US for Benefit of Ehmcke Sheet Metal v. Wausau

• Citation: 755 F. Supp. 906
• Decision Date: 25 January 1991
• Docket Number: No. Civ. S-89-1704-DFL EM.,Civ. S-89-1704-DFL EM.
• Court: U.S. District Court — Eastern District of California
• Parties: The UNITED STATES, for the Benefit and Use of EHMCKE SHEET METAL WORKS, a California corporation, Plaintiff, v. WAUSAU INSURANCE COMPANIES, a Wisconsin corporation, and American Pacific Roofing Company, Inc., a California corporation, Defendants.

755 F. Supp. 906

The UNITED STATES, for the Benefit and Use of EHMCKE SHEET METAL WORKS, a California corporation, Plaintiff, v. WAUSAU INSURANCE COMPANIES, a Wisconsin corporation, and American Pacific Roofing Company, Inc., a California corporation, Defendants.

No. Civ. S-89-1704-DFL EM.

United States District Court, E.D. California, Sacramento Division.

January 25, 1991.

Michael Van Dyke, Gray, Cary, Ames & Frye, San Diego, Cal., for use-plaintiff W.G. Ehmcke Sheet Metal Works.

Dennis W. Richardson, Greve, Clifford, Diepenbrock & Paras, Sacramento, Cal., for defendant Employers Ins. of Wausau.

R. Timothy Ireland, Corona, Belistreri & Ramseger, San Diego, Cal., for defendant American Pacific Roofing Co.

G. Wayne Murphy, Anderson, Mc Pharlin & Connors, Los Angeles, Cal., for Merchants Bonding Co.

ORDER

LEVI, District Judge.

BACKGROUND

This is an action brought by Ehmcke Sheet Metal Works ("Ehmcke"), a subcontractor on a federal government construction project, against American Pacific Roofing Company, Inc. ("APR"), the prime contractor on the project and against APR's surety on the contract, Wausau Insurance Companies ("Wausau"). In its original complaint in this action, filed August 24, 1989, Ehmcke sued APR for breach of contract and sued Wausau both on the surety bond and for breach of the covenant of good faith and fair dealing. This court has subject matter jurisdiction because the suit against Wausau on the surety bond is authorized by the Miller Act, 40 U.S.C. § 270b(a).¹

On February 9, 1990, after Wausau filed a motion to dismiss, Ehmcke stipulated to the dismissal without prejudice of its claim against Wausau for breach of the covenant of good faith and fair dealing. APR answered and counter-claimed against Ehmcke, and its surety, Merchants Bonding Company on December 27, 1990. Wausau answered on January 26, 1990. The discovery deadline was set for November 14, 1990, but was extended by stipulation of all the parties to December 14, 1990.

Ehmcke now moves under Fed.R.Civ.P. 15 for leave to amend its complaint to assert three additional claims:

(1) To reassert the claim for breach of the covenant of good faith and fair dealing against Wausau,

(2) To assert a fraud claim against APR, and

(3) To assert additional damages for breach of contract against APR for delay and lost efficiency.

DISCUSSION

I. Standards Governing Leave to Amend.

The standards governing the grant of leave to amend are found in Fed.R. of Civ.Proc. 15(a):

A party may amend the party's pleading once as a matter of course ... otherwise a party may amend the party's pleading only by leave of court or by written consent of the adverse party; and leave shall be freely given when justice so requires.

Amendments are liberally allowed, within the discretion of the court, although that discretion is not unlimited. Jordan v. County of Los Angeles, 669 F.2d 1311, 1324 (9th Cir.), rev'd on other grounds, 459 U.S. 810, 103 S.Ct. 35, 74 L.Ed.2d 48 (1982). A court may deny leave to amend because of undue delay, bad faith, undue prejudice to the opposing party, or futility of the proposed amendment. Foman v. Davis, 371 U.S. 178, 182, 83 S.Ct. 227, 230, 9 L.Ed.2d 222 (1962). The most important of these factors is the prejudice to the opposing party. Zenith Radio Corp. v. Hazeltine Research, Inc., 401 U.S. 321, 330, 91 S.Ct. 795, 802, 28 L.Ed.2d 77 (1971); Hurn v. Retirement Fund Trust of Plumbing, Heating and Piping Industry of So. Calif., 648 F.2d 1252, 1254 (9th Cir.1981) (permitting two year delay), quoting Howey v. United States, 481 F.2d 1187, 1190-91 (9th Cir.1973) (permitting five year delay). When the question turns on the possible futility of the amendment, the issue takes on the characteristics of a motion to dismiss. See Moore v. Kayport Package Exp., Inc., 885 F.2d 531, 538 (9th Cir.1989); Rutman Wine Co. v. E. & J. Gallo Winery, 829 F.2d 729 (9th Cir.1987) (court may deny leave to amend on the basis that the proposed amendment will be futile).

