Masterclean, Inc. v. Star Ins. Co.

• Court: South Carolina Supreme Court
• Citation: Masterclean, Inc. v. Star Ins. Co., 347 S.C. 405, 556 S.E.2d 371 (S.C. 2001)
• Decision Date: 26 November 2001
• Docket Number: No. 25379.,25379.
• Parties: MASTERCLEAN, INC., CPM Environmental, Inc., William B. Smith and Barbara P. Smith, Plaintiffs, v. STAR INSURANCE CO., Defendant and Third Party Plaintiff, v. Masterclean of North Carolina, Inc., Third Party Defendant.

347 S.C. 405

556 S.E.2d 371

MASTERCLEAN, INC., CPM Environmental, Inc., William B. Smith and Barbara P. Smith, Plaintiffs, v. STAR INSURANCE CO., Defendant and Third Party Plaintiff, v. Masterclean of North Carolina, Inc., Third Party Defendant.

No. 25379.

Supreme Court of South Carolina.

Heard October 23, 2001.

Decided November 26, 2001.

Robert Bryan Barnes and Kate B. Barroll, of Rogers, Townsend & Thomas, of Columbia, for Plaintiffs.

C. Allen Gibson, Jr., and Jonathan D. Crumly, Sr., both of Buist, Moore, Smythe & McGee, of Charleston, for Defendant/Third Party Plaintiff.

L. Franklin Elmore and Nancy W. Monts, of Ogletree, Deakins, Nash, Smoak & Stewart, of Greenville; and Edward G. Gallagher, of Washington, DC, for Amicus Curiae The Surety Association of America.

Justice BURNETT.

We agreed to answer the following questions certified by the United States District Court for the District of South Carolina:

Does South Carolina recognize a cause of action in tort by a principal against its surety for the surety's bad faith refusal to pay first party benefits to an obligee pursuant to a construction performance bond?

If so, what are the elements of this cause of action and what legal standards apply to the surety's actions in the investigation and resolution of an obligee's claim against the bond? Does a principal have a private right of action against its surety pursuant to S.C.Code. Ann. §§ 38-57-70 & 38-59-20 (1989)?

FACTS

The University of South Carolina ("U.S.C.") contracted with Masterclean, Inc.¹ ("Masterclean") to remove asbestos from a U.S.C. building. Masterclean obtained a performance bond from Star Insurance Company ("Star") pursuant to South Carolina law for $1,383,214 to assure performance. See S.C.Code Ann. § 11-35-3030(2)(i) (Supp.2000).

U.S.C. notified Star in November 1995 of Masterclean's default on the contract and made a claim on the bond. Star began a claim investigation. U.S.C. formally terminated the contract in December 1995.

Star eventually concluded Masterclean defaulted on the contract but refrained from deciding the claim on the bond pending negotiations with U.S.C. As negotiations progressed, U.S.C. hired a replacement contractor to complete the project.

The South Carolina Chief Procurement Officer issued a ruling in May 1996 finding Masterclean in default and ordering it to pay $1,000,000 in damages. All parties entered a negotiated settlement for $900,000 with Star liable for $100,000 and Masterclean paying the difference.

Plaintiff argues Star should have mitigated the damages by performing its bond obligations once it determined Masterclean defaulted and before U.S.C. obtained a replacement contractor.² Plaintiff alleges Star's failure to take over the project entitles it to damages in tort for Star's bad faith refusal to honor U.S.C.'s claim under the bond.

ISSUE

Can Plaintiff sue Star in tort for its bad faith refusal to pay U.S.C. under the performance bond?

LAW/ANALYSIS

A surety is a tripartite agreement among the surety company, the principal who is primarily responsible for performing the contract, and the obligee for whose benefit the agreement is made. 74 Am.Jur.2d Suretyship § 3 (1974). "Suretyship is a contractual relation resulting from an agreement whereby one person, the surety, engages to be answerable for the debt, default, or miscarriage of another, the principal." Id. § 1; see also, Philco Fin. Corp. v. Mehlman, 245 S.C. 139, 139 S.E.2d 475 (1964). South Carolina law treats a surety agreement as a credit arrangement where the surety lends credit to the principal who otherwise has insufficient credit to obtain the contract with the obligee. Philco Fin. Corp. v. Mehlman, supra.

A surety must pay the obligee only if the principal defaults, but the surety generally retains a right of indemnification from the principal. Restatement (Second) of Security § 82 cmt. b (1974). At all times, the principal retains the primary obligation to perform the contract and the primary liability for default of the contract. 74 Am.Jur.2d Suretyship § 3 (1974).

