Section 4.3.5 Comparison of Suretyship and Insurance

• Library: Construction Law Practice Manual 3rd Edition 2016

§ 4.3.5 Comparison of Suretyship and Insurance

Contracts of suretyship should not be considered contracts of insurance. One obvious difference between a surety bond and an insurance policy is the length. Most insurance policies are pages and pages of definitions, exclusions, and exceptions. Many insurance policies are on the insurance companies’ standard forms, offered to most insureds on a take it or leave it basis. The courts refer to these types of insurance policies as contracts of adhesion.¹⁴⁶

On the other hand, many surety bonds are one page documents on a form dictated by statute. Even when the bond form is not spelled out by statute, sureties will often issue bonds on the bond form required by the obligee. For example, the project’s owner or architect may describe what form of performance and payment bond the prime contractor is required to obtain. This form may be the form created by the American Institute of Architects (the “AIA”), or some other form used by the owner or construction lender.

Another important difference between a surety and an insurance company is, if there is a loss covered by an insurance policy, the insurance company pays the claim and does not seek to recover its loss from the entity that paid the premium. For example, if a contractor damages property near a construction site, the contractor will expect its liability insurer to pay the damages. This is because a contract of insurance is a contract under which the insurer undertakes to indemnify an insured against loss, damage, or liability arising from an unknown or contingent event.¹⁴⁷

By definition, suretyship is not insurance.¹⁴⁸ When a surety receives a claim covered by its bond, the surety can insist the entity that purchased the surety bond (the “principal”) pay the claim directly, or repay the surety if the surety pays the claim. The surety may also insist under the provisions of A.R.S. § 12-1641 that the claimant bring an action against the principal on the bond, and pursue the action to judgment and collection, before the surety is required to pay under the bond.

One additional difference between insurance and suretyship is that a contract of suretyship creates a three-party or tripartite relationship. The parties are: (1) the obligee, who is the party protected, (2) the principal obligor (the contractor), and (3) the surety, who promises the obligee to answer for the debt, default, or miscarriage of the principal.¹⁴⁹

Although there are clear differences between surety contracts and insurance contracts, Arizona courts and the Arizona Legislature consider suretyship as a kind of insurance for certain purposes. Originally, the only sureties were individuals who assumed the surety obligation gratuitously. Gratuitous sureties were and still are favorites of the law, and a change to the underlying obligation may give an absolute discharge to the surety’s obligation.¹⁵⁰

Today, corporate sureties are often affiliated with insurance companies and charge premiums for issuing surety bonds. This evolution of suretyship has prompted Arizona courts to treat contracts of suretyship as a type of insurance contract, and by analogy apply the rules governing liability applicable to insurance policies.¹⁵¹

In Dodge v. Fidelity and Deposit Co. of Maryland,¹⁵² the court recognized the Arizona Legislature included suretyship within the regulatory powers of the Department of Insurance. As a result, the court held a performance bond surety could be treated the same as an insurance company. This treatment includes possible exposure to liability for the tort of “bad faith” under the rules applicable to insurance companies who breach the duty of good faith and fair dealing implied in every contract. Although a subsequent California Supreme Court decision has held that suretyship is different from insurance, and the tort of bad faith does not apply, sureties doing business in Arizona must be aware of the Dodge decision.¹⁵³

That said, not every insurance contract with an insured or every surety relationship with an obligee or claimant gives rise to tort bad faith liability.¹⁵⁴ A bad faith tort claim requires proof of the following three elements: (1) a breach of contract or a breach the covenant of good faith and fair dealing implied in every contract, (2) a special relationship between the parties sufficient to give rise to tort damages, and (3) separate tort damages.¹⁵⁵ A “special relationship” is “characterized by elements of public interest, adhesion, and fiduciary responsibility.”¹⁵⁶ These elements may not always exist in a claim against a surety. For example, many payment and performance bonds are statutory bonds and claims under such bonds do not arise out of contract.¹⁵⁷ The lack of a contractual relationship may be a critical defect in a claim for tort bad faith damages.¹⁵⁸

Alliance TruTrus, L.L.C. v. Carlson Real Estate Co., 229 Ariz. 84, 270 P.3d 911 (Ct. App. 2012) 4.3-12

