TORTIOUS BAD FAITH CLAIMS AGAINST SURETIES - NOT IN NEVADA. Great American Insurance Company v. General Builders, Inc.

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1 TORTIOUS BAD FAITH CLAIMS AGAINST SURETIES - NOT IN NEVADA by Sharon A. Parker, Associate* Construction in Las Vegas is booming. There are currently over 100 major construction projects at various stages of planning, development and construction in Las Vegas, including transportation systems, public facility projects, forty-two high rise buildings and condominium projects, thirteen mixed-use projects, each of which includes hotels, residential, retail and office space within walking distance, colossal expansions to many of the well-established casino resorts, and the addition of many new resorts throughout Nevada. This construction boom, unlike any Nevada has ever seen, includes the MGM City center, a $7 billion, sixty-six acre mixed-use project on the Las Vegas Strip. Upon completion, it will be a city unto itself, and is currently the most expensive privately funded construction project in the western hemisphere. Construction industry growth in the Las Vegas valley, both in the number and magnitude of construction projects, has dramatically affected the surety bond industry. In 2001, 160 companies collected premium revenues of $38,133,125 from issuing surety bonds in Nevada. By 2005 this had nearly doubled: 162 companies collected $74, in premiums. With the explosion of construction and surety bonding activity, questions have soon followed on issues of construction and suretyship under Nevada law. One question that the Nevada Supreme Court has answered is that a surety cannot be liable for bad faith to its bonded principal. Great American Insurance Company v. General Builders, Inc. In this case, General Builders contended that it was entitled to punitive damages from its surety, Great American, on the basis that General Builders lost a sizeable construction contract when Great American revoked performance and payment bonds after contract award and execution of the bonds. The Nevada Supreme Court rejected General Builders claim. 113 Nev. 346, 934 P.2d 257 (1997) The Background General Builders, a Nevada contractor, was awarded a contract to enlarge and remodel a hospital in Winnemuca, Nevada. Upon entering into the construction contract, the hospital gave General Builders ten days to obtain payment and performance bonds. General Builders contacted Pac Coast Bond & Insurance Services ( Pac Coast ), which obtained performance and payment bonds for General Builders issued by the surety, Great American. Attached to the bonds were powers of attorney which appeared to confirm Pac Coast s authority to issue the bonds. Unknown to General Builders, however, was that Pac Coast s agency agreement with Great American required that its bonds could not be issued without Great American s express approval. Pac Coast had not obtained any approval prior to issuing the bonds to General Builders.

2 Upon learning of Pac Coast s actions, Great American notified General Builders that the bonds were being revoked because the issuing agent did not have authority to issue them. Without any bonds, General Builders lost the hospital construction contract. General Builders sued Great American for breach of contract and tortious breach of the implied covenant of good faith and fair dealing ( bad faith ) because the surety had revoked the bonds. At the trial court level, the court granted General Builders motion for a directed verdict against Great American on both claims. The jury awarded General Builders $947,556 in compensatory damages and $2.5 million in punitive damages. Great American appealed. The Appeal On appeal, the Nevada Supreme Court found that Great American and General Builders had formed a valid surety contract based upon the Pac Coast agent s apparent authority. The Court noted that the issuing agent had Great American s corporate seal which was embossed on the bonds and an unconditional power of attorney representing authority to enter into the surety contracts and to issue bonds on Great American s behalf. Nonetheless, the Court rejected General Builders bad faith tort action, vacated the district court s punitive damages award, and held that this tort remedy was inapplicable in General Builders breach of contract claim against Great American. The Court reiterated its previous holdings that under Nevada law, tortious bad faith actions are limited to cases involving special relationships, which are characterized by public interest, adhesion and fiduciary responsibility. The Court reasoned that the relationship between Great American and General Builders did not fall into this category because they were both experienced commercial entities represented by professional and experienced agents and were never in unequal bargaining positions. The Court furthered observed that there was no need to award General Builders punitive damages because it had been made whole with money damages in the amount of the expected profits. Moreover, the Court acknowledged the fundamental distinction between surety and insurance: a contractor obtains liability insurance for its own protection, while a construction project s owner requires bonds in the event the contractor defaults. Insurance Company of the West v. Gibson Tile Company, Inc. In this recent 2006 case, the Nevada Supreme Court expanded upon its previous holding in Great American, and expressly held that a surety cannot be liable to its principal for tortious bad faith in Nevada. 122 Nev. Adv. Op. 40, 134 P.3d 698 (May 11, 2006). The Background This litigation arose from a dispute regarding payment and performance bonds Insurance Company of the West ( ICW ) issued in February 1997 on behalf of Gibson Tile ( Gibson ), a subcontractor at the Las Vegas McCarran International Airport. Gibson

