|
Sureties and Principals
By John M. Daley, Esq.
Since "surety bonds"
are usually issued by "insurance companies," persons who post a
surety bond sometimes assume that they have purchased an "insurance"
policy. This is incorrect, and principals who rely on this
assumption are making a potentially costly mistake.
"Insurance" is a two-party
contract between the insurer and its insured whereby the insurer agrees to
indemnify its insured from (and often to defend against) claims asserted by
third parties. A "surety bond," on the other hand, is a
three-party contract between the surety, the principal, and a creditor whereby
the surety agrees to "guarantee" obligations owed by the principal
to the creditor.
Since the primary purpose of a
surety bond is to protect the rights of the creditor, not the rights of
the principal, a
surety owes no duty to defend its principal against the creditor's claims. See
Schmitt v. Insurance Co. of North America, 230 Cal.App.3d 245 (1991).
Of course, if a surety knows
there is a defense to liability, it might defend against liability in order to
protect its own interests. If the principal does not actively assert
his own defenses, however, the surety might not even know that a defense
exists. Thus, the surety might make a payment under the bond even though
liability could have been avoided.
Once the surety has paid the
claim, however, the principal owes a duty to reimburse its surety, even if a
defense could have been asserted. 72 C.J.S., Principal and Surety § 230
(1987); 74 Am.Jur.2d Suretyship § 171 (1974). In 74 Am.Jur.2d Suretyship §
171 (1974), the surety's right to reimbursement is explained as follows:
[I]t is an established
rule of law, based on equitable considerations, that where one person is in the
situation of a mere surety for another, whether he became so by actual
contract or by operation of law, and pays or is compelled to pay the
debt which the other in equity and justice ought to have paid . .
., he is entitled to relief against the other, who was in fact the
principal debtor; that
is, the law in such cases implies a promise on the
part of the principal to reimburse the surety for the amount paid.
The principal can also be
required to reimburse the surety for all expenses incurred by the surety,
including attorneys' fees, in connection with the claim made under the bond.
72 C.J.S., Principal and Surety § 252d. (1987); 74 Am.Jur.2d Suretyship §
199 (1974).
In order to avoid his
obligation to reimburse his surety, the principal must show that the surety
was a "volunteer," i.e., that (1) the surety was a stranger or
intermeddler who had no interest to protect and was under no legal or moral
obligation to pay and (2) the surety did not believe in good faith that he had
such an interest. Employers Mutual Liab. Ins. Co. of Wisconsin v. Pacific
Indemnity Company, 167 Cal.App.2d 369, 387-381 (1959). Of course, this is
almost never the case when a bond has actually been issued.
In summary, whenever a
principal has posted surety bond to guarantee his obligations, he should be
sure to do whatever is necessary to assert any and all defenses to liability
whenever a claim is made under the bond, without relying upon his surety to do
so.
Of course, this does not mean
that the bond principal should not seek the assistance of his surety in
defending against claims. Since sureties and their counsel are often
experienced in the area in which the bond was issued, they are usually happy
to consult with and advise their principals about possible defenses to
liability.
Ultimately, however, it is the
principal, not the surety, who must bear the burden of establishing a defense
to liability.
| 
