Rhode Island Hosp. Trust Nat. Bank v. OHIO CAS. INS.

• Decision Date: 26 July 1985
• Docket Number: Civ. A. No. 82-0274-B.
• Citation: 613 F. Supp. 1197
• Parties: RHODE ISLAND HOSPITAL TRUST NATIONAL BANK, Plaintiff, v. The OHIO CASUALTY INSURANCE COMPANY, Defendant.
• Court: U.S. District Court — District of Rhode Island

613 F. Supp. 1197

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

Civ. A. No. 82-0274-B.

United States District Court, D. Rhode Island.

July 26, 1985.

COPYRIGHT MATERIAL OMITTED

Gordon P. Cleary, George Vetter, Vetter & White, Providence, R.I., for plaintiff.

Barbara S. Cohen, Levy, Goodman, Semonoff & Gorin, Providence, R.I., for defendant; Louis J. Burnett, Simpson, Moran & Burnett, Birmingham, Mich., of counsel.

OPINION

FRANCIS J. BOYLE, Chief Judge.

The Plaintiff, Rhode Island Hospital Trust National Bank ("The Bank"), seeks payment as assignee of two bonds issued by the Defendant, Ohio Casualty Insurance Company ("Ohio"), in the total amount of $675,000. The bonds were issued to secure payment for wood burning stoves ordered from Franklin Cast Products, ("Franklin Cast"), a Rhode Island Corporation, by its distributor, Franklin-America, Inc., ("Franklin-America"), a Michigan corporation.

Bond # X-XXX-XXX provides in its entirety:

KNOW ALL MEN BY THESE PRESENTS, that Franklin-America, Incorporated, as Principal, and The Ohio Casualty Insurance Company, an Ohio Corporation of Hamilton, Ohio, as Surety, are held and firmly bound unto Franklin Cast Products, Inc., as Obligee, in an amount not to exceed Three-hundred Fifty-thousand Dollars ($350,000) for the payment whereof the Principal and Surety bind themselves firmly by these presents.

WHEREAS, the Principal and Obligee have entered into an agreement dated November 5th, 1979 whereby the Principal will act as the distributor for the Obligee's merchandise in less than one shipping container amounts, and

WHEREAS, the agreement calls for the Principal to receive merchandise and make payment to the Obligee according to specified terms,

NOW THEREFORE THE CONDITION OF THIS OBLIGATION IS SUCH, that if the Principal shall receive merchandise and make payment to the Obligee according to the terms of the agreement, then this obligation shall be null and void, otherwise to remain in full force and effect.

The term of this bond shall be for the period from signature date to July 31, 1980.

This bond may be terminated by any party thereto by giving fifteen (15) days prior notice of cancellation. Such cancellation will in no way effect orders placed for delivery prior to the effective date of cancellation.

Signed, sealed and dated December 15, 1979.

Bond # X-XXX-XXX in the amount of $325,000 is identical in form except that the fifth paragraph stating the term of the bond is omitted.

The parties disagree as to whether the bonds are penal sums to be paid upon the failure of Franklin-America to pay for stoves delivered by Franklin Cast or whether they are surety bonds that limit liability to the net amount actually due Franklin Cast from Franklin-America. The labels of "guaranty" or "surety" do not control the meaning of the bonds. Rather, the relevant intent of the parties, manifested by the terms of the agreement, controls.

FACTS

From 1977 through 1981, the Bank financed Franklin Cast's purchases of stoves from a Taiwanese supplier for resale. The Bank predominately used back-to-back letters of credit, issuing them for Franklin Cast's account to Franklin Cast's supplier. In turn, Franklin Cast and the Bank took a commercial letter of credit from Franklin's customers as the Bank's security for the money it advanced to Franklin Cast to purchase the stoves.

In November, 1979, Franklin-America and Franklin Cast entered an agreement under which Franklin-America was to distribute stoves for Franklin Cast. Franklin-America was uncomfortable with letter-of-credit financing and requested that they use surety credit rather than bank credit.

The principals of Franklin-America were also engaged in the construction business and had obtained payment and performance bonds from Ohio. Franklin-America then asked Ohio, to draw up bonds for the benefit of Franklin Cast. While earlier bonds were issued and cancelled, ultimately, Ohio issued two bonds in the amounts of $325,000 (# X-XXX-XXX) and $350,000 (# X-XXX-XXX) each, on December 15, 1979. Bond # X-XXX-XXX, in the amount of $350,000, was limited in term up until July 31, 1980. On December 20, 1979, Franklin Cast advised Ohio that it had assigned all of its "claims and their proceeds, which might arise presently or in the future" out of the two bonds, to Rhode Island Hospital Trust. Ohio "acknowledged" receipt of the notice of assignment although it had denied the assignability of earlier issued bonds. Plaintiff claims that it advanced money to Franklin Cast in reliance on the assignment to it of the rights to proceeds under the bonds.

