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The Supreme Court of California holds that an obligee may not recover in tort for a surety's breach of covenant of good faith and fair dealing implied in a performance bond.
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Cates Constr., Inc. v. Talbot Partners et al.,
1999 Cal. LEXIS 4847 (Co. July 29, 1999).
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| In 1989, defendant Talbot Partners ("Talbot") hired plaintiff Cates Construction, Inc. ("Cates") to build a condominium project in Malibu, California. The construction contract required Cates to have the project ready for occupancy in eight months. The contract also required Cates to furnish a performance bond and a labor and materials bond, both of which were subsequently issued by Transamerica Insurance Company ("Transamerica").
During construction, Cates submitted twenty-two payment requests, each of which was paid. Talbot rejected the twenty-third request because Talbot had already paid several hundred thousand dollars more than the cost of the work. On November 29, 1990, six months after the project should have been completed, Talbot advised Transamerica that Cates apparently intended to abandon the project and that Talbot had already paid everything it owed under the contract. Talbot demanded that Transamerica perform under the bond. In December, Cates abandoned the project and filed a Mechanic's Lien in the amount of $645,367. Transamerica refused to intercede, claiming a legitimate dispute existed between Cates and Talbot. In March 1991, Transamerica, after having been assigned Cates' rights against Talbot, began the process of completing the job pursuant to the performance bond.
Transamerica then sued Talbot, alleging causes of action for breach of the construction contract, foreclosure on the Mechanic's Lien, and declaratory relief. Talbot cross-complained against Cates for breach of the construction contract and against Transamerica for breach of the performance bond and breach of the implied covenant in good faith and fair dealing in the performance bond. By stipulation of the parties, the contract claims were tried before a retired California Supreme Court Justice sitting without a jury. The Justice ruled against Transamerica and Cates on all their causes of action. Those rulings were not appealed.
Talbot then tried the tort causes of action against Transamerica before a jury. The jury found that Transamerica breached the implied covenant of good faith and fair dealing and awarded $28,000,000 in punitive damages. Although the California Court of Appeal reduced the punitive damages to $15,000,000, it affirmed the judgment in all other respects. Transamerica appealed and the California Supreme Court reversed the Court of Appeal.
The Supreme Court of California first addressed whether Transamerica was contractually liable under the performance bond for damages attributable to Cates' failure to complete the project by June 1, 1990. Transamerica maintained that the performance bond merely assured completion of the condominium project in the event of Cates' default, as opposed to timely performance. The Supreme Court viewed the issue as one of contract interpretation. The Court first looked to the obligations created under the contract between Cates and Talbot, which explicitly stated that all time limits were "of the essence of the contract." The Court noted that the contract required Cates to obtain a performance bond "as security for the faithful performance of the Contract Documents" and that the bond expressly referred to the contract between Cates and Talbot.
Taken together as a whole, the Court found that the bond required Transamerica to answer for damages suffered by Talbot as a direct result of Cates' failure to "promptly and faithfully" perform the contract. Although the bond did not explicitly mention the subject of delay damages, the Court reasoned that Transamerica knew from the contract, which had been "made a part" of the bond, that time was "of the essence" of the contract and that the bond's purpose was to provide security for the "faithful" performance of the contract in the event of Cates' default. The Court therefore held that Transamerica was contractually liable under the performance bond for damages attributable to Cates' failure to complete the Project in a timely manner.
The Court then addressed whether Transamerica could be liable in tort for breach of the implied covenant in good faith and fair dealing. After reviewing the regulatory common law and public policy background, the Court held that tort remedies are not available to obligees under a performance bond. The Court initially noted that it had never recognized the availability of tort remedies for breaches occurring in the context of a construction performance bond or any other so called "contract of suretyship." Thus, the Court framed the issue as whether the exceptional approach thus far reserved for breaches in the insurance policy setting should be extended to breaches in the context of a surety bond given to assure performance on a construction contract.
The Court first found that the mere inclusion of surety arrangements in the Insurance Code, as suretyship is in California, was not dispositive of the issue. In its analysis, the Court reviewed various policy considerations to decide whether tort remedies should be available for breach of a performance bond. California courts permitted tort recovery in the insurance setting because the courts found insurance contracts to be characterized by adhesion and unequal bargaining power. In contrast to insurance, the Court found that the surety relationship is not marked by adhesion and unequal bargaining power. Rather, the Court reasoned that if the obligee does not agree with the terms of the bond secured by the principal, it may consent to a modification of the underlying contract or may end bargaining altogether and seek a different principal whose financial resources and qualifications enable it to procure a bond
with acceptable terms. Further, performance bonds typically incorporate the underlying construction contract, the terms and conditions of which have been negotiated by the principal and the obligee without any input from the surety. The Court then concluded that unlike insurance policy, the typical performance bond bares no indication of adhesion or disparate bargaining power that might support tort recovery by an obligee.
