Associated Indem. Corp. v. CAT Contracting, Inc.

• Decision Date: 08 May 1998
• Docket Number: No. 96-0387,96-0387
• Parties: 41 Tex. Sup. Ct. J. 389 ASSOCIATED INDEMNITY CORPORATION and Fireman's Fund Insurance Company, Petitioners, v. CAT CONTRACTING, INC., GTS Equipment, Inc., Michigan Sewer Construction Co., Construction Equipment Co., Mario Diponio, Benjamin Diponio, Phyllis Diponio, Guilio Catallo, and Rosemary Catallo, Respondents.
• Court: Texas Supreme Court

Page 276

964 S.W.2d 276

41 Tex. Sup. Ct. J. 389

ASSOCIATED INDEMNITY CORPORATION and Fireman's Fund Insurance Company, Petitioners, v. CAT CONTRACTING, INC., GTS Equipment, Inc., Michigan Sewer Construction Co., Construction Equipment Co., Mario Diponio Benjamin Diponio, Phyllis Diponio, Guilio Catallo, and Rosemary Catallo, Respondents.

No. 96-0387.

Supreme Court of Texas.

Argued Oct. 8, 1997.

Decided Feb. 13, 1998.

Rehearing Overruled May 8, 1998.

Joseph A. Rodriguez, Brownsville, Jeffrey Parsons, Tracy Phillips, Houston, James A. Knox, Dallas, for Petitioners.

Roger W. Hughes, Harlingen, David E. Keltner, Fort Worth, Edward A. Stapleton, III, Brownsville, Tom Lockhart, Harlingen, for Respondents.

PHILLIPS, Chief Justice, delivered the opinion of the Court, in which GONZALEZ, ENOCH, SPECTOR, BAKER, ABBOTT and HANKINSON, Justices, join.

The primary issue presented is whether at common law a surety owes a duty of good faith to its principal. The court of appeals, holding that this duty existed, affirmed the trial court's judgment for the principal against its surety for bad faith conduct. 918 S.W.2d 580. For the reasons set forth below, we hold that a surety does not owe a common law duty of good faith to its principal. However, we further hold that because there is some evidence to support the trial court's finding that the surety in this case did not satisfy the contractual condition of good faith under the parties' indemnity agreement, the surety is not entitled to indemnification under that agreement. Finally, we hold that the court of appeals correctly rejected the principal's claims that the surety violated the Deceptive Trade Practices Act and breached an informal fiduciary duty. We therefore reverse the judgment of the court of appeals in part and affirm in part, rendering judgment that all parties take nothing.

I. Facts and Procedural Background

In 1988, CAT Contracting, Inc. and Michigan Sewer Construction Company (collectively "Contractor") agreed to construct eight miles of concrete pipeline for the Cameron County Fresh Water Supply District No. 1 ("Owner"). As required by the contract and by statute, see TEX. GOV'T CODE § 2253.021(a),(d); TEX. LOC. GOV'T CODE § 252.044(a), Contractor secured bonding to guarantee its obligations under the contract. Associated Indemnity Corporation ("Surety") issued performance and payment bonds naming Owner as obligee; in return, Contractor agreed to indemnify Surety for any losses Surety incurred under the bonds. The indemnity agreement was signed by Guilio Catallo, individually and as president of CAT, and by Mario Diponio, individually and as vice-president of Michigan, along with their respective spouses, business partners and a related corporate entity. (When the context requires, "Contractor" includes these additional parties to the indemnity agreement.)

The indemnity agreement vested Surety with exclusive authority to determine whether any claim under the bonds should be settled, and for how much. It further provided that Surety's decision to settle a claim, if "made in good faith," was binding on Contractor, triggering Contractor's obligation to reimburse Surety for the settlement amount. Finally, the agreement provided that Contractor's default of the construction contract would constitute an assignment to Surety of Contractor's claims, if any, against Owner as "collateral security" for Contractor's indemnity obligation.

Shortly after Contractor began construction, it became concerned that the soil conditions were too unstable for concrete pipeline. This instability could cause the concrete pipe to rupture when it settled. Contractor expressed these concerns to Owner, which under the contract bore the responsibility for any design errors. Owner's engineers assured Contractor that the design was sound, and ordered Contractor to continue with construction.

After Contractor installed the pipeline, a pressure test revealed fourteen leaks. Contending that Owner's design caused the leaks, Contractor demanded additional payments to make repairs. Owner denied any fault, instead blaming the leaks on Contractor's installation. After Contractor still refused to make repairs, Owner declared the contract in default and called on Surety to complete the work under its performance bond.

