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Double H. Masonry, Inc. v. Liberty Mutual Insurance Co.

United States District Court, D. South Dakota, Western Division

September 30, 2016

DOUBLE H. MASONRY, INC., Plaintiff,
v.
LIBERTY MUTUAL INSURANCE COMPANY, Defendant.

          Double H Masonry, Inc., Plaintiff, represented by Sara Frankenstein, Gunderson, Palmer, Nelson & Ashmore, LLP.

          Double H Masonry, Inc., Plaintiff, represented by Jason M. Smiley, Gunderson, Palmer, Nelson & Ashmore, LLP.

          Liberty Mutual Insurance Company, Defendant, represented by Connor L. Cantrell, The Hustead Law Firm, PC, pro hac vice, Eric J. Pickar, Bangs McCullen Law Firm, Patrick Q. Hustead, The Hustead Law Firm, PC & Terry G. Westergaard, Bangs, McCullen, Butler, Foye & Simmons.

          Liberty Mutual Insurance Company, ThirdParty Plaintiff, represented by Connor L. Cantrell, The Hustead Law Firm, PC, Eric J. Pickar, Bangs McCullen Law Firm, Patrick Q. Hustead, The Hustead Law Firm, PC & Terry G. Westergaard, Bangs, McCullen, Butler, Foye & Simmons.

          MEMORANDUM OPINION AND ORDER

          LAWRENCE L. PIERSOL, District Judge.

         Before the Court is Defendant's Motion to Dismiss Count II of Plaintiff's Second Amended Complaint pursuant to FED R Civ P 12(b)(6) failure to state a claim for which relief can be granted Defendant initially filed a Motion to Dismiss Counts II and III of Plaintiffs Amended Complaint Doc 32 Plaintiff filed a Response to Motion to Dismiss[1] Doc 34 Defendant filed a Reply to Plaintiffs Response Doc 39 Plaintiff then moved to amend its amended complaint Doc 59 This Court granted Plaintiffs motion to amend and ordered Plaintiff to serve the Second Amended Complaint as proposed Doc 60 Plaintiffs Second Amended Complaint contains only Counts I and II Doc 61 The parties then stipulated that the facts and law contained in Docs 32, 34, and 39 applied to the allegations contained in Count II of Plaintiff's Second Amended Complamt and that briefing was complete Doc 63 The Court has considered all filings and for the reasons set forth below, Defendant's motion is denied in part and granted in part

         BACKGROUND

         Milender White Construction Company ("Milender White") is a general building construction contractor and Double H Masonry, Inc ("Double H") is a masonry subcontractor Liberty Mutual Insurance Company ("Liberty Mutual") is the bonding company for Milender White

         Milender White entered in a construction contract with the Oglala Sioux Tribe - Department of Public Safety ("the Tribe") for construction of the Pine Ridge Justice Center (the "Project") located on the Pine Ridge reservation in South Dakota In March of 2012, Double H submitted a bid for masonry work on the Project This bid included $1, 112, 50000 for the cost of interior masonry walls and entryway stone by unit of measure, and $1, 021, 12500 for the cost of exterior masonry walls and block and insulation by umt of measure Double H's bid expressly excluded the costs of rebar materials, heating, sheltering, and caulking Milender White and the Tribe accepted Double H's bid and it was incorporated mto the subcontract In May of 2012, Milender White obtained a payment bond for the Project through Liberty Mutual for the sum of $30, 466, 29700 The general purpose of the payment bond was to guarantee that Milender White would pay its subcontractors all amounts due and owing for labor and materials[2] The payment bond also stated that after being provided a written notice of a claim, Liberty Mutual will "[s]end an answer to the Claimant within sixty (60) days after receipt of the Claim, stating the amounts that are undisputed and the basis for challenging any amounts that are disputed, [3] and Pay or arrange for payment of any undisputed amounts"[4]

