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Bad Faith Settlement Claims by Contractors Against Two Sureties Illustrate When Conduct May Be Improper
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May 31, 2010
ConstructionWebLinks.com
A federal appeals court has barred a surety’s claim for indemnity against a subcontractor on the grounds that the surety settled with the general contractor in bad faith. In another case and under different factual circumstances, a federal court denied a contractor’s claim of bad faith settlement against its surety.
Bad Faith Finding Affirmed
A subcontractor, Southeast Floating Docks, Inc., contracted with Riverman Contracting Co., the general contractor, to manufacture a concrete floating dock system for the Harbour Village Marina in Ponce Inlet, Florida. The contract provided only for manufacture and delivery of the dock system; the general contractor hired another subcontractor to install the system at a quarter of the price quoted by Southeast. Auto-Owners Insurance Co. issued a bond guaranteeing the general contractor that Southeast would perform as required by the subcontract.
Before installation of the dock system was complete, the general contractor issued a punchlist of claimed defects with the dock system. Southeast determined that the punchlist items were installation issues and recommended the general contractor contact the installer. It tried to show the other subcontractor how to remedy the problems, but that sub had been paid and was working on another project. When the general contractor refused to pay Southeast the remaining $82,000 balance on its subcontract, Southeast filed suit in state court for the balance owed. The general contractor counter-claimed and named the surety on the basis of the performance bond.
The state court litigation was extremely contentious -- more than 1,100 pleadings were filed in it and the general contractor obstructed efforts to inspect the docks. The general contractor also filed a civil remedy notice with the Florida Department of Insurance claiming the surety was acting in bad faith in refusing to settle the bond claim.
When trial of the state court case was continued after three years of litigation, counsel for the general contractor contacted an assistant vice president of the surety to warn that the surety faced a “significant bad faith claim” before the Florida Department of Insurance and criticized Southeast’s case. The surety assistant vice president had not been involved in the case up to that point.
Other personnel at the surety had been involved in the case for three years. They had investigated the general contractor’s claim, worked with their own outside counsel, attended nearly all court hearings, worked with counsel for Southeast, and concluded that Southeast had satisfactorily performed and owed the general contractor nothing. They had supported Southeast in the litigation. This was reflected in the surety setting a reserve of only $5,000 for the general contractor’s claim and not requiring Southeast to post any collateral as a condition to defending the claim and withholding payment on the bond.
Without performing an investigation, the surety assistant vice president raised the reserve from $5,000 to $800,000. He then hired an outside lawyer to conduct a new investigation of the bad faith claim. That attorney had previously represented the general contractor’s parent corporation, and his firm had extensive connections with the parent corporation. The new outside lawyer made only a cursory investigation of the claim, ignoring evidence developed in three years of litigation and the assessment of the surety’s employees monitoring the general contractor’s case against Southeast. Southeast later learned that the new lawyer had been allowed to inspect the docks at issue, but Southeast was denied any information about this.
After a secret meeting with the general contractor – of which Southeast was not informed and was not invited to attend -- the surety agreed to settle with the general contractor by paying it the full amount of the bond in exchange for a release of claims against the surety and withdrawal of the bad faith claim. The settlement between the surety and general contractor did not release the subcontractor from any of the general contractor’s claims against it – even though the general contractor previously had offered to pay $100,000 to Southeast to settle their case.
Shortly after settling the general contractor’s state court claims against it, the surety sued Southeast in the U.S. District Court for the Middle District of Florida. The surety sought more than $1.1 million in indemnity from Southeast for the cost of what the surety claimed was a good faith payment on the bond to the general contractor. Southeast defended on the ground that the surety had not settled the general contractor’s claim in good faith.
The jury returned a verdict in favor of Southeast. But, the U.S. District Court judge granted the surety’s motion for a new trial on grounds that: 1) the subcontractor did not produce any credible evidence contradicting the surety’s evidence that it had acted in good faith; and 2) the jury’s verdict on the issue of bad faith was against the great weight of the evidence. Southeast appealed. The U.S. Court of Appeals for the 11th Circuit reversed and directed the District Court to enter judgment on the jury’s verdict. Auto-Owners Insurance Co. v. Southeast Floating Docks, Inc., 571 F.3d 1143 (11th Cir. 2009).
The Court of Appeals wrote that the District Court could properly grant a new trial only if the jury verdict were against the great weight of evidence. The trial court could not simply decide there was more evidence in the surety’s favor or substitute its evaluation of witness credibility for the jury’s. To defeat a new trial motion, the jury verdict need only be supported by evidence.
