When a bond claimant files suit against a contractor and its surety, the surety's primary concern is that its interests are properly represented in court throughout the course of the litigation. Because the surety's liability may be coextensive with that of its principal, the surety must decide at the outset whether to retain counsel to represent the surety and the principal, allow the principal to represent itself or tender the surety's defense to the principal.
If the surety decides at the preliminary stages of the litigation not to undertake the defense of its principal, the surety trusts the principal to retain counsel and commit fully to what may be a lengthy, contentious and costly litigation. This commitment involves not only obtaining representation and appearing in the action, but also a continued level of participation in discovery, during motions practice and at trial. But, what happens if the principal lacks the necessary resources, diligence or expertise to present an effective defense and, as a result, the plaintiff seeks a default judgment against the principal for its failure to participate in the lawsuit? If the surety is already a party to the litigation, should it jump in and rescue its principal from this ominous fate? If a default judgment is entered against its principal, what are the potential implications on the surety?
As reflected in a handful of recent decisions, if a surety does not intervene and "save the day" by challenging an impending default judgment against its principal, the surety could face serious consequences.
American Safety Cas. Ins. Co. v. C.G. Mitchell Constr., Inc.
In 2004, the Virginia Supreme Court in American Safety Cas. Ins. Co. v. C.G. Mitchell Constr., Inc., held a payment bond surety liable for a default judgment entered against its bonded subcontractor for discovery violations. In Mitchell, a sub-subcontractor brought suit against a subcontractor and its surety for work performed on a demolition project. After the subcontractor repeatedly failed to provide a corporate designee for deposition, the trial court entered a default judgment against the subcontractor as a discovery sanction. The plaintiff then moved for summary judgment against the surety, based on the default judgment against the principal. The trial court granted the plaintiff's motion, concluding that the default judgment was binding on the surety. On appeal, the Virginia Supreme Court affirmed the trial court's ruling and held that pursuant to the terms of the indemnity agreement, the subcontractor/principal appointed the surety as its attorney-in-fact with the power to exercise its rights related to such claims. Based on the specific language in that agreement and the fact that the surety had notice and an opportunity to intervene and defend against the default, the court held that the default judgment against the subcontractor/principal was binding on the surety.
At the time Mitchell was decided, surety law analysts were stunned that the court could impose such a harsh result on the surety for its principal's discovery violations. This case was viewed as contrary to the rule recognized in many jurisdictions that a default judgment is not conclusive against the surety under these circumstances. Since Mitchell was decided, however, the Virginia Supreme Court's decision has been cited by a number of other courts. The facts in the Mitchell case are not uncommon in claims litigation and, as a few recent cases make clear, a surety must be vigilant during litigation because a default judgment entered against its principal can have negative consequences on the surety.
The Influence of Mitchell in Other Jurisdictions
Recently, the Kentucky Court of Appeals held in United Fire & Casualty Co. v. Eldridge that a surety was liable on a payment bond following the entry of a default judgment against its principal. In Eldridge, a subcontractor sued both the general contractor and its surety for amounts owed for work performed on a municipal water project. The general contractor failed to answer the subcontractor's complaint, and the court entered a default judgment against the general contractor. While the surety answered the complaint on its own behalf, it failed to raise an objection to challenge its principal's liability or default, despite ample notice of the default hearing and an opportunity to intervene on its principal's behalf. As a result, the court held that the surety was bound by the default judgment against its principal and, like Mitchell, affirmed summary judgment against the surety.
Similarly, the New Mexico Court of Appeals recently decided the same issue as a matter of first impression in McAlpine v. Zangara Dodge, Inc. In McAlpine, the claimant sued both the principal and its surety. The principal's attorney ultimately withdrew from the case and the principal failed to obtain new counsel and participate in discovery. As a result, the court entered a default judgment against the principal. The court subsequently ruled that the surety was bound by the default judgment, in part because it had sufficient notice of the default hearing but failed to challenge the default. In its analysis, the court cited Mitchell and held that because the principal was in default, all of its defenses were deemed to be denied. Therefore, the surety could not avail itself to those defenses because liability had already been established with the entry of a default judgment against its principal. Moreover, the court reviewed language in the indemnity agreement between the surety and the principal to conclude that the language was sufficient to allow the surety to intercede on behalf of its principal at the default hearing. Accordingly, the court held that by failing to challenge its principal's default, the surety allowed its principal's liability, and thus its own liability, to be established.
The recent Eldridge and McAlpine cases highlight the potential risk to a surety when both the surety and its principal are sued together and the principal does not actively participate in the litigation. While the impact of these decisions are limited to the specific facts before the courts, they can still be instructive and provide guidance to a surety that finds itself in a similar situation. Indeed, the holdings of these cases warrant a heightened level of involvement by both the surety and its principal when they are sued together, and sureties should be aware of the fact that they may be penalized by their principal's lack of diligence in defending the action. This is especially important when the surety does not have any independent defenses and the only issue being litigated is whether the principal is liable to the claimant. Nothing in these decisions suggests, however, a surety should not be permitted to defend on any ground personal to it that was not an issue in the litigation against its principal.
It should also be noted that a number of jurisdictions have not adopted the Mitchell rule. In California, for example, courts have consistently held that a default judgment against a principal is not to be considered conclusive against its surety. Likewise, New York courts recognize that a default judgment entered against a principal is not binding upon a surety, but creates only a rebuttal presumption of the surety's liability. In these jurisdictions, while a principal's default judgment may not be conclusive as to the surety, it may nevertheless be used by the claimant to aid in establishing the surety's liability.
Sureties must be vigilant in defending claims brought against both the surety and its principal, particularly when the principal may not be attentive to the demands of discovery and other issues that arise during the course of litigation. To avoid harsh consequences that may result from a default judgment against its principal, the surety must monitor the progress of the litigation and should consider stepping in and defending its principal if default judgment is threatened. In this same vein, the surety would be wise to be proactive in evaluating, at the preliminary stages of litigation, whether its principal has the necessary resources to properly and effectively defend the case. As the above cases illustrate, the principal's act of simply retaining counsel and making an initial appearance in the case provides no guarantee that the principal will continue to vigorously defend the claim.
The information or opinion provided in this article is the author's own and not necessarily that of Watt, Tieder, Hoffar & Fitzgerald, LLP. The author is solely responsible for the information and opinion that he or she has provided. The information contained herein does not replace seeking specific legal counsel to directly address individual client needs.
Construction Business Owner, July 2009