Surety assigned its employee, Steve Mollenhauer, who is both a lawyer and a civil engineer, to investigate the dispute. After Mollenhauer met separately with representatives of Contractor and Owner, Surety agreed with Owner to repair the fourteen existing leaks, reserving the parties' rights regarding ultimate liability for the repairs. Surety expressly recognized at that time that its investigation was ongoing and thus far "inconclusive." Mollenhauer testified that Surety agreed to perform the repairs immediately to mitigate damages and to expedite its investigation, as repairs would necessarily require excavation around the leaks.

After notifying Contractor of its decision to perform repairs, Surety retained a local contracting company, Mercer & Ussery, to conduct the work. Mercer, a competitor of Contractor, had earlier installed a different section of the same pipeline. Surety agreed to compensate Mercer on a "time and materials" basis, paying Mercer costs plus fifteen percent, without any predetermined limit. Mercer completed the repairs in February 1991, billing Surety over $242,000.

Lee Wolz, a construction consultant whom Surety hired to assist in its investigation, monitored the repair operations and examined the leaks. Wolz wrote to Mollenhauer on February 15, 1991, that unstable soil conditions made it "next to impossible to restrain the pipe while it is being laid over a long distance," so that Owner's design may have created an "impossible spec to achieve." Wolz, who had extensive construction experience but was not an engineer, recommended that Mollenhauer consult with an engineering firm to investigate the design issue. Mollenhauer did not do so.

A pressure test performed after Mercer completed its repairs revealed twelve more leaks. Contractor's representatives, continuing to blame the leaks on the pipeline design, once again met with Mollenhauer in April 1991. Maury Stiver, an engineer retained by Contractor to substantiate its design flaw claim, presented his report to Mollenhauer at the meeting. Mollenhauer testified that he was not satisfied with Stiver's report because Stiver had not visited the pipeline to inspect the leaks. However, Mario Diponio, Michigan's vice-president, testified that Mollenhauer or some other Surety representative told him at the meeting that there was a "good case" that Owner's engineers were at fault, and that Surety would notify Contractor before making any final decision to settle Owner's claim.

Shortly thereafter, without notice to Contractor, Surety settled with Owner. Surety paid Owner $380,000 in full settlement of Owner's claims under the bonds. Also, Surety released any claims it might have had against Owner arising from the transaction, including any rights to contract funds Owner still owed to Contractor. The settlement agreement, however, did not purport to affect Contractor's right to pursue contract claims against Owner. ¹ Contractor claims that, at that time, Owner owed it $425,000 under the construction contract.

After settling with Owner, Surety demanded $835,000 as indemnity from Contractor, including the $380,000 settlement payment, repair costs, and other alleged incidental expenses. When Contractor refused to pay, Surety brought this suit. Contractor counterclaimed against Surety for breach of contract, breach of fiduciary duty, breach of the duty of good faith and fair dealing, Deceptive Trade Practices Act and Texas Insurance Code violations, fraud, tortious interference with contract, and negligent misrepresentation. Contractor claimed that Surety failed to keep it informed, failed to adequately investigate and assert Contractor's claim of design error, and failed to protect Contractor's interests during the settlement process.

After a nonjury trial, the trial court ruled that the DTPA did not apply to the transaction. However, the trial court found that Surety had breached a common law duty of good faith and fair dealing, breached the indemnity agreement by failing to act in good faith, breached a fiduciary duty owed to Contractor, violated article 21.21 of the Insurance Code, and committed fraud, tortious interference with contract, and negligent misrepresentation. The trial court rendered judgment denying Surety indemnity and awarding CAT and Michigan $4,163,305 in lost profits and $425,579 under the construction contract, and the principals and their spouses $700,000 in mental anguish damages.

The court of appeals affirmed in part, holding that Contractor was entitled to recover for Surety's breach of both a common law and contractual duty of good faith. However, the court of appeals reduced Contractor's lost profits award to $406,506 and the principals' mental anguish award to $600,000. It also held that Surety owed no fiduciary duty to Contractor, that article 21.21 of the Insurance Code did not apply to the suretyship relationship, and that, while there was evidence that Surety committed a deceptive act under the DTPA, that conduct was not the producing cause of any damages to Contractor. Finally, the court affirmed the take-nothing judgment against Surety on its indemnity claim. In light of these holdings, it did not reach the issues of fraud, tortious interference with contract, or negligent misrepresentation. Both sides filed applications for writ of error.

II. Duty of Good Faith

A.

Contractor argues that a bond surety owes its principal a common law duty of good faith and fair dealing. We recently examined the tripartite relationship between bond surety, principal, and obligee in Great American Insurance Co. v. North Austin Municipal Utility District No. 1, 908 S.W.2d 415 (Tex.1995)...