Bonding Company Bad Faith: Duty to Principal and Indemnitors

The law imposes a duty upon parties to all contracts to exercise good faith and to deal fairly. In recent years this law has been utilized to impose liability upon insurance and surety companies for not dealing fairly with insureds and beneficiaries.

If the duty of good faith is breached, offenders may be held liable not only for the benefits available under their policies or bonds, but also for consequential damages. Those are damages which might include any losses over and above policy or bond liability, such as those for mental anguish, legal fees and expenses, interest on borrowed funds, value of property lost or sold under distressed conditions, etc., etc.

Additionally, insurance or surety companies may be held liable for punitive damages in some states (including Colorado) if their conduct had been particularly flagrant, fraudulent or in willful or wanton disregard of the rights of others. Riva Ridge Apartments v. Robert G. Fisher, 745 P.2d 1034 (Colo. App. 1987)

It is now fairly well-established that the good faith obligation imposed upon an insurance carrier or surety requires that it conduct an impartial, prompt and reasonable investigation into the merits of a claim or matter submitted to it.

A recent Oregon court decision illustrates that a construction bonding company's obligation of good faith goes both directions: to bond beneficiaries and to principals/indemnitors on their bonds. City of Portland v. Ward & Assoc., Inc., 750 P.2d 171 (Or. App. 1988). "Indemnitors" are persons who agree to reimburse bonding companies for payments they make on claims.

In that case the bonding company settled an owner's claim without first having made a thorough factual investigation to determine whether the claim was valid or whether its contractor-principal had valid defenses.

It turned out that the contractor who was principal on the bond bid did have legitimate defenses to claims made by the owner. The court ruled that the bonding company had a good faith duty to investigate the merits of the owner's claim before settling with the owner. .

The court rejected the bonding company's reliance on the standard language of its General Indemnity Agreement which gave it the right in its sole discretion" to pay, settle, compromise or defend any claim. The court declared:

In order to prove lack of good faith in settling the claim [the principal/indemnitor] needed only to prove that [the surety] failed to make a reasonable investigation of the validity of the claims against them or to consider reasonably the viability of their counterclaims [against the owner] and defenses.

Denial or payment of claims without proper investigation is risky business!