Great American Ins. Co. v. North Austin Mun. Utility Dist. No. 1

• Citation: 908 S.W.2d 415
• Decision Date: 16 November 1995
• Docket Number: No. D-3889,D-3889
• Parties: 38 Tex. Sup. Ct. J. 817 GREAT AMERICAN INSURANCE COMPANY, Petitioner, v. NORTH AUSTIN MUNICIPAL UTILITY DISTRICT NO. 1, Respondent.
• Court: Supreme Court of Texas

Page 415

908 S.W.2d 415

38 Tex. Sup. Ct. J. 817

GREAT AMERICAN INSURANCE COMPANY, Petitioner, v. NORTH AUSTIN MUNICIPAL UTILITY DISTRICT NO. 1, Respondent.

No. D-3889.

Supreme Court of Texas.

Argued Jan. 19, 1995.

Decided June 15, 1995.

Rehearing Overruled Nov. 16, 1995.

David C. Wenholz, Dallas, Arthur F. Selander, Dallas, for petitioner.

Scott R. Kidd, Austin, for respondent.

OWEN, Justice, delivered the opinion of the Court in which all the Justices join.

The issues in this case involve the duties and liabilities of a commercial surety to its bond obligee. We hold there is no common law duty of good faith and fair dealing between the surety and the bond obligee comparable to that between a liability insurer and its insured. We further hold that article 21.21 of the Insurance Code is inapplicable to a commercial surety, and accordingly, reverse the judgment of the court of appeals in part. 850 S.W.2d 285, 902 S.W.2d 488. ¹ We affirm the holding of the court of appeals that the surety in this case is liable under the terms of the bond for the default of the principal.

I

This case arises out of a construction project for a municipal wastewater lift station in which Great American Insurance Company ("Great American") issued payment, performance, and maintenance bonds in favor of the North Austin Municipal Utility District No. 1 ("MUD"). In 1986, MUD determined that it needed to upgrade a wastewater lift station located at Rattan Creek to consist of a wet well/dry well configuration. A wet well is a concrete structure poured into the ground which serves as a holding tank for the wastewater being collected by the station while a dry well is a large, metal cylinder buried in the ground which contains the pumps and electrical equipment necessary to pump wastewater. In planning the facility at Rattan Creek, MUD considered two alternatives: the construction of a new dry well or the refurbishment and relocation of an existing dry well at another lift station that was to be closed.

MUD consulted with an engineering firm, Dippel Ulmann, who prepared bid documents that requested contractors to submit separate bids for the construction of a new dry well and for the refurbishment of the existing well. The specifications, plans, and drawings included in the bid documents, however, were the same for either project and did not contain requirements specifically related to the refurbishment of the existing dry well. The specifications required the thickness of the sides of the dry well to be determined by the structural requirements for the depth of burial, but at a minimum to be 1/4 inch thick.

Underground Utilities Company ("Underground") was awarded the contract on the basis of its bid for the refurbishment and relocation of the existing dry well. Underground removed the dry well and shipped it to a subcontractor, Smith Pump Company, for refurbishment. Smith Pump submitted drawings indicating the manner in which it would refurbish the dry well to Dippel Ulmann, who approved them. The drawings did not include any indication that Smith Pump would thicken the sides of the dry well. After the modifications were completed, the dry well was installed at Rattan Creek and began operating in April of 1988. MUD formally accepted the refurbished lift station as "substantially complete" in December, 1988.

On March 10, 1989, nearly one year after being installed at Rattan Creek, the metal sides of the dry well collapsed inward by approximately three inches. MUD notified Underground and retained a structural engineer to evaluate the cause of the failure. Although the sides of the dry well met the minimum 1/4 inch thickness required by the contract specifications, the engineer determined that the sides were nonetheless not thick enough to withstand the lateral earth pressure created by the depth of burial of the well.

MUD demanded that Underground correct the problem. Underground refused, claiming that it had performed all work according to the plans and specifications approved by MUD's design engineer and that MUD had approved the work. Underground further claimed that Smith Pump, rather than Underground, was liable on the warranty included in the contract documents. Smith Pump denied liability for the inward buckling of the dry well, asserting that an outside force caused the buckling, and pointing out that the dry well was in place at its previous location for over three years without buckling inward and had been operating at Rattan Creek for nearly one year.

