Michael Baker | Snell & Wilmer
A couple of years ago, a California court rendered an opinion that a surety is liable for attorney’s fees and costs even if the amount exceeds the penal sum of the bond. (Karton v. Ari Design & Constr., Inc.). This was further confirmed in another opinion last year (Chavez Gen Constr, Inc. v. Moexinia). This year, once again, in an unpublished opinion, the Court ruled that a surety can be liable for fees and costs even if they exceed the penal sum. This is particularly concerning where the bond’s penal sum is much less than the potential cost of litigating the underlying bond claim. Sureties, principals and indemnitors on the bond should understand the issues and deal with the outsized financial consequences.
What the Court did in these cases, was separate the concept of the penal sum of the bond as the limit from the issue of responsibility for an award of attorney’s fees as costs in a litigation. The courts have held when attorney’s fees can be awarded as statutory costs, they can properly be assessed against the surety, even when they exceed the penal sum. By challenging and litigating the underlying claim on the bond in these cases, the surety took on the risk that the litigation would exceed the penal sum of the bond. In the court’s view the surety elected to gamble, and took on the risk of the loss. This risk is more acute the more the attorneys’ fees as statutory costs exceed the penal sum of the bond.
How do you avoid this conundrum of disputing a claim which may in the end cost more than the penal sum of the bond? Here are some tips that the surety, principal, and indemnitor should be considering. The cases’ holdings suggest the attorneys’ fees are not limited by the bond penal sum. This is not necessarily the case. All of these cases dealt with a statutory prevailing party issue where the attorneys’ fees were assessed per the statute and as a cost item to be paid by the losing litigant. When it comes to construction bonds, even California courts continue to hold that a surety’s liability for attorneys’ fees under its principal’s contract are limited by the penal sum. The point being, know what type of bond is at issue.
You also need to evaluate the risk in terms of the penal sum of the bond- the smaller the penal sum the greater the risk of exposure of attorneys’ fees exceeding the amount. Litigation is expensive and costs can escalate quickly. Consider settling claims on small bond amounts sooner, not later. Also, evaluate if an interpleader action would ultimately limit the exposure.
Courts favor sureties who pay. It is no secret that courts see the sureties as the party with all the leverage. There is typically a disparity in the relationship between surety and claimant, and courts are aware that if the penal sum is small, the surety has nothing to lose if limited to the penal sum. In these cases, the surety can simply outwait or outspend the claimant with no increase in exposure. This approach of waiting and litigating is frowned upon by the court, so consider taking active steps at the outset to mitigate damages and exposure.
Lastly, carefully evaluate a tender of defense. If a surety tenders to its principal and the principal over litigates, the surety’s exposure increases. Often, the surety is not kept abreast of developments and the dispute can become over litigated, increasing the surety’s exposure more than the penal sum. The surety needs to be more proactive and the principal needs to be aware of this too, after all, it is the principal and the indemnitors that will be looked to in order to make up the surety’s loss. Too often, if the principal or indemnitors cannot make the surety whole, then the surety takes a greater loss.
What was once thought of as a minor exposure on smaller penal sums, especially on many statutory bond claims, is no longer the case. No doubt the unintended consequence will be greater premiums, particularly on lesser penal sum bonds.
When one of your cases is in need of a construction expert, estimates, insurance appraisal or umpire services in defect or insurance disputes – please call Advise & Consult, Inc. at 888.684.8305, or email experts@adviseandconsult.net.