Arizona Surety Claims: Surety Bad Faith Revisited in Recent Decisions

Co-Authored By: Jay M. Mann and Patrick F. Welch

Over the last twenty-six years, Arizona has been the epicenter of the national surety bad faith discussion.  In 1989, the Arizona Supreme Court issued probably the leading surety bad faith case in the county – Dodge v. Fid. And Dep. Co. of Md., 778 P.2d 1240, 161 Ariz. 344 (1989).   In Dodge, plaintiffs-homeowners contracted with a residential construction company to build a residence for them.  The contract required the contractor to obtain a performance bond, which the defendant-surety provided.  After the contractor defaulted under the contract, the plaintiffs sued the contractor and surety.  The plaintiffs sued the surety under the performance bond and bad faith.  The surety prevailed on the bad faith claim before the trial court and on appeal before the Court of Appeals.  The plaintiffs appealed. 

The Arizona Supreme Court reversed and held that a performance bond obligee may sue a surety for bad faith.  This was the first reported surety bad faith case ever decided.  Despite the fundamental differences between suretyship and insurance, the Dodge court held that sureties are insurers for purposes of Arizona’s insurance statutes.  Based upon this reasoning, the Dodge court applied the “special relationship” analysis, typically reserved for insurance contracts, to the surety context.  Concluding that sureties are insurers under the insurance statutes, the Dodge court further held that sureties have the same duty to act in good faith as insurers, and observed that the tort of bad faith arises when the surety intentionally denies, fails to process or pay a claim without a reasonable basis for such action.  

In the 37 years since the Dodge decision, a majority of courts around the country have rejected claims against sureties for surety bad faith, recognizing that there are fundamental differences between suretyship and insurance.  See, e.g. Cates Constr. v. Talbot Partners, 21 Cal.4th 28, 980 P.2d 407 (1999); Great Am. Ins. Co. v. N. Austin Muni. Util. Dist. No. 1, 908 S.W. 2d 415, 420 (Tex. 1995); Cincinnati Ins. Co. v. Centech Bldg. Corp., 286 F. Supp. 2d 669, 691 (M.D.N.C. 2003; Boldt Co. v. Thomason Elec. & Am. Contractors Indem. Co., 820 F. Supp. 2d 703, 705-06 (D.S.C. 2007); Inst. of Mission Helpers of Baltimore City v. Reliance Ins. Co., 812 F. Supp. 72, 74 (D. Md. 1992); Bell BCI Co. v. HRGM Corp., 276 F. Supp. 2d 462, 463 (D. Md. 2003); Toltest v. Purcell P&C, LLC, 2013 WL 1571714 at *5-6 (N.D. Ohio April 12, 2013); see also Resolution Trust Corp. v. Fid. & Deposit Co. of Maryland, 885 F. Supp. 228, 230-31 (D. Kan. 1995); In re Commercial Money Ctr., Inc., Equip. Lease Litig., 603 F. Supp. 2d 1095, 1124 (N.D. Ohio 2009)

In March 2014, we wrote an article presented to the Arizona State Bar, Construction Law Section.  The article explored two important unanswered questions from Dodge, including: (1) whether a surety defending a performance bond claim may assert a “bona fide or genuine dispute defense to a bad faith claim?; and (2) whether a payment bond claimant may bring a bad faith claim against a surety issuing a payment bond?[1]  Over the last several months, Arizona courts have issued two important decisions addressing these questions.  The courts’ reasoning in both decisions signals a shift away from Dodge and an effort to curtail surety bad faith liability.  

In a recent case handled by our office, the Superior Court of Arizona issued an unreported opinion granting the surety’s summary judgment motion seeking dismissal of a municipality’s surety bad faith claim involving a “Little Miller Act” performance bond.  The Superior Court held that a surety may deny a performance bond claim and avoid liability for surety bad faith where there is a “bona fide or genuine” dispute between the bond principal and the bond obligee as to the bond principal’s liability.  The Superior Court noted that “[a]s in the insurance context, however, a surety does not breach to covenant of good faith and fair dealing if the owner’s [obligee] claim is fairly debatable.”  The Superior Court further observed that “a surety faced with a dispute between owner and contractor, and the owner’s demand that it perform under the bond, a performance bond surety is not required to perform an investigation sufficient to determine who is right.  It need only investigate sufficiently to decide if a bona fide dispute exists.  If it does this, and there is a bona fide dispute, then it has not committed the intentional tort of surety bad faith.”  

