Reliance Insurance Company of Philadelphia, Pennsylvania v. Malcolm B. Colbert

365 F.2d 530, 124 U.S. App. D.C. 339, 1966 U.S. App. LEXIS 5478

• Court: Court of Appeals for the D.C. Circuit
• Decided: July 18, 1966
• Docket: 19680_1
• Status: Published

Opinions

McGOWAN, Circuit Judge:

The District Court, after trial without a jury, gave judgment for $18,374 against a defaulting contractor and the surety upon a completion bond. Only the surety has appealed, contending that material alterations were made in the construction contract without its knowledge and consent. We disagree with the District Court’s conclusion that these alterations were of such a nature as to have no ponderable impact upon the surety’s undertaking; and we reverse and remand for a determination of what that impact was.

I

Appellees are a group of church trustees who decided to build a Sunday School Annex. They executed a contract with a builder on October 20, 1962, and, on November 3 following, two addenda, the first enlarging the scope of the work to be done and the second fixing a total contract price and a payment schedule. Addendum No. 2 obligated the owner to reimburse the contractor for the full cost of a completion bond “at the time of delivery” of such bond. The contractor thereafter went to appellant surety company which, on November 21, 1962, issued and turned over to the contractor a completion bond. The bond remained in the possession of the contractor until after the execution of Addendum No. 3 on February 4, 1963.¹ Addendum No. 3 altered the payment schedule in several respects. Construction was eventually abandoned before the building was finished. Appellant surety refused the demand to complete, and this suit followed.

The District Court found, among other things, that the church had in substance been victimized by the contractor; that the architect employed by the church had been grossly negligent in giving his approval to the work performed by the contractor; and that the value of the materials and labor contributed by the contractor did not exceed $6,251. It arrived at its judgment of damages by this formula:

Amount of Contract $57,450.00

Deduct value of work done 6,251.00 Cost to complete $51,199.00

Deduct unpaid contract price 32,825.00

$18,374.00

The District Court both found as a fact and concluded in law that the changes in the contract wrought by Addendum No. 3 “were not so substantial vis-a-vis the Bonding Company as to affect its security”; and that the surety “must be held to a strict accounting,” since there had “been no changes in the contract which materially changed its position vis-a-vis the obligee * * *.” The District Court also appeared to conclude that the surety was, in essence, es-topped from relying upon Addendum No. 3 as constituting an alteration in the contract to which its bond was addressed. This latter position is embodied in a finding “that whatever obligation to give notice to the Bonding Company may have existed rested only upon the defendant Construction Company which had received but had failed to deliver the bond to the church until it had secured the signature of the Church to Addendum No. 3. The Church in other words had no knowledge of the bond until after Addendum No. 3 was signed.”

II

We turn first to the justification for the judgment derived from the estoppel alternative. The Church Trustees argued to us in this regard that “the bonding company made possible the overreaching of the Church by placing in the hands of the Construction Company an executed bond, and the bonding company must have known that that bond would cause the Trustees of the Church to feel secure * * This argument is curiously at odds with the District Court’s purported finding of fact that the Church “had no knowledge of the bond until after Addendum No. 3 was signed.” We have examined the record ourselves and we think the testimony does not support the finding literally.² The finding may perhaps be interpreted to mean that appellees did not actually see the bond, as distinct from knowing of its existence, at the time they executed Addendum No. 3; and the testimony was not adduced with such clarity as to ex-elude this possibility. Indeed, the finding must be read in this non-literal way in order to make it at all compatible with the theory of estoppel argued to us by appellees, namely, that the surety should not have given the bond to the contractor for ultimate delivery to the Church; and that, by doing so, the surety made it possible for the contractor to overreach the trustees by representing its possession of the bond to the trustees as an inducement to sign Addendum No. 3.

In our view of the estoppel argument, it is hot critical whether appellees actually saw the bond or merely knew of its existence. Had appellees been given, or had they insisted upon, an opportunity to look at the bond, they would have found nothing in it authorizing future changes in the contract without notice to the obligor.³ But, even if they had not seen the bond itself, they tell us in so many words that, because they knew of its availability in the contractor’s hands, they could safely rely upon his representations that they would be protected by it even though they were to go ahead with a material alteration in the contract without notice to the surety. Although appellees, unfortunately, appear not to have been sophisticated men of business, they cannot reasonably have assumed that bonding companies customarily issue substantial completion bonds which are open-ended in relation to the terms of the contracts guaranteed. All that appellees were entitled to assume from bare knowledge of the existence of the bond was that it covered the contract in the form the latter was in as of the time the bond was issued, and not as it was about to be changed. The mere fact that the bond was in the contractor’s possession does not enlarge the range of that assumption to include an apparent authority in the contractor to extend the bond’s coverage to any new and different contract that might be made. Actual authority to bind the surety was, accordingly, necessary, and none has been proved.