The Court then looked to a variety of public interest and fiduciary responsibility considerations. In distinguishing between insurance and suretyship, the Court found that whereas the typical insurance policy insures against accidental and generally unforeseeable
losses caused by a calamitous or catastrophic event, a construction performance bond seeks merely to provide additional security to an existing contract with the principal. The Court also focused on the owner's ability to hold retainage as additional security and thus reduce its vulnerability to a surety's inaction.
The Court then reviewed the consequences of allowing tort recovery. The Court reasoned that unlike insurance, obligees such as owners possess sufficient bargaining power to negotiate terms to encourage timely performance of bond obligations and that provide for attorney's fees and interest when breaches occur. Owners may also require liquidated damages clauses to discourage non-performance by sureties. Accordingly, the Court found that tort remedies were unnecessary to induce a surety's performance or to fully compensate for surety's breach of the covenant of good faith. The Court also predicted that allowing tort claims would
increase the already complex nature of construction disputes. Last, the Court found that allowing tort recovery in the construction bond could foster increased litigation, which would result in increased costs to obtain bonds. Thus, the Court held that an obligee may not recover in tort for surety's breach of the implied covenant of good faith and fair dealing. |
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The Appellate Division of the Supreme Court of New York holds that seller of a building may seek indemnification from a mechanical engineer whose negligent design caused seller to have to pay the new owner for costs arising out of the design flaws. The Court also holds that the economic loss doctrine did not bar a claim for professional malpractice.
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17 Vista Fee Assocs. v. Teachers Ins. and Annuity Assoc. of America,
1999 N.Y. App. Div. LEXIS 7981 (July 15, 1999).
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| The plaintiffs/third-party plaintiffs 17 Vista Fee Associates and 17 Vista Associates ("17 Vista") entered into a sale agreement with defendant Teachers Insurance and Annuity Association of America ("TIAA"), pursuant to which 17 Vista was to construct an office building at 17 State Street in Manhattan, and to sell it to TIAA upon completion. To obtain a certificate of occupancy for the building, the sales agreement required 17 Vista to perform several tasks, including construction of the building's smoke purge system. 17 Vista retained Third-Party Defendant Jaros Baum & Bolles ("JB&B"), a mechanical engineer, to perform design services for the building.
17 Vista sold the partially completed building to TIAA in 1990. By 1992, construction was complete, but TIAA was unable to receive a permanent certificate of occupancy because of problems associated with the smoke purge system. 17 Vista continued to work with JB&B in an attempt to repair the smoke purge system. Not until a second fan system was installed years later did the system pass inspection and the Fire Department issue a permanent certificate of occupancy.
After TIAA refused to pay the contract balance, 17 Vista sued TIAA and TIAA counterclaimed for breach of the agreement, part of which related to the smoke purge system. Subsequently, 17 Vista commenced a third-party action against JB&B for indemnification and negligence. 17 Vista and TIAA subsequently entered into a settlement for an undisclosed sum and 17 Vista proceeded with its third party claims against JB&B. Prior to trial, the trial court granted JB&B's motion for summary judgment.
On appeal, the Court first addressed whether 17 Vista could pursue its implied indemnity claim. The Court initially recited the principle of common law or implied indemnity, which permits one who has been compelled to pay for the wrong of another to recover from the wrongdoer the damages it paid to the injured party. However, a party who has actually participated in the wrongdoing is not entitled to indemnity. Thus, under New York law, the owner or contractor seeking indemnity must have delegated exclusive responsibility for the duties giving rise to the loss to the potential indemnitor. Applying such law, the Court found that 17 Vista delegated full responsibility for the design of the smoke purge system to JB&B and thus was entitled to indemnity. Moreover, the Court also rejected JB&B's argument that 17 Vista was an actual wrongdoer because it had allegedly breached the contract with respect to portions of the project other than the smoke suppression system. Rather, he Court found that as long as 17 Vista segregated its claims between the smoke purge system and the other issues, its indemnity claim survives and the trial court erred in dismissing the claim. The Court also held that the trial court erred when it held that the underlying claim to an indemnity claim must sound in tort not contract. Rather, the Court limited the application of such a rule to contribution claims as opposed to indemnity claims.