On April 4, 1989, MUD first sent notice of the defect to the construction surety, Great American, who had issued a performance bond in the amount of $397,503.20 and a one-year maintenance bond in the amount of $386,431.98 on the project. MUD advised Great American of Underground's refusal to correct the problem with the dry well, and demanded performance under the terms of the bonds.

Thereafter, Great American consulted with MUD and Underground about the problem, obtained copies of the report of MUD's engineer, and reviewed copies of the contract documents and specifications. On April 26, 1989, Great American sent a letter to MUD stating that the problem with the dry well appeared to be one relating to its design, and requested evidence that its principal, Underground, had failed to conform with the plans and specifications in the contract. Great American also asked MUD for legal authority holding a contractor liable for an engineering design defect. MUD replied several months later by sending a letter demanding payment on the bonds. Great American once again responded by requesting additional information. The dry well continued in operation during this time.

MUD filed suit against Dippel Ulmann, Smith Pump, Underground, and Great American. Based on liability findings by a jury against all the defendants, the trial court rendered judgment in favor of MUD. Specifically as to Great American, the jury found that it had knowingly committed deceptive acts in violation of article 21.21 of the Insurance Code and had breached a common law duty of good faith and fair dealing. The jury also found that reasonable attorneys' fees would be 33 1/3% of MUD's recovery. Accordingly, based on an actual damages finding by the jury of $411,400, the court entered judgment against Great American by adding prejudgment interest to that amount and trebling that sum under article 21.21, § 16(b) for damages in the amount of $1,558,804.80. The court additionally awarded $779,402.40 in attorneys' fees against Great American. Great American alone appealed the judgment of the trial court, and the court of appeals affirmed.

II

The jury found that Great American failed to deal fairly and in good faith with MUD and that the amount of damages proximately caused by this failure was $411,400. Great American contends that the court of appeals erred in failing to hold that the contractual relationship between a commercial surety and its bond obligee does not give rise to a common law duty of good faith and fair dealing. In response, MUD asserts that the special relationship between a surety and its obligee justifies the judicial imposition of this extracontractual duty.

In English v. Fischer, 660 S.W.2d 521, 522 (Tex.1983), this Court held that a duty of good faith and fair dealing does not exist in the context of all contractual relationships. Such a duty is owed by a liability insurer to its insured, however, because of the special relationship between them. Arnold v. National County Mut. Fire Ins. Co., 725 S.W.2d 165, 167 (Tex.1987). Likewise, this duty is owed by workers' compensation carriers to injured workers. Aranda v. Insurance Co. of N. Am., 748 S.W.2d 210, 212-13 (Tex.1988). At issue, then, is whether the relationship between a surety and its bond obligee is such that it owes a duty of good faith and fair dealing to the bond obligee.

In finding a special relationship between a liability insurer and its insured, factors this Court has considered include unequal bargaining power between the insurer and its insured, the nature of insurance contracts (which permit unscrupulous insurers to take advantage of insureds' misfortunes in negotiating claim resolution), and the insurance company's exclusive control over the claim evaluation process. Arnold, 725 S.W.2d at 167. None of these factors is present in this case.

First, the unequal bargaining power that concerned this Court in Arnold did not exist here. Great American had no control over the form of the bond used in this case. In fact, state law, which required a contractor entering into a formal contract in excess of $25,000 with any governmental or quasi-governmental authority to provide both performance and payment bonds in favor of the governmental entity, mandated that the form of the required bonds "shall be approved by the Attorney General" or the "governmental awarding authority concerned." TEX.REV.CIV.STAT.ANN. art. 5160, repealed by Acts 1993, 73rd Leg., R.S., ch. 268, § 46(1), 1993 Tex.Gen.Laws 583, 986 (current version at TEX.GOV'T CODE § 2253.021(e)). MUD therefore had the ability to exercise control over the form of the bonds. Moreover, the bonds incorporated the terms of the contract between MUD and Underground. It is undisputed that MUD controlled the contract documents at issue here.

Second, concerns that a surety may take advantage of a bond obligee in the claims resolution process ignore the fundamental differences between a liability insurance contract and a surety bond. While a liability insurance contract involves only two parties, the insurer and the insured, suretyship involves a tripartite relationship between a surety, its principal, and the bond obligee, in which the obligation of the surety is intended to supplement an obligation of the principal owed to the bond obligee. Clark, Suretyship in the Uniform Commercial Code, 46 TEX.L.REV. 453 (1968). Unlike a liability insurance contract, in which the obligation...