  

In another recent case not handled by our office, the Arizona Court of Appeals held that a surety on a payment bond issued under Arizona’s “Little Miller Act” may not be sued for surety bad faith.  S&S Paving and Constr., Inc. v. Berkley Regional Ins. Co., No. 1 CA-CV 15-0239 at p.2.  In reaching its decision, the Court of Appeals noted the breadth of liability under the Little Miller Act and “refused to graft a common law remedy onto a statutory scheme that includes within its ambit both the availability of complete relief and specific conditions precedent to recovery.”  Rather, the Court of Appeals recognized that “a common law bad faith remedy would be inconsistent with the legislature’s defined liability for Act sureties” and emphasized Arizona precedent holding that “‘[w]hen a corporate surety undertakes an obligation on a bond pursuant to a specific statutory requirement, its liabilities are measured by the terms of the statute.’” 

The Court of Appeals also rejected S&S’s reliance upon Dodge, noting two important distinctions, including (1) Dodge did not involve a statutory bond, “let alone a carefully crafted statutory scheme that seeks to balance the competing interests inherent in public works project;” (2) “unlike Dodge, where the court found that the surety lacked an incentive to address the homeowner’s claim, a surety under the Act has a strong pecuniary motive to pay valid claims without litigation” because sureties are required to pay attorneys’ fees and interest to prevailing claimants. 

Undoubtedly, S&S will appeal the Court of Appeal's decision to the Arizona Supreme Court. In the authors' opinion, the S&S case is an important decision which will have far reaching implications for Little Miller Act performance bonds, contractor license bonds, motor vehicle dealer bonds, and all other statutory bonds. Like the recent unpublished Superior Court opinion discussed above, the S&S opinion is more good news for sureties and an example of a growing trend rejecting or limiting surety bad faith liability in Arizona.    

        

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[1] Jay M. Mann and Patrick F. Welch, Surety Bad Faith Issues Still Unresolved Twenty-Six Years After Dodge v. Fidelity and Deposit Company of Maryland

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Jay M. Mann is Chair of the firm's Construction and Surety Department. He focuses his practice in the areas of construction, surety and business law. Mr. Mann represents clients in other commercial litigation cases and serves as an ADR neutral in arbitrations and meditations.

is Chair of the firm’s Construction and Surety Department. He focuses   his practice in the areas of construction, surety and business law. Mr. Mann represents clients in other commercial litigation cases and serves as an ADR neutral in arbitrations and mediations. - See more at: http://www.jsslaw.com/news_detail.aspx?id=485#sthash.Msfc8OEz.dpuf

Patrick F. Welch focuses his practice in the areas of general and complex commercial litigation, construction litigation, and fidelity and surety litigation. Mr. Welch is licensed in the States of Arizona and Nevada, and the Commonwealth of Massachusetts. Based in Arizona, Mr. Welch regularly assists surety and fidelity clients with all facets of Arizona and Nevada claim investigations, litigation, trial, arbitration, mediation and appeals.

 

New Federal Crowdfunding Rules

By: Chris Rogers

The new federal crowdfunding rules went into effect May 16, 2016.  Now startups and other growth-oriented companies can raise up to $1 million dollars per year from the general public, provided the company (the Issuer) follows the new rules adopted by the Securities and Exchange Commission (SEC).   In contrast to the donative-models of crowdfunding commonly associated with Kickstarter, Indiegogo, and GoFundMe (where participants may receive, for example, a T-Shirt or early release of a product in exchange for a donation), equity crowdfunding investors are like micro-venture capitalists who could enjoy a return on their investment if the business is successful.  

