CATES CONSTRUCTION INC v. TALBOT PARTNERS (1997)

TIG Insurance, a commercial surety company formerly called the Transamerica Insurance Company (“Transamerica”) and Cates Construction (“Cates”), a building contractor, appeal from judgments entered against them and in favor of respondents Talbot Partners (“Talbot”), a developer, and The Bank of Montecito (“Bank”), Talbot's lender.   The appeals present a number of questions regarding the damages which may be assessed against a corporate surety in a lawsuit brought by performance bond obligees.   In the published portions of this opinion, we conclude, in accord with long-standing California law, that a surety's liability for compensatory damages is co-extensive with that of the principal.   We also conclude that a surety may be liable for a tortious breach of the covenant of good faith and fair dealing implied in the bond.   We affirm the award of compensatory damages in favor of Talbot and the award of compensatory damages to the Bank.   As to the award of punitive damage in favor of Talbot, we determine that the award is excessive, and reduce the award to $15 million.   Finally, we conclude that the trial court used an erroneous method for calculating pre-judgment interest.   We reverse those awards and remand to the trial court for a correct calculation.

FACTUAL AND PROCEDURAL SUMMARY

In 1989, Talbot hired Cates to build a condominium project, called the Portico, on Malibu property which Talbot had purchased for $1 million.   The construction contract provided that Cates would be paid the Cost of Work, as defined, plus a twelve percent fee;  that the project would be complete and ready for occupancy in eight months;  and that time was of the essence.   The Bank provided Talbot's construction financing, secured by a deed of trust on the property and conditioned on the issuance of a performance bond in favor of the Bank.

At the time the construction contract was signed, Talbot required Cates to furnish a performance bond and a labor and materials payment bond to assure that the project would be timely completed and that Talbot would be protected if it were not.   Cates and Transamerica executed the bonds, with Cates as principal and Talbot as obligee.   The Bank was a co-obligee on each bond under a Lender's Dual Obligee Rider executed by Transamerica and Cates.   Talbot paid the $27,000 premium on the bonds.

The performance bond provided that in the event of default by Cates, if Talbot had performed under the construction contract, Transamerica was required to promptly “1) Complete the Contract in accordance with its terms and conditions, or 2) Obtain a bid or bids for completing the Contract in accordance with its terms and conditions ․ and arrange for a contract between such bidder and Owner, and make available as Work progresses ․ sufficient funds to pay the cost of completion less the balance of the contracting price, but not exceeding ․ [$3.9 million].”   Transamerica and Cates had previously entered into an indemnity agreement which allowed Transamerica to recover from Cates all good faith disbursements made by Transamerica under the bonds.

Under a fund control agreement entered into by Talbot, Cates, and Transamerica, Cates was to submit monthly applications to Talbot for reimbursement of costs incurred.   Talbot and the Bank were to review the requests and the Bank was to disburse the funds to Surety Disbursements, which was to confirm the progress of the work and obtain lien releases before disbursing funds to Cates or to subcontractors.

Construction on the Portico project began on May 1, 1989.   Cates and Talbot agreed to various extensions of time.   At trial, Talbot waived any claim for damages through June 1, 1990.

During the course of construction, Cates submitted twenty-two payment requests which were paid as submitted.   The twenty-third request was submitted in early November 1990.   It was not paid, because both Talbot's and Cates's records showed that Talbot had already paid several hundred thousand dollars more than the Cost of Work. Attempts to resolve the problem failed.   In late November, Cates notified Talbot that unless additional amounts were paid it would abandon the job as of December 4, 1990.   On November 29, Talbot advised Transamerica of Cates's intent to default, informed Transamerica that it had paid everything it owed under the contract, and demanded that Transamerica perform under the bond.

Cates abandoned the job on December 4, 1990.   The project was incomplete and not ready for occupancy.   On December 17, 1990, Cates recorded a $645,367 mechanic's lien on the project, against Talbot.   Cates went out of business shortly thereafter.

After a good deal of correspondence and other communications between all the parties, on January 9, 1991, Transamerica informed Talbot that its position was that Talbot had breached the contract by failing to make payments, that there was a legitimate dispute between Cates and Talbot, and that Transamerica would not intercede or arrange for performance of the contract.   Correspondence and communications continued.

