Good Faith, Suretyship, and the Ius Commune - Troy L. Harris

• Jurisdiction: United States,Federal
• Publication year: 2002
• Citation: Vol. 53 No. 2

Good Faith, Suretyship, and the Ius Commune

Troy L. Harris^*

I. Introduction

Why should a twenty-first century American lawyer care what early modern scholars of the Roman law wrote? What could Bartolus de Saxoferrato (d. 1357), Johannes Andreae (d. 1348), or Baldus de Ubaldis (d. 1400) have to say that would be of interest to us today? One answer is that of the legal historians: to understand why the law is the way it is today one needs to understand how it developed. This Article argues for a different answer, namely, that those Roman law scholars worked out answers to important problems that American courts and commentators are only beginning to consider. Considered in this light, the works of the Roman legal scholars have the same value as learned commentary generally. As Richard Epstein has recently observed, "We can learn from ancient text about problems that we face today and can bring to them a greater appreciation of their intellectual subtlety."¹

The specific questions that this Article considers come from the realm of commercial law: Is there a reciprocal duty of good faith between a surety or guarantor and the principal obligor,² independent of any explicit contractual provision to that effect?³ If so, what is the relation- ship between that duty and the surety's indemnification rights against the principal obligor? To focus the question further, suppose the surety chooses to perform the secondary obligation over the principal obligor's objection and despite knowing that it has a significant, valid defense to the secondary obligation. Such a defense might be, for example, active interference by the obligee that rendered the principal's performance impossible. A surety might choose to perform despite such a defense to protect an ongoing business relationship with the obligee, at the expense of the principal obligor. Assuming that the surety's decision, so far as the principal obligor is concerned, is in the utmost bad faith, can the surety still seek indemnity from the principal? Conversely, suppose that the surety performs over the principal's objection and despite the existence of a somewhat technical defense, for example, unenforceability of the secondary obligation through the passage of time. Does the principal obligor have a good faith duty to indemnify the surety?

Part I of this Article surveys the contexts in which these suretyship issues arise in modern commercial law. Part II shows that American courts are split on the questions of the existence and extent of any duty of good faith on the part of the surety, and the effect of that duty on a surety's indemnification rights. Part III describes the overall approach to those questions offered by the recent Restatement (Third) of Suretyship and Guaranty.⁴ While the Restatement implicitly recognizes a duty of good faith performance of the surety contract, it makes no attempt to explain how that duty relates to a surety's extensive indemnification rights when the surety performs over a defense available to it. Moreover, the rules articulated in the Restatement for this situation—where it attempts to articulate rules at all—are unsatisfactory, conceptually and practically. Part IV of this Article demonstrates that, unlike the Restatement, the early modern Roman lawyers considered in some detail the relationship between the duty of good faith and the surety's indemnification rights. These lawyers, working within the ius commune (i.e. the European legal system influenced by the Roman law), concluded that the duty of good faith required a surety to conduct at least a minimal investigation into the defenses against the creditor potentially available to the surety and to assert those that were not frivolous. Although the surety could perform despite the availability of technical defenses (apices iuris) without impairing its indemnification rights, the duty of good faith severely circumscribed the surety's ability to do so. Indeed, the surety's rights under the Roman law were much more limited than under the Restatement.

II. Suretyship in Modern Commercial Law

In the most general terms, suretyship involves three parties: the principal obligor, the creditor to which the principal obligor owes some contractual duty, and the surety which promises the creditor it will perform the underlying duty in the event the principal does not.⁵ As others have noted,⁶ the law of suretyship affects modern commercial transactions in a variety of ways,⁷ and drawing the line between relationships that implicate suretyship principles and those that do not can be difficult and controversial.⁸ Perhaps the most familiar context involves accommodation parties on negotiable instruments under Article 3 of the Uniform Commercial Code ("U.C.C."). Because an accommodation party agrees to answer for the debt of another, it is entitled to assert various defenses traditionally available to sureties.⁹ By virtue of their inclusion in Article 3, these defenses have enjoyed substantial scholarly attention.¹⁰ What has received less attention, however, is the relationship between an accommodation party's defenses, its right of reimbursement,¹¹ and the duty of good faith.¹²