Known as “Regulation Crowdfunding”, the new federal rule provides another exemption from the default requirement that any offer or sale of a security must be registered under the Securities Act of 1933.  Because the process of registering a securities offering (commonly referred to as “going public”) is complicated and expensive, Issuers most often rely on the “all accredited investor” private placement exemption found in Regulation D.  That exemption, Rule 506, exempts offers and sales to accredited investors (e.g., individuals with net worth in excess of $1 million, and others).  

However, with Regulation Crowdfunding expanding permissible potential investors to virtually everyone in the United States, proponents hope that entrepreneurs can spend less time seeking out high net worth potential investors capable of writing large checks, and rely instead on the power of a compelling business idea or plan, modern technology, and small aggregate investments.  A successful crowdfunding campaign could allow entrepreneurs to invest more of their time on their core business, thus potentially increasing their likelihood of success. 

To comply with Regulation Crowdfunding, an Issuer must meet stringent requirements, including filing an offering statement on Form C (available here).  A completed Form C will include, among other items, the following:

•  description of the Issuer’s company and business plan;

•  identification of officers, directors, and principal existing stockholders or members,

• provision of financial statements in US GAAP (in some cases must be reviewed by a public accountant),

• disclosure of significant risks to the company and/or its business. 

In addition to the cap of raising $1 million in any 12-month period by any Issuer, Regulation Crowdfunding allows limits the amount any investor can invest across all crowdfunding Issuers in any 12-months. 

For example, an investor with income or net worth below $100,000 may invest only the greater of:

(i)                 $2,000, or

(ii)               5% of the lesser of his annual income or net worth. 

An investor with net worth and income greater than $100,000 may invest 10% of the lesser of her:

(i)                 annual income, or

(ii)               net worth. 

No individual may invest more than $100,000.  In addition to these requirements, an Issuer relying on Regulation Crowdfunding must use a registered broker-dealer or funding platform to facilitate the securities offering, and take reasonable steps to verify compliance with the limitations on the investment amounts.  As for ongoing reporting requirements, the Issuer must also file a crowdfunding-specific annual report (Form C-AR) each year that provides updated information including financial statements.

Any securities offering, including a crowdfunding, is a serious endeavor requiring planning and careful observance of the legal requirements (which are only summarized in part here).  Anyone considering using Regulation Crowdfunding should be mindful of anti-fraud Rule 10-b5.  That rule prohibits making untrue statements or withholding or omitting material information.  An investor is entitled to know all information about a potential investment that could reasonably be deemed important to a potential investor in making its investment decision.  A violation of anti-fraud rules impose joint and several liability for all members of the selling group (e.g., officers and directors). 

For that reason, it is important for any Issuer to thoughtfully analyze its business and the risks it faces and be prepared to provide detailed, written, disclosure that will mitigate issues in the future.  Successful Issuers often use that disclosure as a sales opportunity.  Properly crafted disclosures can encourage trust and confidence by demonstrating the Issuer’s command of the core of its business.  Furthermore, Regulation Crowdfunding is only one possible offering structure among several that could be available to an Issuer.  It is important to find the structure that best suits an Issuer’s needs.

The securities attorneys at Jennings Strouss work with Issuers every day in planning and structuring securities offerings tailored to individual needs.  For more information on Regulation Crowdfunding, Form C, state crowdfunding rules, Regulation D, or disclosures, or securities offerings generally, you can reach Chris Rogers at crogers@jsslaw.com (602) 262-5962).

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Chris Rogers focuses his practice primarily in the areas of general corporate law and private securities offerings. He regularly advises companies in connection with private placements of equity and debt instruments, and in preparation for initial public offerings, domestically and in Canada. Rogers has substantial experience representing individuals and investment funds in the purchase and sale of privately-held business interests.

Serial ADA Plaintiffs David Ritzenthaler and Santiago Abreu Have Sued More Than 450 Arizona Business in 2016

By: Lindsay Leavitt

In the past few months David Ritzenthaler, a Scottsdale resident, and Santiago Abreu, a Florida resident, have filed more than 450 lawsuits against Arizona businesses alleging an assortment of violations of the Americans with Disabilities Act (“ADA”). Read my earlier blogs about Mr. Ritzenthaler’s lawsuits here, here and here and Mr. Abreu’s lawsuits here.