Thus, even if appellees did not see the bond, such overreaching as caused them to execute Addendum No. 3 flowed from their readiness to rely upon whatever the contractor told them. But the coverage of the bond in fact is not to be defined by reference to those representations, absent an adequate basis for regarding them as binding upon appellant. Mere possession of the bond by the contractor affords no such basis, particularly where, as here, the contract provisions relating to the bond are not inconsistent with a conclusion that appellees contemplated that the bond would be procured in the first instance by the contractor. Thus, appellant was not es-topped from showing what the coverage of the bond actually was.⁴

Ill

We return to the first — and primary— ground advanced by the District Court, i. e., its conclusion that the alterations made by Addendum No. 3 were not material in relation to the risk assumed by the surety. The payment schedule contained in the contract before the advent of Addendum No. 3 called for an initial deposit of $7,450, and for successive payments of $12,500 upon completion of certain described phases of the construction. The comparative payment schedules provided by Addendum No. 2 and Addendum No. 3 are as follows:

Addendum No. 2 Addendum No. 3

Initial Deposit $ 7,450 $ 7,500

Completion of first floor shell to joists 12,500 10,000

Completion of second floor joists 12,500 10,000

Roofed in 12,500 5,000

Completion of job 12,500 25,000

It was because of financing difficulties that Addendum No. 3 was formulated. Under it the trustees were themselves to provide current financing in the amount of $32,500, consisting of the preconstruction first payment of $7,500, and $25,000 to be paid in escrow. The contractor was to produce $25,000 against the receipt by him of a negotiable note for $25,000 signed by the trustees and secured by real and chattel mortgages on the Church property. Addendum No. 3 said that the initial deposit of $7,500 [sic] called for by the original contract was to be met by an immediate payment of $1450, plus $50, and release of $6000 which the trustees had already deposited in escrow some time before Addendum No. 3 was signed. The $25,000 to be paid into escrow by the trustees was to be released in successive amounts of $10,000, $10,000, and $5,000 as the three phases of construction prior to final completion were reached. Addendum No. 3 then added a new undertaking by the trustees to pay the contractor a 5 per cent commission on the $25,000 (or $1,250) which the contractor undertook in Addendum No. 3 to supply as a loan against the note.

Little discussion by way of comparison of Addenda Nos. 2 and 3 is necessary to demonstrate that the contract terms had undergone a substantial change, certainly of such a nature as to enable a surety to claim with reason that it should have had an opportunity to review its risk before deciding whether to adhere to its commitment to guarantee performance. A surety company is not a public utility. It may, for any or no reason, conclude not to furnish its bond with respect to a particular contract. When it has committed itself with respect to one contract, amendments which convert that agreement into a significantly different one should be brought to the attention of the surety so that it may exercise its' own business judgment as to whether it wishes to continue its commitment. It is not for the parties to the contract to decide among themselves that their amendments are of no interest to the surety, at least when, as here, those amendments go beyond mere matters of form.

It may, of course, be entirely possible that notice to the surety of Addendum No. 3 would have evoked no cancellation of its bond. But the changes in the contract made by Addendum No. 3 are not such as to make this hypothesis a reasonably reliable one. Even a surety company as casual in its methods of operation as appellant appears on this record to have been might well have had second thoughts when it examined Addendum No. 3. We do not, therefore, feel warranted in attributing no significance to the fact that appellant was without opportunity to reappraise its commitment in the light of the contract as it took final shape through the instrumentality of Addendum No. 3.⁵ We do not, in sum, think that liability can be imposed upon the surety in this case, as was done in the District Court, because the contract alterations are held to be of no possible interest to it, or because it is estopped from asserting that such an interest did exist. The judgment against appellant is reversed because these foundations are inadequate support for it.

