On June 11, 2014, the U.S. Court of Appeals for the Third Circuit issued a decision addressing the ugly situation when a contractor and its surety find themselves at odds, and the contractor seeks to avoid the consequences of having executed a typical general agreement of indemnity (“GAI”) by suing the surety in tort.
The typical GAI not only requires the principal/contractor to indemnify the surety, but also provides a relatively broad panoply of other rights to the surety to allow it to protect its interests. Although the principal’s and the surety’s respective interests are often aligned, when these parties become adverse, the surety’s exercise of its rights under the GAI can lead to disputes and litigation. In this situation, the GAI, like any other contract, determines the parties’ respective contractual rights. Given the strength and leverage of the surety’s position through the terms of a typical GAI, the principal may find itself surprisingly unable to operate independently or to exercise its own judgment about how to handle bond claims and to complete bonded projects. After reviewing the GAI – which is a contract – the principal may look outside the contract to the body of tort law in an effort to exercise extraneous rights to avoid the limitations of a breach of contract claim founded on the GAI.
In Reginella Construction Co., Ltd. v. Travelers Casualty & Surety Co. of America, the Pennsylvania-based contractor employed just such a tactic. The contractor/plaintiff alleged that it had been in business for more than 25 years, and had successfully performed millions of dollars of work on public construction projects. In 2010 and 2011, the contractor had several bonded contracts, and it had previously executed a GAI with the defendant/surety.
In the Fall of 2011, the contractor began encountering a variety of challenges that spiraled out of control rapidly. On one bonded project, it terminated a subcontractor, and the subcontractor filed a mechanics’ lien. As a result, the public owner withheld payment in the amount of the lien, and the contractor attempted to bond off the lien. The surety refused to provide such a bond, and ultimately the owner terminated the contractor on May 22, 2012.
In the meantime, on April 26, 2012, the surety wrote to the owner of one of the other bonded projects and demanded that payments that were otherwise due to the contractor be directed to the surety. The surety exercised this right under the GAI because it believed that the contractor was in default to a number of its subcontractors who had asserted payment bond claims on the project. The contractor alleged that the surety told the subcontractors that the contractor was going to be terminated, causing its subcontractors to slow down and assert additional and inflated claims. When the owner refused to make further payment, the contractor elected to terminate its performance on this project on June 11, 2012.
Blaming its suddenly deteriorating financial situation on the surety, the contractor promptly filed a complaint against its surety in the U.S. District Court for the Western District of Pennsylvania. More specifically, the contractor asserted a variety of tort claims, including intentional interference with contract, breach of fiduciary duty, and bad faith. Conspicuous by its absence, however, was any claim for breach of contract, or even a reference to the existence of the GAI.
The surety moved to dismiss, and the District Court found that there was no fiduciary relationship between the surety and the principal, such that the breach of fiduciary duty claim failed as a matter of law. The District Court addressed the fundamental nature of suretyship, and expressed skepticism “that a surety could ever assume a fiduciary-in-fact position towards its principal, a sophisticated commercial entity who is aware at the outset that the surety is contractually vested with the right to take steps against its (the principal’s) interests if certain contingencies occur.”
In that regard, because the Pennsylvania Supreme Court had never explicitly decided whether the surety/contractor relationship could give rise to a fiduciary relationship, the District Court had to predict how the Pennsylvania Supreme Court would rule on the issue. Noting that the surety/contractor relationship is “riddled with conflicting interests and split loyalties,” it predicted that the state Supreme Court would hold, as a matter of law, that a surety does not owe a fiduciary duty to a principal.
Although not raised by the surety’s counsel in defense, the District Court applied Pennsylvania’s gist-of-the-action doctrine in analyzing the other tort claims. The doctrine is not necessarily unique to Pennsylvania, but is based on maintaining the fundamental distinction between contract claims (where the duties allegedly breached arise out of a contract) and tort claims (where the duties allegedly breached arise out of social policy or a general duty of care). Thus, if the true “gist of the action” arises out of a contractual relationship, the doctrine will bar tort claims unless they are unrelated to the contract.
In this case, the District Court dismissed all of the other tort claims because they arose out of the contractual relationship created by the GAI, and were simply breach of contract claims re-cast as tort claims. While the contractor argued that it had pleaded facts about the surety’s conduct that would justify its tort claims for bad faith and intentional interference (“entirely without justification,” “arbitrary,” “unreason-able,” “capricious,” “vexatious,” “self-serving,” “wrongful,” “improper,” “wanton,” “outrageous,” “shocking to the conscience,” and even “overmastering”), the District Court was obviously unimpressed and concluded that these were not facts, but simply “adjective-laden editorial embellishments that the Court was obligated to cast aside.”
The contractor sought leave to amend to somehow further amplify its pleading, but the District Court found that amendment would be futile and reward delay, such that leave was denied. The contractor appealed even though it was already pursuing breach of contract counterclaims in a prior state court proceeding in which the surety was the named plaintiff.
On appeal, the Third Circuit affirmed in all respects. First, the appellate court noted that the contractor had not appealed the District Court’s prediction that the Pennsylvania Supreme Court would find no fiduciary duty arising out of the contractor/surety relationship, so the contractor could not state a valid claim for breach of fiduciary duty. Next, the Third Circuit found that the gist-of-the-action doctrine was properly applied to bar the other tort claims because they were all dependent upon the terms of the GAI. Finally, the appellate court agreed that it was within the District Court’s discretion to deny leave to amend, because granting leave would only cause delay and encourage “wait-and-see” tactics.
Notably, the Reginella case is described as “not precedential,” but since Federal Rule of Appellate Procedure 32.1 (prohibiting Federal Circuit Courts from restricting citation to any type of opinion issued after January 1, 2007) was adopted in late 2006, the case may be cited and provides valuable insight into the Third Circuit’s view of both the typical GAI and the nature of the surety/principal relationship. The practical take-away from the case will be different depending on one’s role in that relationship, but it does reflect a relatively clear respect for the rights and obligations negotiated, documented and agreed to in the typical GAI.