Alta Vista Plaza, Ltd. v. Insulation Specialists Co., 186 Ariz. 81, 919 P.2d 176 (Ct. App. 1995) 4.3-20, 25

Am. Cas. Co. of Reading, PA v. D.L. Withers Constr., L.C., 204 Ariz. 382, 64 P.3d 210 (Ct. App. 2003)...................................................................................................................................................................... 4.3-21

Arizona Gunite Builders, Inc. v. Cont’l Cas. Co., 105 Ariz. 99, 459 P.2d 724 (1960)....... 4.3-6, 23

Arizona Laborers, Health & Welfare Trust Fund v. New Pueblo Constructors, Inc., 131 Ariz. 278, 640 P.2d. 209 (Ct. App. 1982)................................................................................................................................ 4.3-23

B.J. Cecil Trucking, Inc. v. Tiffany Constr. Co., 123 Ariz. 31, 597 P.2d 184 (Ct. App.)1979 4.3-7, 22

Barrett-Hicks Co. v. Glas, 14 Cal. App. 289, 111 P. 760 (1910)................................................... 4.3-19

Bd. of Educ. v. Sever-Williams Co., 258 N.E.2d 605 (Ohio 1970)............................................. 4.3-14

Beaudry v. Ins. Co. of the West, 203 Ariz. 86, 50 P.3d 836 (Ct. App. 2002)........................... 4.3-33

Best Paving, Inc. v. Decker Constr. Co., 165 Ariz. 372, 798 P.2d 1381 (Ct. App. 1990)....... 4.3-6

Bolivar Reorganized Sch. Dist. No. 1 v. Am. Sur. Co., 307 S.W.2d 405 (Mo. 1957)............ 4.3-14

Brown v. United States, 152 F. 964 (2d Cir. 1907)........................................................................... 4.3-14

Brown Wholesale Elec. Co. v. Beztak of Scottsdale, Inc., 163 Ariz. 340, 788 P.2d 73 (1990) 4.3-26

Brown Wholesale Elec. Co. v. H.S. Lastar Co., 152 Ariz. 90, 730 P.2d 267 (Ct. App. 1986) 4.3-9

Caron v. Andrew, 133 Cal. App. 2d 402, 284 P.2d 544 (1955).................................................... 4.3-16

Cates Constr., Inc. v. Talbot Partners, 21 Cal. 4th 28, 86 Cal. Rptr. 2d 855, 980 P.2d 407 (1999) 4.3-33

Cemex Constr. Materials South, LLC v. Falcone Bros. & Assocs., Inc., 237 Ariz. 236, 349 P.3d 210 (Ct. App. 2015)................................................................................................................................................. 4.3-31

Chrysler Corp. v. Hanover Ins. Co., 350 F.2d 652 (7th Cir. 1965)............................................. 4.3-17

City of Independence ex rel. Briggs v. Kerr Const. Paving Co., 975 S.W.2d 315 (Mo. Ct. App. 1997)...................................................................................................................................................................... 4.3-25

City of Lake Geneva v. States Improvement Co., 172 N.W.2d 176 (Wis. 1969)................... 4.3-14

Commercial Standard Ins. Co. v. West, 74 Ariz. 359, 249 P.2d 830 (1952)............................. 4.3-17

Cont’l Cas. Co. v. Clarence L. Boyd Co., 140 F.2d 115 (10th Cir. 1944)................................. 4.3-23

Cont’l Cas. Co. v. Grabe Brick Co. 1 Ariz. App. 214, 401 P.2d 168 (1965)............................... 4.3-8

Cont’l Cas. Co. v. U.S. for Use of Robertson Lumber Co., 305 F.2d 794 (8th Cir. 1962) 4.3-28

Cont’l Cas. Co. v. United States, 308 F.2d 846 (5th Cir. 1962).................................................... 4.3-22

Cushman v. Nat’l Surety Corp., 4 Ariz. App. 24, 417 P.2d 537 (1966)................................. 4.3-4, 17

Darner Motor Sales, Inc. v. Universal Underwriters Ins. Co., 140 Ariz. 383, 682 P.2d 388 (1984) 4.3-32

Decca Design Build, Inc. v. Am. Auto. Ins. Co., 206 Ariz. 301, 77 P.3d 1251...