IV

What we have said above, however, does not mean that appellant may under no circumstances be made to respond upon the bond in suit here. It can be argued, of course, that one who guarantees a contract and is given no chance to review that commitment in the light of significant alterations made in it without his knowledge or consent, should be released without having to face the vexations and uncertainties of litigation over the precise impact of such alterations upon him. The very prospect of such ensuing litigation would presumably be one of the reasons why the guarantor might decide to avail himself of the privilege of cancelling his commitment. Appellant, however, was not a volunteer, but a compensated surety, and one with a singular lack of interest in the fate of a bond which it put into circulation without having received the premium. We need not decide that under any and all circumstances a compensated surety is to be released only to the extent of demonstrable prejudice.⁶ We do hold that, on this record, prejudice in fact shall be the standard of measurement of appellant’s release from its undertaking. Inquiry must be made into the manner in which the risk undertaken by the surety was varied by the Church’s failure to abide by the contract guaranteed, and the kind of prejudice that thereby resulted to the surety. If that prejudice proves impossible of rational measurement, the surety must receive a total discharge. If the prejudice is subject to measurement, the surety must receive only a partial discharge, measured by the extent of that prejudice.

The District Court has not as yet considered the matter in this light, nor have the parties been called upon to adduce their evidence and to make their representations with reference to this principle. Because the contract guaranteed was significantly altered by the parties without notice to the surety, thereby denying it the opportunity to bring its own complete discretion to bear upon whether it would continue to participate in the transaction, we think that the burden of persuasion on the issue of prejudice in this case should be on appellees.

We remand for further proceedings not inconsistent herewith.

It is so ordered.

1 . Addendum No. 3 recited that it was “to supersede all agreements, contracts, and addenda written previously, or alter or cancel any or all previous agreements as will be noted.” With respect to the completion bond, Addendum No. 3 provided that “[P]ursuant and immediately after signing of this addendum, contractor will deliver into the hands of the building committee, a completion bond * * * and the owner agrees to pay the sum of * * * ($575) to cover the cost of this bond.”

2 . Mr. Baylous, one of the trustees who signed Addendum No. 3, testified as follows :

“Q. Will you state whether or not before you executed the document, you presented this document (Addendum No. 3) to any bonding company? A. We didn’t show it to anyone at all. Mr. Basay [the contractor] is the one that called for the bond and when the bond had arrived and we seen the bond and signed the bond, and we signed these papers here.”

Mr. Oustis, another trustee, testified somewhat confusedly but unmistakeably to the effect that the trustees signed Addendum No. 3 only after they had been satisfied as to the existence of the bond:

“Q. I show you Plaintiff’s Exhibit No. 6 (the bond). Do you remember when you got that paper? A. This document was presented after we had received this addendum. Preceding this, he came back with this document because we did not agree to this until such time as the completion bond was presented to us.

* * # * *

“Q. Do you remember what Mr. Basay told you? A. Mr. Basay informed us that this, a completion bond, served a purpose for us that the work would continue under any conditions, that this was our protection, that if anything should happen that the building would be completed.”

3 . The bond is a short form, and the date of its execution, November 21, 1962, clearly appears. It purports in terms to secure only a construction contract dated October 20, 1962. Addendum No. 3 was dated and executed February 4, 1963. Although Addenda Nos. 1 and 2 were executed November 3,1962, they are not expressly referred to in the bond. There is no dispute, however, that they had been delivered to appellant prior to its issuance of the bond. Although a more careful surety would certainly have described the contract more precisely in the bond, we do not think that this omission entitled appellees to believe three months later that a further substantial alteration of the contract could safely be made without bringing it to the attention of the surety.

4 . Oases holding the surety liable where it delivers to a contractor a bond which on its face gives no notice to the creditor of certain conditions or agreements are not applicable. See, e. g., Butler v. United States, 88 U.S. (21 Wall) 272, 22 L.Ed. 614 (1874) ; Dair v. United States, 83 U.S. (16 Wall) 1, 21 L.Ed. 491 (1872) ; Title Guar. & Sur. Co. v. Schmidt, 213 F. 199, 201-203 (8th Cir. 1914).

5 . A surety’s obligation may, of course, be affected by departures in performance from the contract terms even without formal alteration. It is, thus, relevant to inquire into the extent which that occurred here. Addendum No. 2 provided for an initial down payment, and subsequent payments to follow as specified stages of the construction were satisfactorily completed. Sureties presumably rely on such payment provisions to provide a source of indemnity in case the contractor defaults. Apparently the result of the Church’s failure to abide by Addendum No. 2 was that more money was paid to the contractor than he should have received by the time he finally abandoned construction. See generally and compare Gibbs v. Hartford Accident & Indemnity Co., 62 So.2d 599 (Fla.1952); Restatement, Security, § 128, comment f, 34dr-46 (1941); Simpson, Suretyship § 78 at 393, 396-400 (1950); 4 Williston, Contracts § 1243 at 3560, 3564 and n. 17 (1936); Arant, Rationale of the Rule that an Obligee’s Premature Payment Discharges His Surety, 80 U.Pa.L.Rev. 842 (1932).

6 . Ibid.