         Under the terms of the subcontract, Double H commenced work on the Project Pursuant to the prime contract, the Tribe agreed to pay for all materials for the project Further, pursuant to various oral contracts, written agreements, and change orders, Milender White also agreed to pay Double H for additional work on the Project In November of 2013, conflicts arose between Double H and Milender White and the Tribe regarding Double H's entitlement to payments for work performed and material provided on the Project On November 26, 2014, Double H provided Liberty Mutual, Milender White, and the Tribe with notice of its claim on the payment bond Pursuant to Section 71 of the payment bond, Liberty Mutual had sixty days in which to respond to Double H's notice of claim On January 9, 2015, [5] Double H filed suit against Liberty Mutual for breach of the bond Doc 1 On January 26, 2015-sixty days after Double H filed its notice of claim-no employee of Liberty Mutual had responded to the notice of claim indicating the amounts that were undisputed and the basis for challenging any amounts that were disputed[6]

         On February 20, 2015, Liberty Mutual filed a Motion to Stay Pending Arbitration between Double H and Milender White Doc 14 On May 26, 2015, Double H filed an amended complamt adding Count II - Contractual and/or Tortious Bad Faith and Count III - Violation of Unfair Trades Practices Act (SDCL §§ 58-33-67, -461) Doc 29 at 32-34 In Count II, Double H alleged that Liberty Mutual owed Double H a duty of good faith and fandealing and that this duty was violated when Liberty Mutual failed to send an answer to Double H within sixty days after it received Double H's notice of claim, failed to independently and reasonably investigate Double H's claims, failed to pay for five undisputed claims, and filed a motion to stay this litigation Id. at ¶¶ 243-45, ¶¶ 249, ¶¶ 252-53, ¶¶ 255

         On June 9, 2015, Liberty Mutual filed this Motion to Dismiss[7] Doc 32 On July 28, 2015, this Court heard oral argument regarding the Motion to Stay On November 4, 2015, this Court issued a five-page Memorandum Opinion and Order granting Liberty Mutual's Motion to Stay the proceedings between Double H and Liberty Mutual and ordered that it would subsequently rule on the present Motion to Dismiss Count II of the Second Amended Complaint Doc 75

         DISCUSSION

         Liberty Mutual maintains that pursuant to Federal Rule of Civil Procedure 12(b)(6) this Court must dismiss Count II because it fails to state a legally sufficient cause of action, namely that no cause of action exists in South Dakota for a bad faith claim against a surety While South Dakota law recognizes a bad faith cause of action in the insurance context, it has not been determined whether a surety bond is also subject to a bad faith cause of action "When there is no state supreme court case dnectly on point, our role is to predict how the state supreme court would rule if faced with the [same issue]" Cotton v Commodore Express, Inc, 459 F.3d 862, 864 (8th Cir 2006)

         Standard of Review

         In considering a motion under Rule 12(b)(6), the factual allegations of a complaint are assumed true and construed in favor of the plaintiff, "even if it strikes a savvy judge that actual proof of those facts is improbable" Bell Atlantic Corp v Twombly, 550 U S 544, 556 (2007), cited with approval in Data Mfg, Inc v United Parcel Serv, Inc, 557 F.3d 849, 851 (8th Cir 2009) "While a complaint attacked by a Rule 12(b)(6) motion to dismiss does not need detailed factual allegations, a plaintiffs obligation to provide the grounds' of his entitle[menf] to relief reqmres more than labels and conclusions, and a formulaic recitation of the elements of a cause of action will not do[]" Twombly, 550 U S at 555 (internal citations omitted) The complaint must allege facts, which, when taken as true, raise more than a speculative right to relief Id. (internal citations omitted), see also Benton v Merrill Lynch & Co, Inc., 524 F.3d 866, 870 (8th Cir 2008)

         Although a plaintiff, in defending a motion under Rule 12(b)(6), need not provide specific facts in support of its allegations, Rule 8(a)(2) "still requires a showing, ' rather than a blanket assertion, of entitlement to relief" Twombly, 550 U S at 555 n 3 (further explaining that "[w]ithout some factual allegation in the complaint, it is hard to see how a claimant could satisfy the requirement of providing not only fair notice' of the nature of the claim, but also grounds' on which the claim rests"), see also Ashcroft v Iqbal, 556 U S 662, 678 (2009) ("the pleadmg standard Rule 8 announces does not require detailed factual allegations, ' but it demands more than an unadorned, the-defendant-unlawfully-harmed-me accusation") As such, a claim must have facial plausibility to survive a motion to dismiss Ashcroft, 556 U S at 678 Determining whether a claim has facial plausibility is "a context-specific task that requires the reviewing court to draw on its judicial experience and common sense" Id. at 679