Of particular importance, the Court found that 17 Vista's indemnity claim was improperly dismissed as New York's economic loss doctrine does not bar actions for professional malpractice. The Court first acknowledged that to plead a tort claim, 17 Vista must establish a legal duty independent of the contract claim, but the Court then found that claims against professionals involve such an independent duty imposed by law. Thus, the Court held that 17 Vista's allegations that JB&B failed to exercise the skill and judgment required of the engineering profession were sufficiently distinct from JB&B's contractual duties, and thus stated a claim for professional malpractice. |
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United States Court of Appeals for the Fourth Circuit enforces provision of A.I.A. Form Agreement that defeats the discovery rule concerning when a claim accrues for purposes of statute of limitations; holding that the provision does not violate either Maryland or Nebraska law.
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Harbor Court Assoc. v. Leo A. Daly Co.,
179 F.3d 147 (4th Cir. 1999)
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| The plaintiffs, Harbor Court Associates and Murdock Development Company ("HCA/Murdock") were the developers of Harbor Court Complex, located in the Inner Harbor area of Baltimore, Maryland. On April 28, 1983, HCA/Murdock hired Leo Daly ("Daly"), an architect with a principal place of business is in Nebraska, to design and construct the project. The parties used an A.I.A. document, which stated that, for disputes arising out of the contract: "any applicable statute of limitations shall commence to run and any alleged cause of action shall be deemed to have accrued in any and all events not later than the relevant Date of
Substantial Completion of the Work, and [as to any failures occurring after substantial completion] not later than the date of issuance of the Final Certificate of Payment."
Construction began in mid-1984, and the project received a final certificate of completion on September 11, 1987. For the next eight years, the Complex operated without any major design or construction problems. In April, 1996, a fifteen-square-foot area of brick exploded off the face of the Complex. Structural engineers later determined that the brick veneer of the Complex suffered from fundamental and latent defects in design and construction.
HCA/Murdock subsequently sued Daly for negligence and breach of contract, including a count for indemnification. Daly moved for summary judgment against HCA/Murdock, arguing that the actions were time barred as more than three years had elapsed since final payment. Exercising its diversity jurisdiction, the Federal District Court held that a Maryland court would enforce the agreed-upon accrual date and thus the claims were time-barred. As a result, the District Court granted Daly's motion for summary judgment.
On appeal to the United States Court of Appeals for the Fourth Circuit, HCA/Murdock alleged that Nebraska law governed the dispute and under Nebraska law, such a provision is unenforceable. Appellants also argued that, even if the trial court properly chose to apply Maryland substantive law, the provision was unenforceable because it violated public policy. The Court of Appeals found that such a provision was enforceable under either Maryland or Nebraska law, and thus the choice-of-law issue was irrelevant to its analysis.
The Court first addressed Maryland law. Maryland follows the "discovery rule," which provides that for the purposes of the statute of limitations, a claim may not accrue until the person knew or should have known the operative facts giving rise to the claim. Thus, under a traditional discovery rule approach, HCA/Murdock would argue that the claim did not accrue until the brick "exploded" off the face of the Complex and its claim was not time-barred. However, the Fourth Circuit noted that the Maryland Court of Appeals had never addressed whether parties' attempts to contract around the discovery rule would be unenforceable as against public policy of the state, and thus the Court treated the issue as one of first impression.
The Court first recited Maryland's reluctance to strike down voluntary bargains on public policy grounds. Absent a finding that the challenged agreement is "patently offensive to the public good," the Maryland courts will uphold the agreed-upon contractual terms. Given Maryland's commitment to contract, the Court of Appeals for the Fourth Circuit would not conclude that Maryland courts would decline to allow parties to contract around the discovery rule. In its analysis, the Court focused on the fact that there were sophisticated parties who added certainty to their allocation of risk by disposing of the discovery rule. Thus, the Court held that
such a clause would not be deemed "patently offensive" so as to render it unenforceable under Maryland law.
Turning to Nebraska law, the court addressed HCA/Murdock's claim that an unbroken line of state precedent precluded enforcement of the accrual date provision at issue. The Court found that Nebraska courts, while imposing a blanket prohibition against altering the statute of limitations period itself, had never addressed a contractual provision that modified only the accrual date of the statutory period. Stated alternatively, Nebraska courts had only addressed the time for bringing an accrued action, not the test for fixing the actual date of accrual. In this context, the Court found that a Nebraska court, like that of Maryland, would allow
sophisticated business actors to eliminate this uncertainty from their business affairs.
The Court concluded that, under either Maryland or Nebraska law, the contractual provisions modifying the parties standard AIA contract were enforceable and that HCA/Murdock's action was barred by the three-year statute of limitation. Accordingly, the Court affirmed the judgment of the lower court. |
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