Argonaut Ins. Co. v. Town of Cloverdale, Ind.

• Decision Date: 09 February 1983
• Docket Number: No. 82-1268,82-1268
• Citation: 699 F.2d 417
• Parties: ARGONAUT INSURANCE COMPANY, Plaintiff-Appellee, v. TOWN OF CLOVERDALE, INDIANA, Defendant-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 417

699 F.2d 417

ARGONAUT INSURANCE COMPANY, Plaintiff-Appellee, v. TOWN OF CLOVERDALE, INDIANA, Defendant-Appellant.

No. 82-1268.

United States Court of Appeals Seventh Circuit.

Submitted Jan. 6, 1983.

Decided Feb. 9, 1983.

Jerdie D. Lewis, Lewis & Lewis, Terre Haute, Ind., Rexell A. Boyd, Boyd & Young, Greencastle, Ind., for defendant-appellant.

Eric A. Frey, Rosenfeld, Wolfe, Frey & Hunt, Terre Haute, Ind., for plaintiff-appellee.

Before CUMMINGS, Chief Judge, POSNER, Circuit Judge, and NEAHER, Senior District Judge. ^*

POSNER, Circuit Judge.

The appeal in this diversity case requires us to decide a question of suretyship under the common law of Indiana. The essential facts are undisputed. The Town of Cloverdale, Indiana hired a contractor, HESCO, to build sewers. HESCO gave the town a performance bond in the amount of $238,000. The surety on the bond was Argonaut Insurance Company. Under its contract with HESCO, the town "agree[d] to pay the Contractor the sums herein specified in monthly installments as the work progresses upon estimates signed by the Engineer [an engineering firm the town had hired to supervise the project]," and the engineer was authorized, "at his discretion, [to] include in the aforesaid progress payments an estimate of the equipment and materials ... which has [sic] been delivered upon the site of the work, and for which receipted invoices have been delivered to the Engineers." About halfway through the project HESCO defaulted and Argonaut stepped in and hired another contractor to complete the work. Argonaut later discovered that the engineering firm had included in its progress-payment estimates, and the town had paid HESCO, $17,000 for materials delivered to the construction site for which either receipted invoices had not been submitted or "retainage" had not been deducted (the contract provided that 10 percent of each progress payment was to be withheld "as part security for the faithful performance" of the contract).

Argonaut demanded that the town pay it $17,000 in addition to the $16,000 due as the last installment payment for completion of the project. (The town had to pay Argonaut to complete the project because the cost of the project exceeded the amount of the performance bond.) The town was willing to pay Argonaut the $16,000 final installment on condition that Argonaut abandon its claim to the additional $17,000, but Argonaut refused, and sued the town for $33,000. Trial was by jury. At the close of the evidence Argonaut moved for a directed verdict. The judge took the motion under advisement and sent the case to the jury, which hung. Twenty-seven months later the judge granted Argonaut's motion and entered judgment for $50,000--$33,000 plus interest from the date of Argonaut's demand for the $17,000 in unauthorized progress payments.

If a contract that a surety has guaranteed is altered without the surety's consent, he is discharged, on the theory that he insured only the original contract. Indiana Telco Fed. Credit Union v. Young, 156 Ind.App. 483, 487, 297 N.E.2d 434, 436 (1973). As a corollary to this rule, he is discharged if the obligee under the suretyship contract (the Town of Cloverdale, in this case) makes advance payments to the principal (HESCO) beyond those provided for in the contract (we postpone consideration of whether the discharge is total or partial in this situation). Detroit Fidel. & Sur. Co. v. Bushong, 96 Ind.App. 352, 175 N.E. 683 (1931); United States for Use & Benefit of H & S Industries, Inc. v. F.D. Rich Co., 525 F.2d 760, 771 (7th Cir.1975); Stearns, The Law of Suretyship 123 (5th ed., Elder, 1951). Whether this is a true corollary may be doubted, since the fact that a prepayment is unauthorized does not mean that it breaks or alters the contract. But the corollary has an independent rationale, and therefore need not be rested on deduction. The rationale is that unauthorized advances reduce the principal's incentive to complete the contract, thereby increasing the risk to the surety, and increase the cost of the surety's substitute performance (in this case the argument would be that if the Town of Cloverdale had retained the $17,000 it erroneously paid HESCO its loss on its dealings with HESCO would have been that much less). Both parts of this rationale, however, are questionable. Arant, Rationale of the Rule That an Obligee's Premature Payment Discharges His Surety, 80 U.Pa.L.Rev. 842, 853 (1932). The principal's default may be and usually is unrelated to any slackening off due to unauthorized advances and may indeed be retarded rather than accelerated by them. And whether the advances increase the surety's risk depends on what the principal did with them; if he used them on the project the amount at risk to the surety may be unaffected.

Though the rule on unauthorized advances may well be just a vestige of an era when sureties were usually not compensated and therefore were treated with a judicial tenderness that they do not deserve today, see Stearns, supra, at 2, we have no evidence that Indiana is about to jettison the rule. But we are entitled, in light of its shaky foundations, to pay sympathetic attention to the exception that the town presses on us: a surety is not discharged by reason of an unauthorized payment made in good-faith reliance on an engineer's or architect's certificate of progress. See cases cited in Annot., Contractor's Bond--Payment Releasing Surety, 127 A.L.R. 10, 77 (1940); Simpson, Handbook on the Law of Suretyship 394-95 n. 10 (1950). Although we have found no Indiana cases dealing with this exception there is no reason to think the Indiana courts would reject it. Argonaut points out that it is not seeking discharge in full but only the crediting of the unauthorized payments against its obligations under the suretyship contract. However, the modern rule--for which there is ancient authority in Indiana, see Weik v. Pugh, 92 Ind. 382, 386 (1884); Foster v. Gaston, 123 Ind. 96, 106-07, 23 N.E. 1092, 1096 (1890)--is that a discharge because of unauthorized payments to the principal operates only to the extent...