Arizona Surety Claims: Surety Bad Faith Revisited in Recent Decisions

Jay M. Mann and Patrick F. Welch | Jennings Strouss & Salmon PLC | May 23, 2016

Over the last twenty-six years, Arizona has been the epicenter of the national surety bad faith discussion.In 1989, the Arizona Supreme Court issued probably the leading surety bad faith case in the county – Dodge v. Fid. And Dep. Co. of Md., 778 P.2d 1240, 161 Ariz. 344 (1989).In Dodge, plaintiffs-homeowners contracted with a residential construction company to build a residence for them.The contract required the contractor to obtain a performance bond, which the defendant-surety provided.After the contractor defaulted under the contract, the plaintiffs sued the contractor and surety.The plaintiffs sued the surety under the performance bond and bad faith.The surety prevailed on the bad faith claim before the trial court and on appeal before the Court of Appeals.The plaintiffs appealed.

The Arizona Supreme Court reversed and held that a performance bond obligee may sue a surety for bad faith.This was the first reported surety bad faith case ever decided.Despite the fundamental differences between suretyship and insurance, the Dodge court held that sureties are insurers for purposes of Arizona’s insurance statutes.Based upon this reasoning, the Dodge court applied the “special relationship” analysis, typically reserved for insurance contracts, to the surety context.Concluding that sureties are insurers under the insurance statutes, the Dodge court further held that sureties have the same duty to act in good faith as insurers, and observed that the tort of bad faith arises when the surety intentionally denies, fails to process or pay a claim without a reasonable basis for such action.

In the 37 years since the Dodge decision, a majority of courts around the country have rejected claims against sureties for surety bad faith, recognizing that there are fundamental differences between suretyship and insurance.See, e.g. Cates Constr. v. Talbot Partners, 21 Cal.4th 28, 980 P.2d 407 (1999); Great Am. Ins. Co. v. N. Austin Muni. Util. Dist. No. 1, 908 S.W. 2d 415, 420 (Tex. 1995); Cincinnati Ins. Co. v. Centech Bldg. Corp., 286 F. Supp. 2d 669, 691 (M.D.N.C. 2003; Boldt Co. v. Thomason Elec. & Am. Contractors Indem. Co., 820 F. Supp. 2d 703, 705-06 (D.S.C. 2007); Inst. of Mission Helpers of Baltimore City v. Reliance Ins. Co., 812 F. Supp. 72, 74 (D. Md. 1992); Bell BCI Co. v. HRGM Corp., 276 F. Supp. 2d 462, 463 (D. Md. 2003);Toltest v. Purcell P&C, LLC, 2013 WL 1571714 at *5-6 (N.D. Ohio April 12, 2013); see also Resolution Trust Corp. v. Fid. & Deposit Co. of Maryland, 885 F. Supp. 228, 230-31 (D. Kan. 1995); In re Commercial Money Ctr., Inc., Equip. Lease Litig., 603 F. Supp. 2d 1095, 1124 (N.D. Ohio 2009)

In March 2014, we wrote an article presented to the Arizona State Bar, Construction Law Section.The article explored two important unanswered questions from Dodge, including: (1) whether a surety defending a performance bond claim may assert a “bona fide or genuine dispute defense to a bad faith claim?; and (2) whether a payment bond claimant may bring a bad faith claim against a surety issuing a payment bond?[1] Over the last several months, Arizona courts have issued two important decisions addressing these questions.The courts’ reasoning in both decisions signals a shift away from Dodge and an effort to curtail surety bad faith liability.

In a recent case handled by our office, the Superior Court of Arizona issued an unreported opinion granting the surety’s summary judgment motion seeking dismissal of a municipality’s surety bad faith claim involving a “Little Miller Act” performance bond.The Superior Court held that a surety may deny a performance bond claim and avoid liability for surety bad faith where there is a “bona fide or genuine” dispute between the bond principal and the bond obligee as to the bond principal’s liability.The Superior Court noted that “[a]s in the insurance context, however, a surety does not breach to covenant of good faith and fair dealing if the owner’s [obligee] claim is fairly debatable.” The Superior Court further observed that “a surety faced with a dispute between owner and contractor, and the owner’s demand that it perform under the bond, a performance bond surety is not required to perform an investigation sufficient to determine who is right.It need only investigate sufficiently to decide if a bona fide dispute exists.If it does this, and there is a bona fide dispute, then it has not committed the intentional tort of surety bad faith.”