         Bad Faith Cause of Action in Insurance Law

         South Dakota law has developed a bad faith cause of action most notably in the insurance context Stene v State Farm Mutual Auto Ins Co, 1998 S.D. 95, ¶ 19, 583 N W 2d 399, 403 (noting that "[a] cause of action against an insurance company for bad faith failure to pay a claim is recognized in South Dakota Matter of Cert of a Question of Law, 399 N W 2d 320, 322 (S D 1987)") "The bad faith causes of action have been created and defined by the courts in South Dakota, without nurturing (or impediment) by the South Dakota legislature" Roger M Baron, When Insurance Companies Do Bad Things The Evolution of the "Bad Faith" Causes of Action in South Dakota, 44 S D L REV 471, 471-72 (1998-1999), see also Trouten v Heritage Mut Ins Co, 2001 S.D. 106, ¶ 30, 632 N.W.2d 856, 862 (explaining that "[t]h[e] implied covenant of good faith is a principle of contract law and, with the exception of insurance contracts, we have consistently refused to recognize an independent tort action for its breach") (emphasis added) Litigation of bad faith claims can be presented in either a first or third-party bad faith context[8] Hein v Acuity, 2007 S.D. 40, ¶ 9, 731 N W 2d 231, 235

         A first party bad faith claim is essentially an mtentional tort and occurs when an insurance company engages in wrongdoing during the process of paying a claim to its insured Id. (citing Gruenberg v Aetna Ins Co, 510 P.2d 1032, 1036 (Cal 1973))[9] In order to prove a first-party bad faith claim, an insured must show "an absence of a reasonable basis for denial of policy benefits and the knowledge or reckless disregard of a reasonable basis for denial" Matter of Certification of a Question of Law, 399 N W 2d 320, 324 (S D 1987), see also Hein, 2007 S.D. 40, «fl 9, 731 N W 2d at 235 (explaining that "an insurer is permitted to challenge claims that are fairly debatable[, ] [h]owever, a frivolous or unfounded refusal to comply with a duty under an insurance contract constitutes bad faith")

         Both parties agree that in the insurance context, a cause of action for bad faith exists under current South Dakota law Doc 32 at 7 ("South Dakota allows a cause of action against an insurance company for bad faith failure to pay an insurance claim"), Doc 34 at 11-35 (arguing that a surety bond is insurance under South Dakota Law and a surety can therefore be sued under a bad faith action) The issue now before this Court is whether a surety bond is a type of insurance and thus subject to a bad faith cause of action As detailed by the parties' briefs, several jurisdictions have addressed the issue, however, it is one of first impression in South Dakota

         Jurisdictions Not Recognizing a Bad Faith Claim in a Surety Context

          California

         In its initial brief, Liberty Mutual argues that "suretyship is essentially credit and not insurance" and therefore South Dakota should not recognize a bad faith cause of action Doc 32 at 9 In defense of its position, Liberty Mutual cites almost exclusively to the California Supreme Court case of Cates Constr, Inc v Talbot Partners, 21 Cal 4th 28 (Cal 1999) In Cates, Talbot Partners ("Talbot") hired Cates Construction, Inc ("Cates") to build a condominium and Transamenca Insurance Company ("Transamenca") issued the bond on Cates' behalf Id. at 35 Conflicts arose between the parties and Talbot demanded that Transamenca perform under the bond Id. at 35-36 Citing the existence of a legitimate dispute between Cates and Talbot, Transamenca refused to pay the claim Id. at 36 Thereinafter, a lawsuit between all parties ensued Id. Included in Talbot's suit against Transamenca was a tort claim for breach of the implied covenant of good faith and fair dealing under the performance bond Id. At tnal, a jury found Transamenca liable for the breach and awarded Talbot $28 million in punitive damages Id. at 38 The court of appeals reduced the amount of punitive damages to $15 million, but affirmed the judgment in all other respects Id. Transamenca appealed Id.