II. Can a Surety be Sued by a Subcontractor for Breach of the Covenant of Good Faith?

The court will first address Ehmcke's effort to reassert its state law cause of action against Wausau for breach of the covenant of good faith and fair dealing. Wausau challenges this portion of Ehmcke's motion arguing primarily that the amendment would be futile, because California law does not recognize such a cause of action by a subcontractor against a surety. Wausau brought a motion to dismiss this same claim in Ehmcke's original complaint, based on Moradi-Shalal v. Fireman's Fund Insurance Companies, 46 Cal.3d 287, 250 Cal.Rptr. 116, 758 P.2d 58 (1988). Ehmcke filed a statement of non-opposition to dismissal without prejudice. Now, nine months later, plaintiff requests leave to reassert this claim.

A. The Miller Act

This lawsuit is based on the Miller Act which requires a contractor on a federal construction project to furnish a payment bond of a statutorily specified amount to secure payment to all suppliers of labor and material. 40 U.S.C. § 270a(a)(2). By statute, the surety's payment bond must run to the benefit of the United States, and subcontractors are permitted to sue the surety on the bond in federal court in the name of the United States. 40 U.S.C. §§ 270a(a), 270b(b). Suppliers of material on construction projects ordinarily acquire a mechanic's lien on the real property involved to secure payment. Because a mechanic's lien cannot attach to federal property, the Miller Act's bond requirement was designed to substitute for this common law remedy. See F.D. Rich Co. v. U.S. ex rel. Industrial Lumber Co., 417 U.S. 116, 122, 94 S.Ct. 2157, 2161, 40 L.Ed.2d 703 (1974); U.S. ex rel. Martin Steel Constructors, Inc. v. Avanti Constructors, Inc., 750 F.2d 759, 761 (9th Cir.1984), cert. denied, 474 U.S. 817, 106 S.Ct. 60, 88 L.Ed.2d 49 (1985).

In this case, to comply with the Miller Act, APR entered into a suretyship agreement with Wausau. Ehmcke now seeks to sue on the bond under the Miller Act — which it plainly may do — but also seeks to add a state law cause of action against Wausau for breach of the covenant of good faith and fair dealing.²

As an initial matter, the court notes that such a state law claim is not preempted by the remedy on the bond provided in the Miller Act. The Ninth Circuit has ruled that the Miller Act does not exclude state law claims against sureties for conduct relating to the performance of obligations arising out of Miller Act bonds. K-W Industries v. National Sur. Corp., 855 F.2d 640 (1988). In K-W Industries, the Montana Supreme Court determined, on a certified question, that the Montana unfair insurance claims practices code provision subjects sureties to liability to subcontractors for unfair insurance claims practices in amounts exceeding the amount of the bond. The Ninth Circuit then determined that Congress did not intend the Miller Act to preempt state insurance laws: "The Miller Act simply supplies the equivalent of a mechanic's lien; it does not supplant any other remedies the supplier may have against any party involved in a federal construction project." Id. at 643.

Thus, if California law permits an action for breach of the covenant of good faith and fair dealing against a surety by a party who has not contracted for the surety bond, the Miller Act will not preempt that action.

B. Does California Common Law Permit a Subcontractor to Sue the Prime Contractor's Surety for Breach of the Covenant of Good Faith and Fair Dealing?

California substantive law determines whether a subcontractor such as Ehmcke may maintain a tort claim for breach of the covenant of good faith and fair dealing against the prime contractor's surety. See K-W Industries, 855 F.2d at 641. This is an issue of first impression in the California courts, and it is not obvious how the California Supreme Court would resolve the issue.³ In such uncertainty "a federal court must use its own best judgment in predicting" what the California Supreme Court would decide. See Amfac Mortgage Corp. v. Arizona Mall of Tempe, Inc., 583 F.2d 426, 434-5 (9th Cir.1978).⁴

The starting point for analysis of this potential cause of action must be the California Supreme Court's recent decision in Moradi-Shalal v. Fireman's Fund Insurance Companies, 46 Cal.3d 287, 250 Cal. Rptr. 116, 758 P.2d 58 (1988). In Moradi-Shalal, the California Supreme Court overruled its earlier decision in Royal Globe Ins. Co. v. Superior Court, 23 Cal.3d 880, 153 Cal.Rptr. 842, 592 P.2d 329 (1979). Royal Globe had found that the California Unfair Practices Act § 790.03(h) permitted a third party claimant to sue an insurer for violation of a statutory obligation of fair dealing. In overruling Royal Globe, the Court in Moradi-Shalal noted and relied upon a number of adverse consequences that had flowed from Royal Globe's extension of a cause of action to those not in privity of contract with the insurer. First, the court noted that the rule in Royal Globe "promotes multiple litigation, because its holding contemplates, indeed encourages, two lawsuits by the injured claimant: an initial suit against the insured, followed by a second suit against the insurer for bad faith refusal to settle." 46 Cal.3d at 301, 250 Cal.Rptr. 116, 758 P.2d 58. Second, the Court found that granting a cause of action against the insurer by the injured claimant "may tend to encourage unwarranted settlement demands by claimants, and to coerce inflated settlements by insurers." 46 Cal.3d at 301, 250 Cal.Rptr. 116, 758 P.2d 58. The court quoted extensively from commentators expressing the concern that such inflated settlements would lead to higher insurance coverage costs to the public. Third, the Court identified a serious conflict of interest created for the insurer by the Royal Globe holding: the insurer "must not only protect the interests of its insured, but also must safeguard its own interests from the adverse claims of the third party ...