CITY OF LOS ANGELES v. AMWEST SURETY INSURANCE COMPANY

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Court of Appeal, Second District, Division 7, California.

CITY OF LOS ANGELES, Plaintiff and Respondent, v. AMWEST SURETY INSURANCE COMPANY, Defendant and Appellant.

No. B114161.

Decided: July 29, 1998

Busch & Berger and Stanley Haren, Calabasas, for Defendant and Appellant. James K. Hahn, Los Angeles City Attorney, Ronald Tuller, Assistant City Attorney and Valentin Dinu, Deputy City Attorney, for Plaintiff and Respondent.

SUMMARY

A bonding firm issued a bond guaranteeing a contractor's promise to build public improvements in a subdivision, given in exchange for a city's promise to approve a subdivision map.   The bond required payment of a specified “penal sum.”   The city approved the map, but the contractor failed to build the improvements, and the property passed to a new owner.

The “frustration of purpose” doctrine did not excuse performance of the bond.   That doctrine excuses only a performance frustrated by events the contracting parties assumed would not occur.   Here, the contractor's default was precisely the event which the parties agreed would trigger the bonding company's obligation.

Enforcement of the bond works no impermissible forfeiture, even if the sum paid exceeds the city's actual out-of-pocket loss.   A bond properly may require payment of a “penal sum,” a species of liquidated damage, in lieu of indemnity for actual loss.   The bonding company, in any event, produced no proof that the city suffered no loss.

Summary judgment was properly granted enforcing the bond.

FACTS AND PROCEDURAL HISTORY

Jama Construction Corp. sought to subdivide a parcel of real property.   The “Subdivision Map Act” required Jama to obtain approval for the subdivision from the City of Los Angeles (City).   In a written agreement City granted approval, in exchange for Jama's promise to build the public improvements (street lights, sidewalks) shown on the plans.

The agreement required Jama to post a surety bond guaranteeing its obligation to build the public improvements.   Jama arranged for appellant Amwest Surety Insurance Company to issue the required bond.   On the bond's face appeared the annual premium, $1,680, and “penal sum,” $56,000.   Amwest's performance was conditioned as follows:  if Jama fully performed its agreement with City, then the obligation of Amwest “shall become null and void;  otherwise it shall be and remain in full force and effect.”

No other conditions appeared in the bond.   The bond did not purport to require Amwest to indemnify City against loss.   It did not condition Amwest's obligation on proof that the public improvement work had commenced, or that City had spent money or would in the future spend money actually constructing the improvements or causing them to be constructed.   Nor was the bond limited in time.

City performed as agreed and issued the Subdivision Map to Jama.

Jama never built the subdivision or the public improvements.   A new owner is now in possession of the property.

City sued to enforce the bond.

Each side moved for summary judgment based on stipulated facts:  that City and Jama had entered the agreement;  that Amwest had provided the bond;  that Jama had failed to perform the agreement with City. Neither the stipulated facts, nor any evidence presented in connection with the summary judgment motions, revealed or addressed:  how or why Jama failed to complete construction;  who the new owners are, or how they acquired the property;  whether the property can still be developed, or likely will be developed by the new owners;  whether City has incurred or likely will incur in the future expense to construct the public improvements.

The trial court denied Amwest's motion and granted City's.

Amwest appealed.

DISCUSSION

 Amwest's main argument is that performance under the bond was excused by the doctrine of “frustration of purpose” because Jama's abandonment of the development thwarted performance of the agreement between Jama and City.

The doctrine of frustration of purpose is summarized in the Restatement Second of Contracts, section 265, as follows:

“Where, after a contract is made, a party's principal purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his remaining duties to render performance are discharged, unless the language or circumstances indicate the contrary.”  (Emphasis added.)

 In other words, the party asserting the “frustration of purpose” excuse must show that performance has been frustrated by events the parties assumed would not occur.   If the event argued to cause “frustration” was among the risks the parties knowingly allocated by contract, there is no defense.

The relevant contract for this analysis, of course, is the bond.   City seeks to enforce the bond, not the agreement with Jama. Amwest was not a party to City's agreement with Jama, and Jama's default under that agreement is pertinent to the “frustration” analysis only if that default was an event which the parties to the bond did not anticipate.

Here, there was no evidence that Amwest's performance under the bond was “frustrated” by Jama's default.   Amwest's obligation was simply to pay the penal sum;  there was no showing of any impediment to doing so.

Further, the event which Amwest argues frustrated performance, Jama's failure to build out the subdivision, was not “an event the non-occurrence of which was a basic assumption on which the contract was made.”   On the contrary, Jama's non-performance was precisely the event which Amwest agreed would require it to perform.

The excuse of frustration, in short, did not remotely apply in this case.

 Nor did Amwest establish a failure of consideration for the bond.

 Amwest had the burden to prove failure of consideration.   Failure of consideration (like frustration of purpose, and other excuses for nonperformance of a contract) is an affirmative defense which the defendant must plead and prove.  (5 Witkin, California Procedure (4th ed.1997), Pleading, § 1018, pp. 469-470.)   Under Code of Civil Procedure section 437c, subdivision (o)(1), when a plaintiff moving for summary judgment has met his burden of showing each element of his cause of action, the burden shifts to defendant to demonstrate that there is a triable issue of material fact as to an element of the cause of action, or a defense thereto.   Here, City met its burden of showing that Jama breached the agreement, and that Amwest was obliged under the bond to make good Jama's breach.   Thus the burden shifted to Amwest to demonstrate that consideration for the bond had failed.

