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District Court Rejects Breach of Fiduciary Duty and Tort Claims Alleged Against a Surety

Construction and Surety Alert | June 6, 2013
By: William J. Taylor

In a diversity action brought in the United States District Court for the Western District of Pennsylvania, the district court recently granted a surety’s motion to dismiss with prejudice the claims brought against it by the surety’s principal for breach of fiduciary duty, intentional interference with contractual relations, and bad faith.  Applying Pennsylvania law, the court in Reginella Construction Company, Ltd. v. Travelers Casualty and Surety Company of America, 2013 WL 2404140 (W.D.Pa. May 31, 2013), predicted that the Pennsylvania Supreme Court would not impose fiduciary duties upon a surety, and that no fiduciary relationship arose between the surety and its principal.  Further, finding that the parties’ relationship was governed by their indemnity agreement and the language of the bonds themselves, the court held that the principal’s intentional interference and bad faith tort claims were barred by Pennsylvania’s “gist of the action” doctrine, which prohibits a plaintiff from bringing a cause of action in tort when the action arises from a matter that is governed by a contract between the parties.

In Reginella Construction the surety, Travelers, issued performance and payment bonds on behalf of its principal, Reginella, for two school district projects in Pennsylvania and a turnpike project in Ohio.  Prior to the issuance of these bonds Reginella had executed a General Agreement of Indemnity in favor of Travelers.  On the school district projects, Travelers, two years into the construction, sent a letter to the school district demanding payment on the project for “the entire amount of the contract funds remaining in the custody of [the school district], including any and all estimates earned by [Reginella] but unpaid at this time.”[1]  The school district thereafter withheld all payments owed to Reginella, and Travelers and the school district rejected Reginella’s payment proposals that were designed to assure that its subcontractors would be paid.  According to Reginella, this halt in project payments resulted in the project being shutdown a month later.  Reginella further alleged that Travelers also caused the project shutdown by meeting privately with its subcontractors and informing them that the school district was going to terminate the project.  Reginella asserted that these meetings induced the subcontractors to slow down, stop working, and submit inflated and premature claims against Reginella.   

On the Ohio turnpike project Reginella alleged that Travelers refused to issue a lien bond in its favor after one of its subcontractors filed a $533,226 mechanic’s lien on the project.  As a result of this lien, the project owner refused to pay Reginella until it could bond off the lien, and this lack of payment resulted in Reginella not being able to pay amounts it owed to other subcontractors, suppliers and laborers.  Despite Reginella’s offer to divert all payments from the project to Travelers if it would issue the requested lien bonds, Travelers continued to refuse to do so.  Negotiations between Reginella, Travelers, and the project owner stalled until the owner finally terminated its contract with Reginella.

Faced with contract terminations from two owners, Reginella filed suit against Travelers.  In regard to the school district project, Reginella alleged that Travelers breached its fiduciary duty to Reginella as its surety, that Travelers intentionally interfered with Reginella's business relationships with the school district and with its subcontractors, and that Travelers acted in bad faith in refusing to pay Reginella's subcontractors as required under the terms of the bond agreements on the project.  In regard to the turnpike project, Reginella  alleged that Travelers again breached its fiduciary duty as Reginella's surety and that it acted in bad faith in refusing to issue the lien bonds as allegedly required by the contract bond.  Travelers asserted that as a matter of law under both Pennsylvania and Ohio law it had no fiduciary duty to Reginella, that its alleged interference with the school district and Reginella's subcontractors was privileged, and that neither Pennsylvania nor Ohio law[2] recognized a tort-based bad faith claim by a principal against a surety.  Travelers moved for dismissal of all claims pursuant to Rule 26(b)(6), Federal Rules of Civil Procedure.  The court granted Travelers’ motion and dismissed all of Reginella’s claims with prejudice.

The Principal’s Breach of Fiduciary Duty Claim

The court, sitting in diversity, applied state law to Reginella’s claims.  Finding that the Pennsylvania Supreme Court has never ruled on the issue, the court was obligated to predict how the Supreme Court would rule, based on analogous precedent and other reliable indicators.  Based upon its analysis the court predicted that, “as a matter of law, the Pennsylvania Supreme Court would not impose fiduciary duties on a surety.”  The court further held that the facts alleged in the Complaint, even when accepted as true and construed in the light most favorable to Reginella, failed to show that a fiduciary relationship arose between the parties during their course of dealing.

