Rhode Island Hosp. Trust Nat. Bank v. Ohio Cas. Ins. Co., 85-1876

• Decision Date: 25 April 1986
• Docket Number: No. 85-1876,85-1876
• Parties: RHODE ISLAND HOSPITAL TRUST NATIONAL BANK, Plaintiff, Appellee, v. The OHIO CASUALTY INSURANCE COMPANY, Defendant, Appellant.
• Court: U.S. Court of Appeals — First Circuit

Page 74

789 F.2d 74

RHODE ISLAND HOSPITAL TRUST NATIONAL BANK, Plaintiff, Appellee, v. The OHIO CASUALTY INSURANCE COMPANY, Defendant, Appellant.

No. 85-1876.

United States Court of Appeals First Circuit.

Argued Feb. 6, 1986.

Decided April 25, 1986.

Louis J. Burnett, Birmingham, Mich., with whom Anthony F. Muri, Barbara S. Cohen, Licht & Semonoff, Providence, R.I., were on brief, for defendant, appellant.

George Vetter, with whom Gordon P. Cleary, Vetter & White, Providence, R.I., were on brief, for plaintiff, appellee.

Before COFFIN and BOWNES, Circuit Judges, MAZZONE, District Judge ^*.

COFFIN, Circuit Judge.

This case involves the complex world of suretyship law and its impact on the rights of two financial institutions who are parties here because of their relationships with the buyer and seller of wood burning stoves. The district court found that appellant, Ohio Casualty Insurance Company (Ohio Casualty), was required to pay to appellee, Rhode Island Hospital Trust National Bank (the Bank), $325,000 on a bond that Ohio Casualty had issued on behalf of the stove buyer, Franklin America. The bond originally had been issued to the seller of the wood stoves, Franklin Cast (Cast), ¹ but Cast had assigned its right to collect to the Bank. After a careful review of the authorities and the facts, we reverse.

I. Facts

In November 1979, Cast, a Rhode Island corporation, entered into an agreement with Franklin America, a Michigan corporation, under which Franklin America was to distribute wood burning stoves imported from Taiwan by Cast. Cast's ability to import the stoves was dependent in the first instance on financing from the Bank. Since 1977, the Bank had been issuing letters of credit to Cast's supplier in Taiwan to secure Cast's purchases. In turn, the Bank would request a letter of credit from Cast's customers as security for the money it had advanced for the import purchases. In this case, however, Franklin America proposed the use of surety credit rather than a bank letter of credit, and the Bank agreed. Although there were other bonds issued and cancelled, the two bonds relevant here were issued by Ohio Casualty on behalf of Franklin America on December 15, 1979, in the amounts of $325,000 and $350,000. ²

On December 20, 1979, Cast informed Ohio Casualty, Franklin America's surety, that it had assigned all of its claims on the bonds to the Bank. Ohio "acknowledged" receipt of the notice of assignment, although it previously had asserted that this type of bond could not be assigned, prompting the Bank to withdraw an earlier assignment.

On June 9, 1981, Cast notified Ohio Casualty that it intended to proceed against the bonds if Franklin America's balance of $625,257.74 for stoves shipped as of December 31, 1980, was not paid by the end of 1981. Before Cast took any such action against Franklin America and Ohio Casualty, Franklin America took the initiative. In July 1981, it sued Cast in the United States District Court for the Eastern District of Michigan, alleging, inter alia, breach of contract and misrepresentation in connection with the stove shipments, and seeking $1 million in damages. Cast, which went out of business in November 1981, did not appear to defend the Michigan suit, and a default judgment was entered against it in the amount of $901,949.

The Bank, which had been a co-defendant in the Michigan lawsuit, had successfully sought dismissal from that case on jurisdictional grounds. In April 1982, it brought the action that is the subject of this appeal, seeking payment from Ohio Casualty on the two bonds issued in December 1979. The district court, 613 F.Supp. 1197, found that the $350,000 bond had been legitimately cancelled by Ohio Casualty, but that Ohio Casualty was obligated to pay on the $325,000 bond. The district court found that, under the principles of suretyship applicable to this case, Ohio Casualty was unconditionally liable on the bonds once Franklin America failed to pay for the stoves it received. Ohio Casualty filed this appeal, claiming, inter alia, that the district court's view of suretyship law was in error.

