• Default Judgment Against Bond Principal Has No Preclusive Effect on Surety
  • September 11, 2003
  • Law Firm: Halloran & Sage LLP - Hartford Office
  • In a March 6, 2002 decision, a Massachusetts Superior Court Justice rejected the claims by a subcontractor under payment bond that the surety was bound by a default judgment that had entered against its bond principal earlier in the same action. Yee Consulting Group, Inc. v. Michael J. Gresh Painting Co., Inc., MICV2000-04562 (March 6, 2002). This decision coincides with what is becoming a fairly well-settled suretyship law that a default judgment of the bond principal has no conclusive effect against the surety. Instead, most courts give the default either no effect or consider it merely prima facie evidence, rebuttable by the surety.

    In Yee Consulting, the plaintiff claimed to be owed funds for services it furnished to a construction project pursuant to an agreement with the bond principal. Both the bond principal and the surety were named as original defendants in the lawsuit. However, the bond principal had ceased all business operations and terminated its staff prior to the commencement of the lawsuit. The bond principal never entered an appearance in the action. The surety pleaded its own defenses and those possessed by its principal. After notice to all parties, the claimant obtained a default against the bond principal and later a judgment in the full amount of the claim following an uncontested default hearing. After obtaining the default judgment against the principal, the claimant then asserted that the surety was conclusively bound by the default judgment.

    Although several cases in the jurisdiction related to this general topic, none involved the exact circumstances here. The surety argued that because the surety and its principal have dissimilar interests, courts have not held the surety bound by a judgment against the principal where judgment was obtained by default or consent of the principal. In the majority of such cases, courts either gave it no preclusive effect or merely treated the default as prima facie evidence, rebuttable by the surety. The majority rule is exemplified by cases such as United States v. Hayes, 369 F.2d 671, 675 (9th Cir. 1966) ("When, therefore, a creditor has obtained a judgment against the principal in an action which the principal has not contested, that judgment, in the creditor's subsequent and first suit against the guarantor, cannot and should not, of itself alone, constitute prima facie evidence of the amount of the guarantor's obligation."); Gearhart v. Pierce Enterprises, Inc., 779 P.2d 93, 95 (Nev. 1989) (although a principal may have been properly defaulted, it was improper to enter a default judgment until the matter had been adjudicated with respect to the surety); United States ex. rel. Vigilanti v. Pfeiffer-Neumeyer Const. Corp., 25 F.Supp. 403, 405 (E.D.N.Y. 1938)("The surety was not responsible for the principal defaulting in this action. Upon the trial of this action it was entitled to offer its defenses. It was not in any wise bound by the default judgment obtained against the principal").

    Further, the Restatement (Third) of Suretyship and Guaranty ยง 67(3) supported the surety's position, indicating that a default is given less than prima facie effect, and a default judgment against a principal constitutes evidence only of its rendition. The reasoning of the Restatement is that the probative significance of a default judgment is much less than that of a judgment after trial on the merits. Also, arguments against duplication of trials have little weight where there has not been a determination made by a fact finder after consideration of evidence introduced by both sides to the litigation. Id., cmt. (c).

    Nor did the fact that the surety and principal were co-defendants in the same action have any impact on the issue. There is nearly universal agreement that a principal's default does not even constitute prima facie evidence against the surety in those situations. The seminal case establishing this rule is United States ex. rel. Fidelity Nat'l Bank v. Rundle, 107 F. 227, 229 (9th Cir. 1901). Rundle involved a lawsuit against a contractor for a debt claimed to be owed and against the contractor's surety. The contractor did not appear or defend and judgment was entered against it. The surety did appear and asserted the defenses of both itself and its principal, the contractor. The plaintiff argued that the surety should be prevented from contradicting the allegations against the defaulted contractor. The court refused, explaining:

    . . . a judgment against the principal upon a bond such as that here sued upon is not admissible in evidence against the sureties, except: First, in cases where the bond is conditioned to pay such judgment as may be rendered against the principal; and, second, in cases in which the sureties have had the opportunity to appear and defend in the action against the principal . . . The present case does not come within the letter of the first exception to the rule, nor within the spirit and intent of the second. . . . This is not the ordinary case in which a judgment has first been obtained against the principal, and a second action is brought against the sureties to compel its payment. . . . Here the action is brought in the first instance against the principal and his sureties.

