Fidelity and surety law.

• Author: Leslie, Robert E.
• Position: Texas, Arizona, California

IN 1995, the Texas Supreme Court in Great American Insurance Co. v. North Austin Municipal Utility District(16) announced the rule that there is no common law duty of good faith and fair dealing between a performance bond surety and the obligee. But there are different conclusions in Arizona and California. Can the disparity in the holdings be reconciled on any basis in fact or law?

Texas rule

Great American involved the construction of a dry well and the refurbishment of an existing well for a utility district. The refurbished well collapsed some time after it was completed by the contractor bonded by Great American. When the contractor refused to rehabilitate the well, the obligee utility district made demand on the performance bond of Great American. After an initial investigation, the insurer commented by letter that it appeared the problem was one of design and asked for any evidence of defective construction by its principal.

The district did not respond, but several months later it sent the surety another demand letter for payment. When the surety wrote back requesting additional information, the obligee filed suit.

At trial, based on a jury's liability findings against all the defendants, the trial court rendered judgment in favor of the district. As to Great American, the jury found that the surety had knowingly committed deceptive acts in violation of Article 21.21 of the Texas Insurance Code and had breached the common law duty of good faith and fair dealing. Based on an actual damage finding by the jury of $411,400, the court entered judgment, adding prejudgment interest and trebling that sum under a Texas statutory provision to $1,558,805. The court also awarded attorney's fees of $779,402 against Great American.

Great American appealed and the Texas Court of Appeals affirmed.(17)

The Supreme Court of Texas affirmed the holding of the Court of Appeals on the liability of the surety under the terms of the bond, but it reversed that part of the case finding the surety had breached the common law duty of good faith and fair dealing. Because the Supreme Court considered issues that were in the unpublished portions of the lower court's opinion, it ordered the entire lower court's opinion published.

In tracing the history of the duty of good faith and fair dealing in Texas, the Supreme Court observed that there must be a special relationship between the contracting parties to invoke that duty, and it has been applied to liability insurance and workers' compensation insurance. Of concern to the courts, which prompted the adoption of the duty of good faith, the court continued, was the perception of abuse by insurers in their dealing with insureds because of the unequal bargaining power between the parties.

Examining the differences between insurance and suretyship in the instant case, the court noted that the form of the performance bond had to be approved by the Texas Attorney General or the "governmental awarding authority concerned," thus eliminating any ability on the part of the surety to dictate the terms of the bond. The court also pointed out that unlike a...