On February 14, 1991, at Transamerica's request, Cates gave Talbot notice of its voluntary default.   On March 1, 1991, Talbot and the Bank informed Transamerica that as a result of the delayed completion of the construction contract, Talbot was in default on its loans and the Bank was proceeding to foreclose.   There were at that time over $935,000 of mechanic's liens against the project, including the Cates lien.

In February, Cates assigned its rights against Talbot to Transamerica, and on March 14, 1991, at a time when Cates was out of business, Transamerica filed this lawsuit to foreclose on Cates's mechanic's lien, naming Cates as plaintiff.   The lawsuit was authorized by the Transamerica claims specialist handling the Talbot claim and was filed by Transamerica's attorneys.

On March 19, 1991, Transamerica, choosing the first of its options under the performance bond, began the process of completing the job.   It did so through an on-site superintendent, PCA, which was not a licensed contractor.

On May 10, 1991, Transamerica joined as plaintiff in Cates's lawsuit against Talbot.   That suit brought causes of action for breach of the construction contract, to foreclose on the mechanic's lien, and for declaratory relief.¹  Cates and Transamerica later named the Bank as a defendant.   Talbot cross-complained against Cates for breach of the construction contract and against Transamerica for recovery under the performance bond, breach of the bonds, and breach of the implied covenant of good faith and fair dealing in the bonds.   In December 1991, the Bank cross-complained against Transamerica for breach of the bonds.

The Bank foreclosed on the project on June 18, 1991.   At that time, Talbot owed the Bank $7,753,282.   Construction was not complete, some of the work was defective and required repair, and the project lacked permit sign-offs for certificates of occupancy.

By stipulation of the parties, the breach of contract claims were heard by retired Justice David Eagleson, sitting without a jury.   Justice Eagleson ruled against Transamerica and Cates on all causes of action in their complaint ² and for Talbot and the Bank on all contract causes of action in their cross-complaints.

On Talbot's cause of action for breach of contract against Cates, the court found that Cates had breached the contract, by, inter alia, failing to construct the project in good quality and free of defects;  charging rates substantially higher than standard local rates;  and using construction funds in ways other than those approved by Talbot, so that subcontractors were unpaid, resulting in mechanic's liens on the project.   The court found that all delays beyond June 1, 1990 were caused by Cates, and that if Cates had not breached the contract, the project would have been available for Talbot to sell on or before June 1, 1990.

On Talbot's causes of action against Transamerica for breach of the bonds and for recovery on the performance bond, the court found that Transamerica breached the performance bond by failing to conduct a thorough or adequate investigation of Talbot's declaration that Cates was in default and by joining in the mechanic's lien suit without such an investigation.   The court found that an investigation would have revealed that Talbot was not in default but Cates was, that Cates's abandonment of the job was unjustified, and that at the time Cates abandoned the job, Talbot had paid the full Cost of Work plus an additional sum of $276,730, and owed no further amounts.   Transamerica also breached by failing to promptly complete Cates's contract when Cates's default would have been readily apparent after an investigation.   The court found that Transamerica understood that its obligation under the performance bond was to complete Cates's contract “complete and ready for occupancy,” but that instead of fulfilling its obligation, Transamerica arbitrarily determined what work it would perform, regardless of the requirements of the contract between Talbot and Cates, and failing to promptly and fully complete Cates's contract.   The court found that Transamerica breached the labor and material payment bond by not promptly paying lien claimants.

The court also found that Transamerica's breaches of the performance bond caused the loss of the project and the damages awarded by the court, and that its breaches of the labor and materials payment bond contributed to Talbot's damages.   Transamerica was liable for all damages caused by Cates's breaches of the construction contract, and was not exonerated or excused from performance under the bonds.

The court awarded damages of $3,142,021 in favor of Talbot and against Transamerica and Cates.   Of that sum, $2,596,600 was the difference between the fair market value the project would have had on June 1, 1990, if it had been complete on that date, discounted to take into account the cost of holding and selling the units, and the amount which Talbot would have owed the Bank on that date if the project had been complete.   The court noted that this was not a calculation of profit, since it did not take into account the amount Talbot paid for the land.

The remainder of the damage award reflected the $276,730, which the court found Cates overdrew, and $268,691 which Talbot paid on the project after June 1, 1990, and which the court found would not have been paid if the contract had been performed as of that date.

