As members of the construction industry know, to describe the relationship between a surety and the party to whom it issues a surety bond (the principal) as confusing would be an understatement. In fact, many believe that the surety-principal relationship is similar, if not identical, to the insurer-insured relationship. In a recent federal court opinion – Reginella Construction Company, Ltd. v. Travelers Casualty and Surety Company of America – a contractor learned the hard way that the principal in a surety-principal relationship is not nearly as protected as the insured in an insurer-insured relationship.
In Reginella, the United States District Court for the Western District of Pennsylvania granted a surety’s motion to dismiss the claims brought against it by the surety’s principal, Reginella, finding, among other things, that a surety does not owe the kind of heightened duty to its principal that an insurance carrier owes to its insured (this heightened obligation is called a fiduciary duty, and we tend to see it in the insurer-insured, attorney-client, trustee-beneficiary, and guardian-ward contexts). In Reginella,the surety, Travelers, issued performance and payment bonds on behalf of its principal, Reginella, for a school district project in Pennsylvania and a turnpike project in Ohio.
On the school district project, Reginella’s relationship with the owner broke down, and the project shutdown. On the turnpike project, Reginella’s relationship with Travelers soured over a disagreement surrounding a lien filed by one of Reginella’s subcontractors. Reginella alleges that Travelers failed to, among other things, (i) pay Reginella’s subcontractors in accordance with the payment bonds that Travelers issued, (ii) issue a bond to address a subcontractor lien, and (iii) generally act in the best interests of Reginella in a way that would facilitate payment from the project owners to Reginella.
Ultimately, Reginella sued Travelers for damages in excess of $15 million for lost business, goodwill, future earnings and residual value of its enterprise against Travelers for, among other claims, Travelers’ alleged breach of its fiduciary duty owed to Reginella in relation to the bonds issued on the two projects. Travelers moved to dismiss the entirety of Reginella’s claims. In applying Pennsylvania law, the Court granted Travelers’ motion and dismissed Reginella’s claims against Travelers, concluding that a Pennsylvania court would not impose fiduciary duties on a surety because a surety is a guarantor issuing a commercial guaranty, not an insurance carrier issuing an insurance policy.
What Does It All Mean?
The Court’s decision makes it clear that in Pennsylvania, a surety’s obligations to its principal are not the same as the heightened obligations that exist in fiduciary relationships. In a fiduciary relationship, the fiduciary (e.g., an insurer) must act with the utmost fairness and refrain from using his position to the other’s detriment and his own advantage. As the Court determined, however, surety relationships are ordinary arm’s-length commercial relationships where each party owes the other a less protected duty of good faith and fair dealing. When entering into surety relationships, contractors need to be mindful of this distinction, especially when a surety begins communicating with project owners on its principal’s behalf.
Principals like Reginella should carefully monitor the surety’s activity and insist on being copied on all communications to and from the surety.
It is important to note that a couple of weeks ago, Reginella asked the Court to reconsider and alter its decision. Therefore, the Court’s decision is not yet final, and we will continue to monitor the result.