supreme Court also held that the award of compensatory damages could not stand. The court found that the subcontractor had not tendered any additional consideration to the surety to create such a contract or to modify an existing contract. The subcontractor's bare requests for additional bonding and the surety's requests that the subcontractor perform its pre-existing duties under the indemnity agreement did not give rise to a new contract.
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©2007 Thelen Reid Brown Raysman & Steiner LLP
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