Recent Significant Claims Handling Cases
Last year, there were three prominent court decisions examining sureties’ handling of claims, and it is important for claim departments to keep these developments in mind in setting and maintaining claims policies.

Payment Within 45 Days
In National Union Fire Insurance Company of Pittsburgh v Wadsworth Golf Construction Company of the Midwest, 863 A2d 347 (Md App 2004), the Maryland Court of Special Appeals (the intermediate appellate court) examined Paragraph 6 of the AIA A312 Payment Bond, which states that a Surety (after a Claimant has made a proper claim) “shall . . . send an answer to the Claimant, with a copy to the Owner, within 45 days after receipt of the claim, stating the amounts that are undisputed and the basis for challenging any amounts that are disputed.” Paragraph 6 of the Payment Bond also requires the Surety to promptly arrange for payment of any undisputed amounts.

In National Union, the surety responded to a subcontractor’s proof of claim submission with a letter stating it would ascertain the position of its principal. The surety thereafter did not respond to the claimant, despite another letter from the claimant requesting an answer. Approximately six months after the submission of the proof of claim, the subcontractor sued the surety. The surety argued that no amounts were yet due to the subcontractor based on a “pay-when-paid” clause. However, the trial court granted the subcontractor’s motion for summary disposition, holding that the surety had waived its right to dispute the claim by failing to provide a response within the required 45-day time period. On appeal, the Maryland Court of Special Appeals affirmed, finding the time limit to be “mandatory” (based on the word “shall”) and stating it could not “imagine a reason for inclusion of the 45-day provision in the bond other than that it is there to be relied upon by the claimant and adhered to by the surety.” (Atlantic Reporter pagination not yet available).

Obviously, any sureties handling claims in Maryland must ensure that responses to claims are provided within 45 days of their receipt. While there have been no prior or subsequent decisions from other jurisdictions interpreting Paragraph 6 of the A312 payment bond, we nevertheless recommend that claims in all states be handled with the above decision in mind, given the possibility that other states will follow the reasoning of National Union.

Payments Made in Bad Faith: Improper Motive Standard
In PSE Consulting, Inc v Frank Mercede and Sons, Inc, 838 A2d 135 (Conn 2004), the Connecticut Supreme Court undertook a substantial review of the case law in various jurisdictions relating to a surety’s duty of good faith in settling claims. The issue in PSE Consulting was whether the surety was entitled to indemnification from its principal after paying $700,000 to a payment bond claimant. While the 45-day requirement in Paragraph 6 of the A312 Payment Bond (discussed above) was not the central issue on appeal in this case, it played a prominent role. The surety failed to properly provide a response to the claimant within 45 days, causing the claimant to file a complaint with the state insurance commissioner, and file a lawsuit alleging, among other things, that the surety violated Connecticut’s Unfair Trade Practices Act and acted in bad faith.

After the surety settled with the claimant, a trial went forward on the surety’s cross claim for indemnification from its principal. The jury found that the surety did not conduct a proper investigation before settling with the claimant, and that the motive for the settlement was to protect itself from the complaint filed by the payment bond claimant with the insurance commissioner and from the bad faith claims in the lawsuit. Accordingly, the jury denied the surety’s claim for indemnification from its principal. On appeal, the court noted that the indemnity agreement, like other contracts in Connecticut, carried with it an implied covenant of good faith. The court surveyed the law in various states, and aligned itself with the majority that require a showing of more than negligence to constitute good faith, and that a “dishonest purpose” or “improper motive” was necessary. The court concluded that there was sufficient evidence that the surety’s investigation was unreasonable, but held that this alone could not support a bad faith finding. However, because there was also evidence that the surety settled the case to avoid the insurance commissioner’s investigation and the bad faith claims by the claimant, the court upheld the jury verdict that the surety acted in bad faith and was not entitled to indemnification.

Payments Made in Bad Faith: Reasonableness Standard
Contrary to the approach taken by the Connecticut Supreme Court in PSE Consulting, the Maryland Court of Appeals (the highest court in Maryland) adopted a “reasonableness” standard in determining whether the surety paid a claim in good faith. Atlantic Contracting & Material Co v Ulico Casualty Co, 844 A2d 460 (Md 2004). The surety paid a payment bond claimant after not receiving sufficient information from the principal concerning defenses to the claim. In the subsequent indemnity action, the trial court found that only part of the claim was covered by the payment bond, and therefore reduced the amount awarded to the surety accordingly. The intermediate appellate court reversed and granted the full amount to the surety, holding that the surety paid the claim in good faith because there was no fraud by the surety. In a subsequent appeal, Maryland’s highest court affirmed the intermediate court’s holding, but stated that the “good faith” definition used by that court was too broad, and held that “the good faith standard allows the surety a discretion limited by the bounds of reasonableness, rather than by the bounds of fraud.” Id at 309.

The court in Atlantic Contracting set forth four criteria to be used in determining whether a surety’s claim payment is “reasonable”:
(1) The obligations of the surety as provided by the terms and coverage of the bond...
(2) whether the principal has made more than generalized demands that the surety deny the claim...
(3) the cooperation, or lack thereof, by the principal, in dealing with the surety...
(4) the thoroughness of the investigation performed by the surety.” Id at 309 (citations omitted).

In looking at the facts of the case before it, the court found that the surety’s payment was reasonable, given the lack of timely information from the principal about potential defenses.

Conclusion
These decisions leave surety claims handlers in a difficult position. On the one hand, a surety must act with expediency to ensure that a determination is made within 45 days as to whether any or all of a claim is disputed. On the other hand, a surety must ensure that any claims decisions will not later be perceived to have been made in “bad faith”. Given the very different results that may be obtained, depending on each state’s definition of “good faith” (and whether a state uses a good faith standard at all), it is important for a surety claim handler to be aware of the rule in the particular state from which a claim arises.

While obviously every surety claims handler strives for all payment decisions to be objectively “reasonable”, extra care is required in those minority of states that hold that a surety is not entitled to indemnification from its principal for payments that were not reasonably made. Pursuant to the decision in Atlantic Contracting, it is important to put the principal on notice of the claim and vigilantly seek the principal’s defenses to the claim. Even if the claim payment turns out to have been inappropriate (as the court concluded in Atlantic Contracting), the payment may still be deemed “reasonable” if the surety did not get adequate or timely information from the principal. In any event, a claims handler must keep in mind that a judge or jury may later scrutinize all communications with the claimant and with the principal, along with all steps taken to investigate the claim; and great care must be taken that all decisions are made in a reasonable and timely manner.

A New York appeals court has held that a surety’s failure to respond in 45 days did not prevent it from asserting the contractual limitations period. D. J. Rossetti, Inc. v. Joseph Fancese, Inc., 273 AD2d 781 (NY App 2000).

While this firm has not conducted a comprehensive survey of the law of each state, the jurisdictions cited by the courts in Atlantic Contracting and PSE Consulting as using a “reasonableness” or “negligence” standard are: Illinois, California, Hawaii, Kansas, Oregon, Kentucky, New York, and now, Maryland.