The court distinguished the surety/principal relationship from that of an insurer and an insured (in which the insurer does owe a fiduciary duty to its insured).  Quoting precedent from the Pennsylvania Commonwealth Court, the court concluded that “surety bonds are in the nature of commercial guarantee instruments rather than policies of insurance” and that “suretyship is not insurance.”  The court held as follows:

The underlying economics of suretyship also weigh against transmuting a surety into a fiduciary.  First, a surety bond is a financial credit product, not an insurance contract; second, the surety has a contractual relationship with two parties that often have conflicting interests, namely the owner of the project and the principal, which causes the surety to balance these interests when responding to claims; third, the parties to a surety contract are typically commercially sophisticated, have relatively equal bargaining power and ample access to legal and technical advice; fourth, the pricing of the premium by the surety is not based upon the risk of fortuitous loss (as is the case in insurance contracts), but rather on the assumption that the principal will reimburse the surety in the event of the principal's default and surety's corresponding loss; fifth, the principal purchases the bond from the surety not for its own benefit, but for the benefit of its customer, the project owner; and sixth, the principal must usually agree to indemnify the surety if claims are filed, which is the reverse of an insurance contract, where the insurer agrees to indemnify the principal who owns the policy.

Id. at *10 (citations omitted).  The court concluded that surety bond agreements “are standard commercial contracts” and that the contracts sureties enter into with their customers are “ordinary arm’s-length commercial guarantees.” 

Further, the court held that while a fiduciary relationship may also exist between two parties to a contract based on the nature of their relationship, such an obligation arises only when there is “overmastering influence on one side or weakness, dependence, or trust, justifiably reposed on the other side,” such that the parties' relationship “is marked by such a disparity in position that the inferior party places complete trust in the superior party ... so as to give rise to a potential abuse of power.”  Id. at *11 (citations omitted).  The court found that no such relationship existed between Reginella, as principal, and Travelers, as surety, in that Reginella had 25 years of public construction experience, with both equal bargaining power and access to sophisticated legal and financial advice.  Thus, since neither the status of the principal/surety relationship or actual relationship between Reginella and Travelers gave rise to any type of fiduciary duty on the part of Travelers, the court found that as a matter of law Reginella had no claim for breach of fiduciary duty against its surety.

The Principal’s Intentional Interference and Tort Bad Faith Claims

In these claims Reginella alleged that Travelers tortiously interfered with its school district and turnpike-related business relationships and that Travelers acted in bad faith by obstructing Reginella's completion of both projects.  The court refused to consider these claims as tort claims because it held that the gist of the action doctrine barred them as a matter of law.  The court held that the gist of the action doctrine will bar tort claims “(1) arising solely from a contract between the parties; (2) where the duties allegedly breached were created and grounded in the contract itself; (3) where the liability stems from a contract; or (4) where the tort claim essentially duplicates a breach of contract claim or the success of which is wholly dependent on the terms of a contract.”  Id. at *13 (citations omitted).  Further, it found that:

It is clear from the language of the indemnity and bond agreements that Travelers's allegedly tortious actions were taken in pursuit of perceived rights and duties that those agreements set forth.  With respect to the [school district] project, the agreements expressly permit Travelers to take possession of the work, collect payment from the [school district], and arrange for the work's completion in the event of Reginella's default.  Regarding the [turnpike] project, the contract bond is silent as to Travelers's obligation to issue additional bonds subsequent to the contract bond's execution. Apart from the fiduciary duty claims, what the parties appear to be disputing is whether Reginella defaulted on the [school district] project and whether the contract bond for the [turnpike] project required Travelers to issue lien-over bonds.  The only way to answer these questions is to refer to those agreements and the parties' larger course of dealing, the quintessential mode of analysis for a breach of contract claim.  

Id. at *14.  The court found that Reginella’s purported tort claims were “in fact re-engineered breach of contract claims,” and that “Pennsylvania law is clear that it is no tort to breach a contract, no matter how much bad faith is alleged.”  Accordingly, the principal’s claim for intentional interference with contractual relations and for the tort of bad faith were barred by the gist of the action doctrine and dismissed with prejudice by the court.

The district court’s well-reasoned opinion highlights the contractual nature of the surety/principal relationship and appropriately chastises the plaintiff for attempting to “re-engineer” breach of contract claims into tort claims.  While principals and indemnitors often complain about the harsh terms of the indemnity agreements that they sign to induce the surety to issue bonds on their behalf, court after court has held that such agreements are enforceable and govern the rights and obligations between the surety and the principal/indemnitor.

For additional information, please contact William Taylor (taylorw@whiteandwilliams.com | 215.864.6305) or another member of the Construction and Surety Group.


[1] The court opinion never explained why Travelers made this demand, but noted that Travelers had the right to do so under the indemnity agreement if there was a default by Reginella.

[2] The court found that there was no actual conflict between the laws of Pennsylvania and Ohio in regard to these claims, and therefore referred to each forums’ laws interchangeably.

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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