In another recent case not handled by our office, the Arizona Court of Appeals held that a surety on a payment bond issued under Arizona’s “Little Miller Act” may not be sued for surety bad faith.S&S Paving and Constr., Inc. v. Berkley Regional Ins. Co., No. 1 CA-CV 15-0239 at p.2.In reaching its decision, the Court of Appeals noted the breadth of liability under the Little Miller Act and “refused to graft a common law remedy onto a statutory scheme that includes within its ambit both the availability of complete relief and specific conditions precedent to recovery.”Rather, the Court of Appeals recognized that “a common law bad faith remedy would be inconsistent with the legislature’s defined liability for Act sureties” and emphasized Arizona precedent holding that “‘[w]hen a corporate surety undertakes an obligation on a bond pursuant to a specific statutory requirement, its liabilities are measured by the terms of the statute.’”

The Court of Appeals also rejected S&S’s reliance upon Dodge, noting two important distinctions, including (1) Dodge did not…

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Likely Increase of Use of Wood in Tall Building Construction

Bart Kempf | Construction Developments | May 27, 2016

Wood – architecture’s oldest building material – Likely Increase of Use of Wood in Tall Building Constructionhas experienced a renaissance of sorts in recent years, in the process providing a boost to the forest and wood products industry. Wood-product proponents tout a range of benefits relative to alternative materials such as concrete and steel, including: renewability; a smaller carbon and environmental footprint; and lower cost. Many argue that advances in wood technologies – especially mass-timber products such as cross-laminated timber (CLT) – have been a “game changer” in the construction industry, with such products providing vastly improved strength, durability, seismic performance, and fire-resistance. Supporters also assert that mass-timber products are easily installed and generate almost no on-site waste since they are pre-fabricated. Despite these advantages, there is no full recognition in U.S. building codes for CLT, although its use could be authorized under the “alternate methods” of construction, § 104.11, and its use is recognized in Chapter 6 of the 2015 IBC.

In 2014, the U.S. Department of Agriculture (USDA), with private group support, announced the U.S. Tall Wood Building Competition. The 2015 west coast winner is a project which is a 12-story, multi-purpose building to be constructed primarily of CLT; the east coast winner is a 10-story condominium, which will be the largest wooden building in New York City. In London, the Oakwood Tower, at 1,000 feet, is planned to have a completely timber frame.

The emerging potential and promise of wood products in construction is exemplified by two recent developments: (1) the introduction in the U.S. Senate of the bipartisan Timber Innovation Act of 2016, and (2) the establishment of a new pilot project by the U.S. Green Building Council (USGBC) that expands the types of wood certification programs that may qualify for credits under the Leadership in Energy and Environmental Design (LEED) program.

The Timber Innovation Act of 2016

The enthusiasm for CLT and other mass-timber products – and their potential for use in the construction of tall wood buildings – recently reached the halls of Congress with the introduction of S.2892, the Timber Innovation Act of 2016. The Act was introduced on April 28, 2016, by Sen. Debbie Stabenow, ranking member of the Committee on Agriculture, Nutrition, and Forestry (the “Senate Agriculture Committee”) and a bipartisan group of senators. The Act authorizes several programs to promote: (1) mass timber (defined as “a type of building component or system that uses large panelized wood construction, including cross-laminated timber, nail laminated timber, glue laminated timber, laminated strand lumber, and laminated veneer lumber”) and (2) tall wood buildings. (defined as “a building designed to be constructed with mass timber and more than 85 feet in height.”). Programs created by the Act include:

  • Research and Development (R&D) and Competitive Grant Programs to Advance Tall Wood Building Construction Section 4 of the Act requires USDA to establish separate R&D and competitive grant programs to advance tall wood building construction. Both programs would be carried out to achieve several priorities set forth in the Act related to tall wood building construction, including: improving commercialization and assessing safety; assessing life-cycle environmental footprint issues; identifying necessary building code modifications; and studying the impact that widespread adoption would have on wildlife and forest biodiversity.
  • Tall Wood Building Competition Subject to the availability of appropriations, the Act would require USDA to hold an annual competition for tall wood building design.
    Wood Innovation Grant Program Section 6 of the Act provides that USDA – in implementing the wood innovation grant program as set forth in “Request for Proposals: 2016 Wood Innovations Funding Opportunity” (80 Fed. Reg. 63498 (October 20, 2015)) – may make a grant available for the purpose of advancing innovation in tall wood building construction.
  • Educational and Technical Assistance Section 7 of the Act requires USDA to carry out a program of education and technical assistance for mass timber applications.

