A federal court in Mississippi ruled that a surety was limited to the defenses raised in a coverage denial, notwithstanding the fact that the surety subsequently raised additional defenses.  C & I Entertainment, LLC v. Fidelity and Deposit Co. of Maryland, 2014 WL 3640790 (N.D. Miss. July 22, 2014).

After a dispute arose over a project, the contractor, also principal on a bond with a surety for the project, filed a construction lien and suit against the owner.  Construction was alleged to have reached substantial completion, and the owner sued the contractor.  The surety investigated claims by the owner under a reservation of rights, and then denied the owner’s claim on the bond, asserting that all claims were barred under a two-year limitations period contained in the bond.  The surety then sent another letter setting forth the bond’s condition-precedent requirement that the owner agree to pay the balance of the contract price before the surety’s obligation could be triggered as another reason for denial.  The owner prevailed against the contractor, and the contractor paid the verdict.

The owner sued the surety for bad faith denial of the claim, and the surety moved for summary judgment, arguing: (1) the owner failed to meet conditions precedent to the surety’s obligations, including notice that it was considering declaring the contractor in default and paying the balance on the contract; and (2) the surety’s investigation was under a reservation of rights.  The court denied the surety’s motion for summary judgment, finding that issues of fact existed as to whether the conditions precedent to coverage had been met.

In doing so, the court noted that the original denial relied solely on the two-year limitations period contained in the bond within which to assert claims.  The owner had argued that Mississippi law does not recognize a contractual limitation period is shorter than the limitations period afforded by state statute, which, in Mississippi, is three years.  The court noted that, even though a surety may investigate a claim under a reservation of rights, a reservation of rights may also be waived by words or conduct.  Additionally, the court noted that the denial included “no reservation of rights language,” even though the surety subsequently sent a letter which asserted additional defenses to the claim under a reservation of rights.

The court also noted that sureties, like insurers, can be liable for bad faith in failing to pay claims, and that, in the defense of a lawsuit, an insurer may rely on any exclusion in a policy to show that no coverage existed, whether or not that exclusion was the stated basis for denial.  However, the court concluded that “once coverage is established, a court should evaluate whether there was an arguable basis for denial of coverage based solely on the reasons for denial.”