3 had signed a General Indemnity Agreement ( GIA ) in connection with the bonds, which specified that the surety, ICW, was entitled to indemnification from Gibson for all payments, fees and expenses incurred by ICW as a result of ICW issuing its bonds to Gibson. Under the GIA, Gibson was also obligated to deposit cash or collateral of a kind and amount acceptable to the surety, ICW, into a joint account controlled by both entities in the event of a dispute over a bond claim. On the McCarran Airport project, Gibson did not pay several of its suppliers, contending that it had received faulty materials. Two suppliers sued Gibson and the surety, ICW, for payment. Initially, Gibson refused to satisfy these claims because the general contractor on the project had withheld payment to Gibson, alleging that the work was faulty. As a result, ICW incurred attorney s fees and costs related to its defense against the suppliers bad claims. Eventually, the surety, ICW, sued Gibson under the terms of the GIA to recover its incurred fees and costs defending against the bond claims. ICW also specifically sought to enforce its right to cash collateral. Gibson filed a countersuit against ICW alleging that the surety, ICW, had, in bad faith, breached an oral agreement to issue additional bonds for other construction projects which Gibson wanted to bid. At trial, the district court permitted the jury to be instructed that a surety owes its principal a fiduciary duty. Based in large part upon this instruction, and despite evidence that Gibson was denied additional bonds because of its poor financial condition, the jury awarded Gibson $1,585,000 in compensatory damages and $4,270,552 in punitive damages, while ICW took nothing by its complaint. The Appeal On appeal, the surety, ICW relied upon case law from multiple other jurisdictions and argued that bad faith liability should not lie against a surety because the typical two-party insurance relationship differs substantially from the tri-partite surety relationship in the following ways: The concerns giving rise to a fiduciary duty in an insurance contract are not present in the surety context. A surety has no responsibilities to the principal except to stand in as an alternate guarantor. A surety does not have a duty to defend the principal or to represent the interests of any party but itself. A surety is entitled to reimbursement from its principal for amounts paid to the obligee upon the principal s default. A surety s risk of loss is entirely within the principal s own control, unlike claims against an insurance policy which often arise as a result of an unpredicted and/or uncontrolled event.

4 Public interest in suretyship agreements is significantly less than in insurance. In the tripartite relationship of a surety bond, a surety s obligation to a bond obligee is secondary to that of the principal. Surety contracts are pure commercial contracts solely for the principal s economic advantage, and not for protection or security. The Nevada Supreme Court agreed with ICW, and held that a surety cannot be liable for tortious bad faith. In so ruling, the Court first analyzed whether a special relationship existed between ICW and Gibson that could give rise to tort liability. The Court relied heavily upon its previous decision in Great American, and noted that it is only the rare and exceptional case where there is such a special relationship between the parties so as to warrant a bad faith cause of action, such as that between insurers and insureds, partners, and franchises and franchisees. The common elements between all of the relationships are that of reliance: a need to protect the weaker party that is not adequately met by ordinary contract damages or situations in which one party holds a vastly superior bargaining position. Based upon this reasoning, the Court held that there is not a special relationship between a surety and its bonded principal. The Court explained that the surety-principal relationship differs from other situations where one party is in a weaker position or largely reliant upon another; namely that of an insurer s responsibilities to its insured. Sureties issue bonds in reliance upon the financial condition and performance record of the principal. As such, both parties are often sophisticated and in a similar bargaining position. This alleviates the need to protect the weak party, and does not raise the same concerns as when an insurance company refuses to compensate an insured. Furthermore, the Court found that a surety and a principal do not have a fiduciary relationship. Unlike an insurer-insured relationship, which is fiduciary in nature, a surety does not owe such a duty to its principal because bonds are not procured for the principal s protection, but for the protection of a third party, the obligee. The Court concluded that because there is not a special relationship or fiduciary duty between surety and principal, a bad faith tort cause of action against a surety does not lie, and the trial court erroneously instructed the jury to the contrary. On remand, ICW filed a motion for summary judgment on Gibson s contractual obligation to indemnify ICW for all fees and costs it had incurred related to the bond claims. On January 25, 2007, almost ten years after this dispute initially arose, the district court granted ICW s motion. The district court awarded ICW $840,323.73, which was the total amount of fees and costs ICW expended in defending Gibson s claim and appealing the district court s previous erroneous decision.

5 Conclusion Given the scope and magnitude of construction growth in Las Vegas, it is important that there be a stable market so that contractors are able to obtain adequate surety bonds. An important factor in the stability of the construction market is the Nevada Supreme Court s clear delineation of sureties contractual obligations and relationships. With the Court s decisions in the Great American and Gibson Tile cases, it is now firmly established Nevada law that a surety will not be treated as an insurer and will not be liable for bad faith. * Watt, Tieder, Hoffar & Fitzgerald, L.L.P Greensboro Drive, Suite 100 McLean Virginia