         On appeal, the California Supreme Court reversed and found that "[a] construction performance bond is not an insurance policy[, ]" and thus an extra-judicial remedy in tort is unavailable in the surety context Id. at 60-61 In refusing to extend a tort recovery, the court found that "whatever benefits might accrue from permitting such remedies, harmful economic results appear at least as likely to occur" Id. at 58 The court noted that,

Unlike insurance relationships, which involve the interests of only two parties, the surety relationship is a tripartite one implicating the separate legal interests of the principal, the obligee and the surety When contract disputes arise between an obligee and a principal as to whether the principal is in default, it may prove difficult for the surety to determine which party is in the right and whether its own performance is due under the bond
[Construction disputes may be complicated enough to resolve when all three parties are on a level playing field But it is rational to assume that making tort remedies available may encourage obligees to allege a principal's default more readily than they would in the absence of such remedies It is also reasonable to conclude that allowing obligees to wield the club of tort and punitive damages may make it easier to pressure sureties into paying questionable default claims, or paying more on properly disputed claims, because the sureties will be reluctant to risk the outcome of a tort action
With such mcreased leverage, obligees will have sufficient power to detrimentally affect the interests of principals when disagreements arise during construction Claims of default by the obligee may impair the principal's ability to secure bonding on other projects, thus automatically disqualifying the principal from bidding on all public projects and many private ones Moreover, indemnity agreements executed by principals often give sureties the right to pursue them for reimbursement of any loss, including legal expenses and the costs of investigation In efforts to avoid bad faith liability, sureties may strive to "find" bond coverage for obligees while, at the same time, charging their investigation costs to the principal Accordingly, even if the surety's investigation ultimately leads to the conclusion that the principal is not in default, the faultless principal may still suffer adverse consequences These considerations, which have no parallel in disputes involving insurance policies, weigh against the recognition of extracontractual liability in the performance bond context
Finally, allowing tort recovery in the construction bond context may open the door to increased (and sometimes successive) litigation, which in turn may increase the cost of obtaining bonds

Id. at 58-59 (citations omitted)

         In further defense of its holding, the court first noted that California law recognizes tort remedies for breach of the covenant of good faith and fair dealing in the insurer/insured context based on the nature of insurance policies Id. at 44 In particular, the court found that the existence of unequal bargaining power, public interest, the fiduciary relationship between the contracting parties, and the inability of an insured to obtain other recourse in the marketplace provided the basis for allowing this additional remedy in tort Id. In addressmg these policy concerns, the court first distinguished insureds, "who must accept insurance on a take-it-orleave-it'" basis, from obligees, who "decide the form of the bond which they will accept from the pnncipal[, ]" and concluded that "a typical performance bond bears no indicia of adhesion or disparate bargaining power that might support tort recovery by an obligee" Id. at 52-53 Next, the court distinguished the purposes of insurance and surety in that insurance is purchased to protect against unforeseeable losses or catastrophes, whereas a surety more closely resembles a credit arrangement so as to guarantee payment in the event of default by the principal Id. at 53-54 The court also observed that in the event of a claim, msureds have but one avenue to pursue payment, the insurer Id. at 54 Conversely, an obligee in a surety relationship has recourse against both the surety and the principal and "may contract with others in the marketplace to obtain completion of its construction project and thereafter recover the reasonable cost of completion against the principal and the surety" Id. at 55

         The court also analyzed the inclusion of suretyship in the California Insurance Code but found its presence in the Code unconvincing[10]Id. at 47 Notmg that "parties in a surety arrangement[] have certain rights and defenses that do not attend the typical insurance relationship^]" the court concluded that the mere presence of suretyship in the Code was not determinative Id. at 52 Rather, the court found it "must evaluate whether the policy considerations ...


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