II. Summary

Because the law and the relationships of the parties here are complex, we believe it is helpful at the outset to summarize our discussion. We first address briefly and generally the law of suretyship, describing the two types of surety arrangements that may have been used in this case, a suretyship as a primary obligation or a guaranty. The district court held that the type of suretyship determined whether Ohio Casualty was obligated to pay the Bank on the bonds. We disagree that that question is pivotal, and so we do not discuss the question of whether Ohio Casualty served as a surety or as a guarantor for Franklin America. Instead, we move directly from our general discussion of the types of suretyship to a discussion of the defenses available to sureties and guarantors. We conclude that, whatever the nature of the suretyship here, Ohio Casualty was entitled to raise certain defenses available to its principal, among them a prior judgment in favor of the principal. This conclusion leads us to find that the original creditor, Cast, is barred from collecting on the bonds as a result of the default judgment in favor of Franklin America in Michigan.

Finally, after the discussion of defenses, we shall turn to the assignment issue. Although Cast, as the original creditor, would be barred from collecting on the bonds, we must consider whether its assignee, the Bank, which was dismissed from the Michigan action, is subject to the same defense. We conclude that it is, and we explain the principles of res judicata, assignment and suretyship law that lead us to such a conclusion. ³

III. Discussion

Our primary task in this case is to answer a purely legal question: whether a surety such as Ohio Casualty may assert the defenses of its principal in a suit by the beneficiary of the suretyship agreement. We thus begin with a general discussion of suretyship law, and then discuss its application to the facts of this case.

A. Suretyship and Its Defenses

A suretyship is a contractual arrangement in which one party, the "surety", agrees to back up the obligation of another, termed the "principal" or "principal debtor", the latter bearing the primary burden of performing for the creditor. See, e.g., 10 W. Jaeger, Williston on Contracts Sec. 1211, at 683 (3d ed. 1967) (hereinafter Williston ) at 683; L. Simpson, Simpson on Suretyship 4-7 (1950) (hereinafter Simpson ). The term "surety" is often used broadly to include all forms of suretyship, including the "guaranty". It also is used in a narrow sense to indicate a direct, primary obligation to pay someone else's debt, as distinguished from the secondary, collateral obligation of a "guarantor". Simpson 6-9; Williston Sec. 1211, at 684-686; E. Arnold, Suretyship and Guaranty Sec. 4, at 7 (1927) (hereinafter Arnold). The difference between the primary obligation of the surety and the secondary obligation of the guarantor is that the surety joins the original contract with the principal and may be sued as an unconditional promisor along with the principal; the guarantor's liability arises from an independent agreement and is expressly conditioned upon default by the principal. 38 Am.Jur.2d Guaranty Sec. 15 (1968); Simpson 10-11.

The district court found that Ohio Casualty served in the role of a guarantor. It also ruled that sureties who bear a primary obligation to the creditor may assert the defenses of their principals, but guarantors may not do so. The court therefore refused to allow Ohio Casualty to use the Michigan default judgment as an affirmative defense against the Bank's claims on the two bonds.

We conclude that the district court's distinction between the defenses available to a guarantor and those available to a surety who has a primary obligation reflects an erroneous view of the law. The distinction between a surety serving as a primary obligor and a guarantor--that is, the primary vs. the secondary obligation--is relevant to defenses only in that a guarantor sued by a creditor has one potential defense that a surety does not: the defense that the principal has not yet defaulted. We think it is contrary to both precedent and logic to treat sureties and guarantors differently when the defense concerns the continuing viability of the underlying obligation. In fact, the terms "surety" and "guarantor" often are used interchangeably, reflecting their nearly identical characteristics. Restatement of Security Sec. 82 (1941); Simpson 8; Williston Sec. 1211, at 687; J. Elder, The Law of Suretyship Sec. 1.5, at 4 (5th ed. 1951) (hereinafter Law of Suretyship ); see also C-E Building Products, Inc. v. Seal-Rite Aluminum Products of N.H., 114 N.H. 150, 316 A.2d 198, 198-99 (1974) (using terms interchangeably); Morris & Co. v. Lucker, 158 Mich. 518, 123 N.W. 21, 22 (1909). As a leading commentator points out:

"The rights of the surety and the guarantor against the creditor are the same, provided that the creditor knows that the relation of suretyship exists. The outstanding and perhaps only important respect in which the guarantor's undertaking differs from that of the surety is that it is expressly conditioned on the principal's nonperformance of duty." Simpson 22. ⁴

Because the liability of sureties and guarantors is virtually identical, ⁵ we need not decide which obligation Ohio Casualty agreed to undertake. Instead, we turn to the question of suretyship defenses. The basic rule on the liability of sureties is that "the surety is not liable to the creditor unless his principal is liable"[;] thus he may plead the defenses which are available to his principal", Williston Sec. 1214, at 714; Law of Suretyship Sec. 7.1, at 200. See Asociacion de Azucareros de Guatemala v. United States National Bank of Oregon, 423 F.2d 638, 641 (9th Cir.1970); Stephens v. First Bank and Trust of Richardson 540...