    Rundle, 107 F. at 229. Many other jurisdictions have agreed with Rundle's reasoning that a principal's silence and failure to appear cannot be shown in evidence against sureties actively defending in same action. United States ex. rel. Vigilanti, 25 F.Supp. at 405 (New York law); North Jersey Sav. and Loan Assn. v. Wright, Egan, & Assocs., 1987 U.S.Dist.LEXIS 139 (E.D. Pa. 1987) (Pennsylvania law); United States ex. rel. Power Servs., Inc. v. Chattin Indus., Inc., 2000 U.S.Dist.LEXIS 18605 (D.D.C. 2000) (District of Columbia); Sutter v. Hill, 101 N.E.2d 502 (Ohio App. 1950)(Ohio law); Gearhart, 779 P.2d at 95 (Nevada law); Heritage Ins. Co. v. Foster Electric Co., 393 So.2d 28 (Fla. App. 1981)(Florida law).

    The reasoning in the Rundle line clearly is intended to encourage sureties to act when they are not already doing so. The decisions seek to discourage sureties from "standing idly by," and later making claimants re-try their cases. This is related to another important policy of conserving judicial resources. Surety cases addressing this issue have uniformly adopted the reasoning in Rundle, with the one distinguishable exception in the Eleventh Circuit's Drill South case.

    Drill South case

    The Eleventh Circuit recently departed from the reasoning in Rundle in Drill South, Inc. v. International Fidelity Ins. Co., 234 F.3d 1232 (11th Cir. 2000), reh'g en banc denied, 248 F.3d 1186 (11th Cir. 2001), cert. denied, 532 U.S. 1020 (2001). The facts in Drill South were squarely in the Rundle pattern - the surety was actively defending in the same action in which the principal was defaulted. In the opinion, the court began its analysis, like Rundle, by stating the general rule that a surety is bound by its principal's default if the surety had full knowledge of the action and an opportunity to defend. Since the Indemnity Agreement gave the surety the right to step and defend the principal, however, the court concluded that failing to do so violates the general rule.

    The Drill South court's decision to apply the general rule was a direct rejection of the Rundle conclusion that the general rule does not apply where the surety is actively defending in the same litigation. The reasons for this departure, however, were not clear in Drill South. For example, the court wrote that its decision would discourage sureties from standing idly by while defaults enter against their principals. Of course, this was a policy expressly shared by the Rundle line of cases, but those cases concluded that a surety that is actively participating in the same action is not "standing idly by." In addition, in departing from Rundle, Drill South relies on two cases that do not hold a default judgment conclusive, but rebuttable; Home Insurance Co. of New York v. Savage, 103 S.W.2d 900 (Mo. App. 1937) and Charleston & Western Carolina Railway Co. v. Robert G. Lassiter & Co., 179 S.E. 879 (N.C. 1935); and on two other cases that are expressly premised upon violations of state statutes. First Mobil Home Corp. v. Little, 298 So.2d 676 (Miss. 1974); Massachusetts Bonding & Insurance Co v. Central Finance Corp., 237 P.2d 1079 (Colo. 1951). Thus, none of the cases cited in Drill South adequately explains the Eleventh Circuit's rejection of Rundle. Further, there is no reported decision that follows it, leaving Drill South in an exclusive minority.

    Collateral Estoppel

    The bond claimant in Yee Consulting also argued that the surety should be collaterally estopped from re-litigating the defaulted principal's defenses. The basic doctrine of collateral estoppel applies when all of the following are present: (1) the issue in the two suits are identical; (2) the issue has been actually litigated in the first suit and must have been necessary to the decision in that suit, and (3) the party to be estopped was a party or in privity with a party to the first litigation.

    The claimant was unable to show, however, that the plaintiff's claim was actually litigated. The Massachusetts Supreme Court had recently affirmed that a default judgment generally does not have preclusive effect under the doctrine of collateral estoppel because none of the issues is actually litigated or decided. Treglia v. MacDonald, 717 N.E.2d 249 (Mass. 1999). While Treglia conceded that some defaults could have preclusive effect, it strongly suggested that such circumstances would not include those where the defaulted party never appeared or participated in the prior action. Thus, the bond claimant's collateral estoppel argument was not persuasive.

    Practice Note

    Although the court in Yee Consulting ultimately decided in the surety's favor and held that the default judgment against the principles should be given no preclusive effect, the court did not base its decision on the reasoning set forth in Rundle. Instead, the decision was based on collateral estoppel principal and the Treglia case. It is unclear whether the court's reluctance to apply suretyship case law related to a concern over Drill South's departure from the Rundle case law. Until the split between Rundle and Drill South is resolved, the surety practitioner should examine these decisions closely when confronted with the prospect of a default judgment entering against its principal.