As of May 26, 2016, no hearings have been scheduled on the Act in the Senate Agriculture Committee, nor has a companion bill been introduced in the House of Representatives. It therefore appears that it most likely will not become law in the near future. That said, the bipartisan support for the Act – as of May 26, 2016, five Republicans, five Democrats, and one Independent have signed on as cosponsors – suggests that it or a similar bill might find footing in future Congresses.

USGBC Pilot Program – “Legal Wood”

Shortly before the introduction of the Timber Innovation Act of 2016, the USGBC gave proponents of wood products something to cheer about with its establishment of a new Alternative Compliance Path (ACP) pilot that applies to both the LEED 2009 and LEED v4 systems. Under the ACP pilot – known as “Legal Wood” – LEED credit can be obtained where forest products meet verification requirements with respect to “legal sources,” “responsible sources,” and “certified sources” as these terms are defined in ASTM D7612-10 (2015): Categorizing Wood and Wood-Based Products According to Their Fiber Sources. In effect, the ACP pilot allows builders and architects to achieve LEED credit through their reliance on product certifications from a wide range of organizations, including the Sustainable Forestry Initiative, the American Tree Farm System, the Forest Stewardship Council (FSC), and other programs. Before the Legal Wood pilot…

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Buildings and Roofs Not In “Reasonable Condition” Are Still Covered for Windstorm Losses

Chip Merlin | Property Insurance Coverage Law Blog | May 30, 2016

Insurance companies insure all kinds of buildings in all sorts of conditions. Insurers that decide to insure older structures and buildings with older roofs in various states of wear and tear love to recite exclusionary clauses when those roofs and older structures suffer damage.

The Arizona Supreme Court put an end to this type of “accept the premium and deny the claim and coverage” practice of insurers who deny windstorm claims which caused new or additional damage finding the following:

We reject the proposition that windstorm coverage extends only to buildings in objectively reasonable condition. Insurers are free to expressly limit coverage to buildings meeting certain structural qualifications or to inspect buildings before issuing windstorm coverage. Absent such limitations, however, a windstorm is a wind of sufficient force to proximately cause damage to the “ordinary condition of the things insured….1

We are constantly being asked to review denied claims where older roofs with wear and tear are damaged by subsequent windstorm or hail. Those claims and types of losses are covered. There should be no question about that. The problem is some insurance company expert consulting firms fail to note the additional damage trying to help insurers deny payment for the loss by wrongfully claiming that the windstorm or hail caused no additional damage.

Those with this type of issue should read my post from last week, Hail Storms, Wear and Tear, and Inadequate Maintenance.

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Hailstorms, Wear and Tear, and Inadequate Maintenance

Chip Merlin | Property Insurance Coverage Law Blog | May 25, 2016

Hailstorms are wreaking havoc as noted in Brandee Bower’s post yesterday, Greetings From Hail Alley. After contacting their insurance companies, some policyholders unfortunately find their insurance companies deny the claims based on exclusions in the insurance contract involving wear and tear as well as inadequate maintenance.

To be fair, roofs get older and there is always wear and tear on older roofs. Rarely are close up pictures taken of roofs taken just before a hailstorm occurs. Accordingly, changes in the condition of some roofs caused by the winds and hail in a hailstorm versus pre-existing wear and tear become an issue.

My impression is that many insurers are increasingly claiming exclusions caused by wear and tear as well as inadequate maintenance. Indeed, insurance company engineering firms are increasingly advertising their services for these issues. There is nothing unethical about this, but the trend is landing many hailstorm losses into denials and subsequent litigation.