Although not as prolific as Mr. Ritzenthaler, Santiago Abreu, a Florida resident, is targeting Arizona restaurants and bars with his lawsuits. He specifically focuses on ADA violations in the bathrooms—such as improper urinal heights and improper placement of mirrors, soap dispensers and grab bars. In the bar area, he alleges that the service counter is too high for—and thus discriminatory against—a wheelchair bound individual.

Mr. Ritzenthaler’s lawsuits only focus on a business’s handicapped parking spaces. Specifically, he looks at the location, dimensions and signage. I have personally defended more than 60 of these cases and, while I have been able to get a handful immediately dismissed because my clients were exempt under the ADA’s “safe harbor” provision, the reality is that very few parking lots in Arizona fully comply with the ADA.

 

Business owners should contact a knowledgeable ADA attorney or consultant to perform a quick onsite inspection. Doing so could end up saving their business thousands of dollars and help the business owner sleep better knowing that she won't be targeted by these two serial plaintiffs.

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Lindsay Leavitt is a business litigation and employment law attorney at Jennings, Strouss & Salmon, P.L.C. He regularly represents businesses in ADA compliance related disputes and provides advice on preventative measures.

Jennings, Strouss & Salmon Expands eDiscovery and Practice Support

PHOENIX, Ariz. (May 12, 2016) – Jennings, Strouss & Salmon, P.L.C., a leading Phoenix-based law firm, is pleased to announce that it has expanded its eDiscovery and Practice Support department and services.

“The services offered by the firm’s eDiscovery and Practice Support team goes beyond assisting with matters solely related to litigation,” stated Jennifer Brandon, Practice Support Manager. “We are leveraging innovative technology and developing solutions that will provide the highest level of support to all of the firm’s legal teams and client needs.”

Jennings Strouss has invested in three key areas to ensure the proper handling and security of the firm’s and its clients’ electronic data − qualified project managers and technical analysts, state-of-the-art technology, and effective processes. We are devoted to understanding and addressing the increasing demands related to Electronically Stored Information (ESI) and streamlining the eDiscovery process by utilizing best-in-breed software, including review platforms, data analytics, transcript management, and trial presentation. 

About Jennings, Strouss & Salmon, P.L.C.

Jennings, Strouss & Salmon, P.L.C., has been providing legal counsel for over 70 years through its offices in Phoenix and Peoria, Arizona; and Washington, D.C. The firm's primary areas of practice include agribusiness; automobile dealership law, bankruptcy, reorganization and creditors’ rights; commercial litigation; construction; corporate and securities; employee benefits and pensions; energy; estate planning and probate; family law and domestic relations; health care; intellectual property; labor and employment; legal ethics and professional liability defense; real estate; surety and fidelity; and tax. For additional information please visit www.jsslaw.com and follow us on LinkedIn, Facebook, and Twitter.

The firm’s affiliate, B3 Strategies, assists clients with lobbying and public policy strategy at the local, state, and federal levels. For more information please visit www.b3strategies.com.

~JSS~

Contact:  Dawn O. Anderson | danderson@jsslaw.com| 602.495.2806

Alan P. Christenson Featured in Restaurant Hospitality Magazine

 

Jennings, Strouss & Salmon attorney, Alan P. Christenson is featured in Restaurant Hospitality magazine, online.

Read the full article: How to Keep Competitors From Invading Your Turf

Powering Tax Savings in Health Care: Overlooked Arizona Transaction Privilege Tax Deduction May Generate Substantial Utility Costs Savings for Qualifying Hospitals and Health Care Organizations

By: Paul J. Valentine, Attorney, Jennings, Strouss & Salmon, P.L.C

In Arizona, furnishing natural or artificial gas, water, or electricity is generally subject to Arizona’s transaction privilege tax (TPT). Imposed by statute, the tax is levied on the utility company (or distributor) rather than the end user; however, the utility company may pass (and almost always does) the economic burden to the end user. An often ignored deduction exists for qualifying hospitals and health care organizations. As the tax is passed onto the end user, a qualifying entity can provide an exemption letter to the utility company that would end the transferred tax obligation. In short, it can help reduce the qualifying hospital or health care organization’s utility expenses. A short summary of those provisions are provided below. 