Plaintiff asserts sureties are insurers and a performance bond is insurance. Such a determination would allow Plaintiff to sue in tort for Star's bad faith refusal to pay insurance benefits on a first party claim under Nichols v. State Farm Mutual Automobile Ins. Co., 279 S.C. 336, 306 S.E.2d 616 (1983). This is an issue of first impression in South Carolina.³ A survey of other states shows a split of authority in allowing such suits. See Transamerica Premier Ins. Co. v. Brighton Sch. Dist. 27J, 940 P.2d 348 (Colo.1997)(finding an obligee may sue a surety in tort for bad faith refusal); see also, United States for the Use of Don Siegel Constr. Co., Inc. v. Atul Constr. Co., 85 F.Supp.2d 414 (2000)(Federal district court construing New Jersey law to allow an obligee to sue for bad faith damages against a surety); Loyal Order of Moose, Lodge 1392 v. International Fid. Ins. Co., 797 P.2d 622 (Alaska 1990); Dodge v. Fidelity and Deposit Co., 161 Ariz. 344, 778 P.2d 1240 (Ariz.1989); KW Indus. v. National Sur. Corp., 231 Mont. 461, 754 P.2d 502 (Mont.1988); Szarkowski v. Reliance Ins. Co., 404 N.W.2d 502 (N.D.1987); cf. Board of Dirs. of Ass'n of Apartment Owners v. United Pac. Ins. Co., 77 Hawai'i 358, 884 P.2d 1134 (Haw. 1994)(court found a surety owes a duty of good faith to the obligee and principal on the bond, but specifically declined to address whether Hawaii recognized a tort claim against a surety for bad faith refusal); but see, Cates Constr., Inc. v. Talbot Partners, 21 Cal.4th 28, 86 Cal.Rptr.2d 855, 980 P.2d 407 (Cal.1999)(California does not recognize an obligee's bad faith tort claim against a surety); Great American Ins. Co., v. North Austin Mun. Util. Dist. No. 1, 908 S.W.2d 415 (Tex. 1995); Institute of Mission Helpers of Baltimore City v. Reliance Ins. Co., 812 F.Supp. 72 (D.Md.1992)(construing Maryland law to not allow a bad faith claim by obligee against surety).

Plaintiff advances three arguments to support the contention that a surety agreement is an insurance contract subjecting the surety to a Nichols claim. Initially, Plaintiff asserts the Legislature intended to treat sureties as insurance companies for purposes of Nichols liability because they are regulated by the state insurance code. See S.C.Code Ann. § 38-1-10, et. seq. (Supp.2000). Several courts who find an action for a surety's bad faith refusal to pay an obligee base their decision on similar state laws. See Transamerica Premier Ins. Co. v. Brighton Sch. Dist. 27J, supra; Dodge v. Fidelity and Deposit Co., supra.

The South Carolina Insurance Code regulates surety companies. See S.C.Code Ann. § 38-1-20(13), (22), (25), (37) (Supp.2000). However, the surety's presence in a regulatory scheme does not render common law duties of an insurer applicable to a surety. A bad faith tort action arises from the common law due to special characteristics of the insurance relationship, not simply because it is a regulated industry. See Nichols v. State Farm Mut. Auto. Ins. Co., supra. The insurance regulatory scheme provides for administrative penalties, not a Nichols common law right of action. See S.C.Code Ann. § 38-2-10 (Supp.2000) (providing administrative penalties for violating the insurance laws of this state). In sum, because South Carolina regulates surety companies under the insurance code does not mandate finding a Nichols common law action in this case. Cf. Wilson v. McLeod, 274 S.C. 525, 265 S.E.2d 677 (1980) (the presence of a business in the insurance code does not necessarily create an insurance relationship).

Next, Plaintiff contends this Court should extend Nichols to sureties because courts treat surety agreements as insurance contracts at common law. Plaintiff misconstrues the common law's analogy between surety contracts and insurance contracts. A leading treatise on insurance practice highlights the source of this confusion:

It has frequently been held that contracts of suretyships are regarded as those of "insurance," where a corporate surety engages in the business for a profit, and that the rights and liabilities of the parties are governed by the rules applicable to contracts of insurance. This is a rule governing the construction of such contracts, however, and is not intended to alter the normal incidents of a suretyship contract, such as the surety's recourse against the principal for losses paid by it. If a compensated surety's contracts were regarded as insurance for all purposes, it is apparent that the surety would not have such right of recourse, together with all the other rights and duties which devolve upon a surety as such.

Appleman, Insurance Law and Practice, § 5273 (1981).

The treatise clearly shows the surety-insurance analogy is intended for purposes of contract construction alone. This analysis is supported by our holding in State Agricultural & Mechanical Society v. Taylor, 104 S.C. 167, 88 S.E. 372 (1916). In that case, we examined the difference between a "voluntary" surety and a for-profit surety company. Traditionally, courts viewed sureties as a favorite of the law, construing contracts strictissimi juris resolving all doubts and technicalities in the surety's favor. See Laurence P. Simpson Suretyship 101-12 (1950).

The State Agricultural & Mechanical Society rule removes strictissimi juris in surety contracts by for-profit companies. Courts now construe for-profit surety contracts similar to insurance contracts, resolving any doubts against the surety. See, Greenville Airport Commission v. U.S. Fidelity & Guaranty Co. of Baltimore, Md., 226 S.C. 553, 86 S.E.2d 249 (1955). Courts analogize insurance with surety for purposes of contract construction, not to expand common law duties in tort. Finally, Plaintiff attempts to create a common law duty by arguing the public policy reasons articulated in Nichols exist in the surety context. These policy considerations are either...