Suretyship issues also arise in contexts outside the scope of the U.C.C.¹³ The U.C.C.'s suretyship principles generally apply only when the accommodation party has signed the underlying instrument.¹⁴ Thus, where there is a separate guaranty, either of a loan or of the performance of some other contractual obligation, the common law applies.¹⁵ This arena includes contract bond sureties whose businesses generate some $3 billion in premiums annually.¹⁶ While $3 billion in premiums is small by comparison with the nearly $125 billion of property and casualty insurance premiums generated by automobile coverage, it is still a significant figure.¹⁷

Perhaps the most fertile ground for litigation over the relationship between the duty of good faith and the surety's right to indemnification is the modern commercial construction project. This is not surprising because, as Professor Stipanowich has recently pointed out, the construction industry is "[t]he largest production sector in the United States economy."¹⁸ The contract for construction between the owner and the general contractor frequently requires the contractor to furnish a performance bond guaranteeing that if the contractor should default in its performance of the contract, the issuer of the bond (the surety) will see to the completion of the contract.¹⁹ At common law, the surety had an implied right to indemnity when it performed the secondary obligation.²⁰ Not surprisingly, surety lawyers have been unwilling to rely upon the common law alone to define the surety's indemnification rights. Thus, it is standard practice for surety companies to require contractors, for whom they write bonds, to execute indemnity agreements. Under these agreements the principal not only agrees to indemnify the surety against any loss it may incur as a result of writing bonds on the principal's behalf, but the individual backers of the principal (e.g., the principal's chief executive officer) agree to become personally liable to indemnify the surety.²¹

Sometimes, but not always, the indemnity agreement itself obligates the surety to exercise good faith in the payment or settlement of claims by the owner. This, of course, raises two important questions. First, what if the indemnity agreement does not itself require the surety to act in good faith: is there a common law duty to do so? Second, if there is such a duty imposed either by the indemnity agreement or by operation of law, what does it require? Exploring courts' answers to these questions is the task of the next section.

III. Sureties, Good Faith, and the American Courts

American courts are split on the question of whether a surety owes its principal a common law duty of good faith.²² Those jurisdictions that do recognize such a duty disagree about what that duty requires. A useful starting point for exploring these questions is the recent decision of the Texas Supreme Court in Associated Indemnity Corp. v. CAT Contracting, Inc.²³ In denying the existence of any such duty, the court first noted its earlier ruling in Great American Insurance Co. v. North Austin Municipal Utility District Number I²⁴ rejecting the analogy between surety bonds and insurance.²⁵ In Great American, the court held that a surety had no common law duty of good faith to the obligee because not every contractual relationship gives rise to a duty of good faith.²⁶ To the contrary, in CAT Contracting the court said such a duty exists "only for certain special relationships, such as that between an insurer and its insured."²⁷ The court held that no such special relationship existed between a surety and its principal.²⁸

As the court observed in CAT Contracting²⁹ courts that have recognized a duty of good faith in the suretyship context have typically done so on one of the two bases the court specifically rejected: either because they recognize the existence of such a duty in all contracts³⁰ or because they recognize the existence of such a duty in the insurance context to which they analogize surety contracts.³¹ The court might also have pointed out that there is a substantial number of cases in which courts have explicitly or by necessary implication recognized such a duty without articulating any clear theoretical basis for doing so.³² Whatever the underlying rationale (if any), it appears that the majority of states recognize a duty of good faith.³³

Though the weight of authority seems to be on the side of recognizing a duty of good faith, there is no consensus about what that duty requires. The question frequently arises when the surety chooses to perform the secondary obligation at the obligee's request and over the principal's protest that the surety has some defense to the obligee's claim and then seeks indemnification from the protesting principal.³⁴ Some...