An excellent case regarding these issues is Monterra Apartments Ltd. Liability Partnership v. Sequoia Insurance Company.1 Sequoia denied that the hailstorm damaged the roof and claimed that the damage was wear and tear or inadequate maintenance. Regarding these issues, this is what the court found:

The policy clearly and unambiguously excludes coverage where wear and tear is the sole cause of damage. The last sentence quoted above clearly states, however, that the exclusion of coverage in Section I.B.2.1 does not apply—in other words, the policy provides coverage—where an “excluded cause of loss” results in a “specified cause of loss.” The phrase “specified cause of loss” is defined in Section I.H.11 to include “hail.” Therefore, replacing “excluded cause of loss” with “wear and tear,” and “specified cause of loss” with “loss from hail,” the clause reads: “if [wear and tear] results in [loss from hail], we will pay for the loss or damage caused by that [hail].”Thus, when wear and tear contribute to damage by a hailstorm, the policy provides coverage for the hail damage. Further, the policy covers any ensuing damage from the hail, such as water penetrating the roof as a result of the hail.

…The “Covered Cause of Loss” can be stated as “hail” or “loss from hail” because hail presents a “risk of physical loss” and is not excluded by the policy….Using these substitutes, the key provision reads: “if [inadequate maintenance] results in [loss from hail], we will pay for the loss or damage caused by [the hail]. This produces the same result as the wear and tear exclusion discussed above. Thus, when inadequate maintenance permits hail damage to occur, the policy provides coverage for the hail damage.

The parties dispute whether hail or inadequate maintenance damaged the roof or resulted in moisture penetrating the roof. This factual issue is for the jury.

The bottom line is that the insurance company better be prepared to show that all the damage was caused by pre-existing wear and tear or that all the damage resulted from inadequate maintenance. Sometimes that is the case. But in many cases, older roofs having wear and tear are also torn up by the winds and hail stones which are occurring much more often today.

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Subcontractor Not Entitled to Payment After Refusal to Perform Disputed Extra Work

Elizabeth Wright | Robinson Cole | May 20, 2016

In the hustle and bustle of completing a construction project it can be easy to overlook the importance of the contract.  However, when a dispute arises the contract generally dictates the outcome of that dispute.  A recent unpublished Massachusetts Appeals Court decision serves as a reminder of the importance of the contract.

In ACME Abatement Contractor, Inc. v. S&R Corp., 88 Mass. App. Ct. 1102 (2015), the plaintiff subcontractor entered into a contract to perform asbestos removal for a contractor on a public project.  During the course of the project, the contractor directed the subcontractor to remove paint at the project.  The subcontractor refused to perform the work claiming that because the paint did not contain asbestos it did not have an obligation to perform the extra work.  The contractor ultimately hired another contractor to perform the work and refused to pay the subcontractor the balance of its contract price.  As a result, the subcontractor filed suit against the contractor seeking payment for its unpaid contract balance.  In response the contractor filed a summary judgment motion seeking to dismiss the claim.  The contractor argued that the subcontractor’s refusal to perform the work constituted a material breach of the contract precluding the subcontractor’s recovery of its contract balance.  The appeals court agreed and affirmed the trial court’s decision dismissing the subcontractor’s claim.

In support of its decision, the court relied solely upon the terms of the contract.  Specifically, the court noted that the contract required the subcontractor to proceed with work or extra work even in the event of a dispute.  The contract further provided that the failure of the subcontractor to perform such work “shall constitute a material breach of [the] agreement…”  As a result, the court held that the subcontractor’s failure to perform the disputed extra work constituted a material breach of the contract precluding recovery of its contract balance.  The court further held that the subcontractor’s failure to perform the extra work also precluded its recovery under the equitable theory of quantum meruit.  In support of its conclusion the court noted that in order to recover under quantum meruit, the subcontractor must demonstrate that “there is an honest intention to go by the contract, and a substantive execution of it…”

The language contained in the subcontract in this case is not uncommon.  In fact, paragraph 15.1.3 of the AIA A201 contains a similar requirement for the contractor to continue with performance of the work pending resolution of a claim.  Notably the AIA A201 does not state that failure to comply with the provision is a material breach of the contract, however this decision could be seen as persuasive authority to reach a similar conclusion involving a project using the AIA A201 contract form.  Therefore…

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