In July, 1980, Franklin-America and Franklin Cast agreed to extend time for payment of all outstanding invoices until March 31, 1981. Franklin Cast requested that Ohio consent to extensions on the bond that was limited to July 31, 1980. Ohio refused and cancelled that bond after July 31, 1980.

On June 9, 1981, Franklin Cast notified Ohio that due to nonpayment of invoices in the amount of $625,257.74, as of December 31, 1980 for stoves shipped, it intended to proceed against the surety bonds for payment if payment was not received by the end of the year (1981). Franklin Cast had not pursued payment from Franklin-America first.

Franklin-America cancelled the "open" bond in July, 1981 and sent notice to Franklin Cast. It then sued Franklin Cast on the underlying contract regarding the disputed shipment of stoves, alleging defects in the goods in the United States District Court for the Eastern District of Michigan.

By November, 1981, Franklin Cast was out of business. On March 10, 1982, a default judgment was entered against Franklin Cast in the amount of $901,000, in the United States District Court of the Eastern District of Michigan. The Defendant claims that Franklin-America is entitled to raise the affirmative defense of Franklin Cast's breach of the contract and to preclude this litigation by giving res judicata effect to the prior Michigan action.

Whether or not the Plaintiff is subject to that defense depends on whether Ohio was a surety or a guarantor of payment, and whether the Bank is an assignee of Franklin Cast's contract claim or of the proceeds under the bonds.

Plaintiff claims that Franklin America's failure to pay automatically triggered Ohio's liability on the bonds. Defendant contends that because the bonds are a surety agreement, Ohio may use the defenses, available to Franklin-America under the principal agreement, against the Bank. It also claims that it owes nothing to the Bank because the bonds were nonassignable. Also, Ohio contends that bond # 2130-962 was limited in time to July 31, 1980 and that because Ohio refused to extend the time for payment of the bond, it expired on the stated date.

CONSTRUCTION OF BONDS

The primary issue before the Court is the construction of the bonds, which appear to be a hybrid of guaranty and surety instruments. Contracts of guaranty and suretyship both promise to answer for the debt of another; their difference lies in their intended purpose. 38 Am.Jur.2d Guaranty §§ 14-16 (1968). Sometimes the two are indistinguishable. See Texas Water Supply Corp. et al. v. Reconstruction Finance Corp., 204 F.2d 190, 194 (5th Cir.1953). Generally, a guaranty is collateral to the primary agreement and binds the guarantor to perform upon the fact of nonperformance of the primary contract. It is a contract of secondary liability. See 38 Am.Jur.2d Guaranty § 15 (1968). Conversely, a surety generally is primarily and jointly liable with the principal debtor and agrees to take over performance of the principal. See generally A. Stearns, The Law of Suretyship at 2 (5th ed. 1951). Therefore, the surety may use any defenses available to the principal debtor against the creditor. Generally, the liability of the surety may be limited because it is measured by the liability of the principal debtor. See 74 Am.Jur.2d Suretyship § 25 (1968).

In determining the construction of the bonds, the probable intent of the parties, shown by the language of the document controls. Allied Plywood Co. v. Pearson, 121 R.I. 72, 75, 395 A.2d 716, 718 (1978). Both Rhode Island and Michigan hold that if the language is ambiguous, the document is construed most strongly against the drafter, who is in this case, Ohio. Bailey & Gallup v. Lachar, 5 R.I. 530, 534 (1858); Post v. Maryland, 68 Mich.App. 182, 187, 242 N.W.2d 62, 65 (1976). But, this analysis must also produce a reasonable interpretation as deduced from the relative conditions of the parties, their probable intent, and the subject of the bonds. Allied Plywood, supra, 121 R.I. at 75, 395 A.2d at 718.

Although the bonds in question use the term "surety" and are signed by Franklin-America and Ohio Casualty, they do not state whether both these parties may be jointly and severally liable and contain only an ambiguous reference to the underlying agreement. Both bonds contain the following language:

NOW THEREFORE THE CONDITION OF THIS OBLIGATION IS SUCH, that if the Principal shall receive merchandise and make payment to the Obligee according to the terms of the agreement then this obligation shall be null and void, otherwise to remain in full force and effect.

Defendants claim that this provision, in effect, incorporates performance of the underlying obligation of the parties. Yet, literally, on its face, it merely provides the condition upon which the obligor is released from liability, the receipt of merchandise and payment according to the agreement.

A promise by a surety would include doing any and all things which were to be done by the principal debtor. See Peterson et al. v. Miller Rubber Co. of New York, 24 F.2d 59, 62 (8th Cir.1928). The bond agreement does not reveal that Ohio would assume any duties of Franklin-America described in the distributor contract and there is no evidence that Ohio was prepared to become involved in the stove business.

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