Amwest offered no evidence to prove that the $1,680 annual premium, the consideration for the bond, had not been paid.

None of the legal theories suggested in County of Yuba v. Central Valley National Bank (1971) 20 Cal.App.3d 109, 97 Cal.Rptr. 369, centrally relied on by Amwest, support Amwest's appeal.   In Yuba, as here, a municipality issued a subdivision map in exchange for a contractor's promise to build public improvements.   Defendant bank issued a letter of credit pledging to pay for these improvements if the contractor failed to complete them.   The evidence showed that the subdivision map was issued in contemplation of construction of cheap housing on unimproved agricultural land near an air base, but plans for this construction were abandoned after a major personnel reduction at the air base.   The court of appeal upheld the trial court's ruling after trial exonerating the bank from any obligation to pay on the letter of credit.

 The rationale of decision is not clearly articulated in County of Yuba, but at least three distinct theories are suggested:  (1) the obligation under the letter of credit was shown by the evidence to be conditioned on partial completion of the improvements,1 (2) enforcement of the letter would have worked a “forfeiture,” and (3) the County failed to prove any damages.   None of these rationales helps Amwest.

First, the bond did not condition Amwest's performance on construction of the subdivision.   A suretyship obligation is:

“[D]eemed to be unconditional unless its terms import some condition precedent to the liability of the surety.”  (Civil Code section 2806.)

Here, the only condition was Jama's non-performance of the work.   That having occurred, Amwest's liability arose.

 Second, Amwest also failed to show that enforcing the bond would entail an improper “forfeiture.”

Preliminarily, we note the ambiguity of the term “forfeiture” as used in the present context.   One meaning is simply the act triggering payment under the bond:

“Forfeiture of bond.   A failure to perform the condition upon which obligor was to be excused from the penalty in the bond.”  (Black's Law Dictionary.)

Another meaning, that which is invoked in Yuba, connotes payment of damages in excess of those actually suffered, as a penalty, or liquidated damages.   (See Petrovich v. City of Arcadia (1950) 36 Cal.2d 78, 84, 222 P.2d 231.)   This is the sense in which the term is used in cases and statutes which restrict damage recoveries (“the law abhors forfeitures”).   Thus, for example, Civil Code section 1442 provides that a condition involving “forfeiture must be strictly interpreted against the party for whose benefit it is created.”  (See 1 Witkin, Summary of California Law (9th ed.1987), Contracts, § 770, p. 696.)

Civil Code section 1442's requirement of “strict interpretation,” of course, implies that a sufficiently explicit clause can permissibly effect a “forfeiture,” and case law confirms this.  (Petrovich v. City of Arcadia, supra, 36 Cal.2d at 84, 222 P.2d 231 [“The foregoing cases disclose that forfeiture to the full amount of the deposit as a penalty or as liquidated damages was accomplished by express language.”].)

Here, the express language of the bond allowed the forfeiture, if forfeiture there was.   Its only condition was Jama's default.   The bond provided, not for payment of damages, or indemnity, but rather for a specific “penal sum,” suggesting a liquidated liability, without proof of the quantum of any actual loss suffered by City.

Amwest drafted the bond, and as a commercial surety was charged with knowledge that a bond is deemed unconditional unless its terms indicate otherwise.   (Civ.Code, § 2806.)   Amwest also knew or should have known that a different instrument, an indemnity bond, was available if its intent was to pay City only for actual losses:

“If a bond is conditioned to hold the obligee harmless from loss (not liability) incurred through the principal's failure to perform an obligation, the surety's obligation does not arise on default of the principal but on the obligee's sustaining an out of pocket loss as a consequence of the principal's default.  CC § 2778(2);  Alberts v. American Cas. Co. (1948) 88 CA.2d [Cal.App.2d] 891, 200 P.2d 37[citation omitted].”  (Conners, California Surety and Fidelity Bond Practice (Cont.Ed.Bar 1969) § 3.3, p. 20.)

Further, Amwest offered no evidence that payment of the penal sum would effect a “forfeiture” or penalty by compensating City in excess of out of pocket losses.   Amwest did not show that the new owner is obliged to pay for street lights and sidewalks, nor that development will not go forward eventually.   Amwest had the burden to establish an excuse for non performance, but offered no proof.

 Third, similar analysis leads to rejection of any argument that the bond should not be enforced because City suffered no damage.   The bond does not specify that City must suffer damage;  its only condition is that Jama not perform.

“The surety's liability under unconditional bonds arises immediately on default of the principal and becomes fixed without notice to or demand on the surety.   See CC § 2807.”  (Conners, California Surety and Fidelity Bond Practice, supra, § 3.4, pp. 20-21.)

Such arrangements make perfectly good commercial sense.   They relieve the beneficiary of the bond of the expense and uncertainty entailed in proving actual loss.   The bonding company's liability is in a specified amount, so it too benefits from increased certainty.   And, if the actuarial costs of paying a penal sum are higher than paying indemnity, it is safe to assume that the bonding company will charge a higher premium for the former type of bond.

Amwest's bond contemplated payment of a specific penal sum, not indemnity for City's losses or damages.   City was not required to show actual damages suffered in order to hold Amwest liable on the bond.

The trial court did not err in granting summary judgment.

DISPOSITION

The judgment of the trial court is affirmed.   Respondent shall recover its costs on appeal.

FOOTNOTES

1.   The language of the letter of credit, quoted in the opinion, to us appears to create an unconditional obligation.

NEAL, Associate Justice.

LILLIE, P.J., and WOODS, J., concur.

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