In determining whether the surety acted in bad faith, the appeals court adopted the standard set forth in PSE Consulting, Inc. v. Frank Mercede & Sons, Inc., 267 Conn. 279, 838 A.2d 135 (2004): A finding of bad faith requires an improper motive or dishonest purpose. Improper motive can be evidenced by unreasonable conduct by the surety accompanied by other evidence of improper motive, such as a self-interested settlement. Mere negligence or lack of diligence will support a finding of bad faith.
Here, the appeals court found there was “no smoking gun evidence” but there was sufficient evidence for reasonable jurors to draw inferences that the surety’s conduct was unreasonable because:
|  | The surety unreasonably ignored the investigation and assessment by its own employees who had been assigned to evaluate the merits and strengths of the bond claim and to monitor the state court case.
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| | The general contractor’s claim against the bond was weak, so settlement for the full amount of the bond was unreasonable.
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| | The lawyer hired by the surety to investigate the bad faith claim “was tainted by a conflict of interest” and therefore was unreliable, and relying on his investigation and assessment of the claim was unreasonable.
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| | The new lawyer’s investigation was cursory and conducted in secret.
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| | The surety’s engineer’s investigation of the claim never was completed, so the surety’s reliance on it was unreasonable.
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| | The surety’s demand, without explanation and after three years of litigation, that Southeast first post collateral of 100 percent of the bond amount, $956,987, within five days and then tripling the demand to $3 million as the price of continuing to allow Southeast to defend itself and of not paying the bond claim was unreasonable. The appeals court noted that the surety had not previously demanded collateral, even after the general contractor filed a civil remedy notice with the Florida Department of Insurance.
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The appeals court found there was sufficient evidence for the jury to find improper motive by the surety because:
| | The jury could have inferred that the surety intended to eliminate the risk of a bad faith claim by settling with Southeast’s money.
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| | After supporting Southeast’s defenses for three years, the surety immediately shifted its position on the bond claim after a direct threat from the general contractor of a bad faith claim.
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| | Many of the surety’s contacts and negotiations with the general contractor were conducted in secret.
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| | The settlement did not include a release of claims against Southeast, only of claims against the surety.
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Based on the evidence in the record, the appeals court held that there was a reasonable basis for the jury’s verdict that the surety’s settlement was in bad faith, thereby barring its indemnity claim against Southeast. The District Court was ordered to enter judgment on the jury verdict.
Bad Faith Claim Rejected
In contrast, based on significantly different behavior by a surety, the U.S. District Court for the Southern District of Georgia held that the surety did not act in bad faith in responding to a declaration of default against a contractor and allowed the surety to enforce its indemnity rights against the contractor and its principals. Fidelity and Deposit Co. of Maryland v. Douglas Asphalt Co., 2008 U.S. Dist. LEXIS 103120 (S.D.Ga. 2008).
There, the general contractor performing a repaving, widening and rebuilding project on Interstate 75 in southern Georgia was declared to be in default by the Georgia Department of Transportation, which notified the surety of the default and demanded that the surety complete the project. After investigating the notice, the surety decided to take over the project and arranged for completion of the project by another contractor that the surety previously had prequalified. The surety paid more than $15 million to complete the project.
When the general contractor failed to reimburse the surety for completion costs in excess of the contract balance, the surety sued the general contractor for breach of their indemnity agreement. The contractor responded by alleging that the surety had acted in bad faith, thereby relieving the general contractor of its obligations under the indemnity agreement.
Specifically, the contractor argued that the surety had acted in bad faith by:
| | Failing to assert valid defenses to the performance bond claim.
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| | Failing to timely take over the project after default.
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| | Failing to diligently perform the work taken over.
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| | Failing to fund the contractor’s continued work and excluding the contractor from the project.
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Contrary to the contractor’s allegations, the U.S. District Court found after a bench trial that there had been no bad faith conduct by the surety because:
| | The surety tried to convince GDOT to withdraw the default notice. But, GDOT rejected that effort, noting that there were six payment bond claims totaling more than $900,000 and that the general contractor was nearly a year late in finishing the project.
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| | The surety had no duty to fund the contractor’s continued work on the project.
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| | The contractor did not have the capability to complete the project.
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| | The replacement contractor hired by the surety timely, properly and economically completed the project.
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| | The contractor did not ask the surety to defend any of the claims against it and did not deposit collateral with the surety to cover an adverse judgment as their contract required if the surety was to defend against claims.
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| | The surety had no independent duty to the contractor to investigate the claims.
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Even so, the surety made a timely and appropriate investigation of GDOT’s default notice, including making a jobsite visit, reviewing contractor records, meeting with the contractor’s designated representative, seeking to meet with the contractor’s principals, meeting with GDOT, and retaining both engineering and construction consultants.
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| | The contractor admitted that it provided the surety with no defenses to the payment and performance bond claims, and the surety was excused from asserting defenses on the basis of the contractor’s conduct. |
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