The Utility Classification

Arizona’s TPT is imposed by statute – it explains that the amount taxed is determined by calculating a business’s gross income, as adjusted by various exemptions and deductions. Different types of businesses enjoy different deductions and exemptions depending on, in part, statutorily prescribed business classifications. One such classification is the Utility Classification, which taxes the “producing and furnishing to consumers natural or artificial gas and water [and] providing to retail electric customers ancillary services, electric distribution services, electric generation services, electric transmission services and other services related to providing electricity.”

In other words, the Utility Classification taxes the furnishing of water, natural or artificial gas and electricity to retail electric customers and consumers. The term “retail electric customers” is defined as a person who purchases electricity for their own use, not for resale, redistribution or retransmission. The word “consumer” is not defined in the statute, but would likely be interpreted as any purchaser of water or natural or artificial gas.

The Utility Classification Deduction for Qualifying Hospitals and Health Care Organizations

The Utility Classification allows a deduction from the tax base for certain sales to “qualifying hospitals” and “qualifying health care organizations.” In other words, any sale to these qualifying organizations would be reported on the return, but then would be entitled to a corresponding deduction under the applicable category. The qualifying entity would benefit from that deduction because the tax cost would no longer be passed along on its utility invoice. The deduction to qualifying hospitals is broad and includes all sales to eligible organizations.

A “qualifying hospital” is defined by statute and means any of the following:

a.     A licensed hospital [that] is organized and operated exclusively for charitable purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual.

b.     A licensed nursing care institution or a licensed residential care institution or a residential care facility operated in conjunction with a licensed nursing care institution or a licensed kidney dialysis center, which provides medical services, nursing services or health related services and is not used or held for profit.

c.      A hospital, nursing care institution or residential care institution [that] is operated by the federal government, [Arizona] or a political subdivision of [Arizona].

d.     A facility that is under construction and that on completion will be a facility under subdivision (a), (b) or (c) of this paragraph. 

Thus, to qualify for a “qualifying hospital” deduction, the facility must either be a non-profit or operated by a state or federal institution. Although the organization must be a non-profit, there is no requirement that the organization operate as a tax exempt entity. Additionally, the deduction applies to the construction of facilities that would otherwise qualify.

A “qualifying health care organization” is also defined by statute and is more narrowly defined. It means an entity that is recognized as tax-exempt under § 501(c) of the Internal Revenue Code and that uses at least eighty percent (80%) of all monies received from all sources only for health and medical related education and charitable services. This expenditure ratio must be audited yearly by an independent certified public accountant under generally accepted accounting principles.  The results of the audit must be filed with the Arizona Department of Revenue. 

Additionally, the deduction for “qualifying health care organizations” is more limited than that available to a “qualifying hospital.” This deduction is limited to the gross proceeds of sales or gross income from sales to a qualifying health care organization if the electricity, natural or artificial gas, or water is used by the organization “solely to provide health and medical related educational and charitable services.”

Qualifying organizations should request from the Arizona Department of Revenue an exemption letter confirming their eligibility for the deduction. Hospitals, nursing and residential care facilities, licensed kidney dialysis centers, and other tax exempt entities that operate in the health and medical field should seek the advice of competent legal counsel familiar with Arizona’s TPT to determine whether they qualify for this deduction, and for assistance with preparing a request for an exemption letter.

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Paul J. Valentine's practice emphasizes structuring corporate, partnership, and real estate transactions, counseling medium and small businesses and tax-exempt organizations in tax matters, litigating tax cases in federal courts, and handling administrative controversies before the IRS. His experience with Arizona state and city tax controversy includes income tax, sales tax, and commercial rent tax. pvalentine@jsslaw.com