As to the Bank's claims against Transamerica, the court found that the Lender's Dual Obligee rider gave the Bank the same rights Talbot had and imposed on Transamerica the same duties that it owed Talbot.   Citing Glendale Federal Savings and Loan Ass'n v. Marina View Heights Development Co., Inc. (1977) 66 Cal.App.3d 101, 135 Cal.Rptr. 802, the court found that the Bank was entitled to damages in the amount that Transamerica's noncompliance with the bonds impaired the Bank's security interest.   The court awarded the Bank $1.2 million, the difference between the fair market value of the project as of the date of foreclosure, and the amount the property would have been worth on that date if Cates had fully performed.   The court also found that the Bank was entitled to $252,295 for defective work for which Cates was responsible.

After the court's decision, a jury heard Talbot's cause of action against Transamerica for tortious breach of the implied covenant of good faith and fair dealing in the performance bond.   A different judge, the Hon. William Burby, presided over that trial.   On Transamerica's motion, the jury was not informed of the findings or the award in the breach of contract trial.   Instead, the jury heard evidence regarding the entire course of conduct between Transamerica, Cates, and Talbot.   The jury unanimously found that Transamerica was liable to Talbot for breach of the covenant of good faith and fair dealing, and found that Transamerica committed malice and oppression in the conduct which constituted the breach of that covenant.   The parties stipulated that compensatory damages would be one dollar.   After separate trial, the jury awarded Talbot $28 million in punitive damages.

Transamerica's motion for new trial on the contract causes of action was denied by Justice Eagleson.   Its motion for new trial and motion for judgment notwithstanding the verdict on the tort cause of action and the award of punitive damages was heard and denied by Judge Burby.

DISCUSSION

In the first portion of our opinion, we consider the contentions of the parties regarding the bad faith trial, including the contention that as a matter of law, the obligee on a surety bond can have no cause of action against the surety for breach of the covenant of good faith and fair dealing in the bond.   We also consider challenges to the punitive damages awarded in the bad faith trial.   In the second portion of the opinion, we consider contentions regarding the damages awarded in the breach of contract trial.   Finally, in an unpublished portion of the opinion, we resolve issues related to the calculation of pre-judgment interest.

I. Bad Faith and Punitive Damages

A. Is there a tort cause of action for breach of the implied covenant of good faith and fair dealing faith in a commercial surety contract?

 In every contract, there is an implied covenant of good faith and fair dealing that neither party will do anything which will injure the right of the other to receive the benefits of the agreement.  (Comunale v. Traders & General Ins. Co. (1958) 50 Cal.2d 654, 658, 328 P.2d 198.)   Because the covenant is a contract term, compensation for its breach has almost always been limited to contract damages, calculated in the same manner as breach of an express contract term.   In the case of insurance contracts, however, the Supreme Court has determined that an insurer's bad faith breach of the covenant provides the basis for an action in tort.  (Crisci v. Security Ins. Co. of New Haven, Conn. (1967) 66 Cal.2d 425, 58 Cal.Rptr. 13, 426 P.2d 173.)   An insurer guilty of fraud, malice, or oppression may also be liable for punitive damages.

 In the contract before us, Transamerica, a commercial surety, guaranteed that Cates, the principal, would perform the construction contract it entered into with Talbot, the obligee.   Since the contract was one of suretyship, the relationships between Transamerica and its principal and Transamerica and its obligee were governed, in part, by the Civil Code.   (Civ.Code, § 2787 et. seq.)   The task before us is to determine whether this commercial surety contract is insurance, so that a bad faith breach of the contract is tortious and can subject the surety to punitive damages, as Talbot argues;  or whether it is merely another form of commercial contract which, in the event of breach, subjects the surety only to contract damages, as Transamerica contends.   We conclude that under the Insurance Code and relevant case law, a commercial surety bond is insurance, and a commercial surety which breaches the implied covenant may be held liable in tort.   Our conclusion is reinforced by our examination of the rationale the Supreme Court has enunciated for the law of insurance bad faith.

 Are surety bonds insurance?

 Under the Insurance Code, insurance is “a contract whereby one undertakes to indemnify another against loss, damage, or liability from a contingent or unknown event.”  (Ins.Code,  § 22.) ³  The Insurance Code includes surety contracts, like automobile, marine, or disability insurance, as a class of insurance (Ins.Code, § 100), and defines surety insurance as a contract “guaranteeing of behavior of persons and ․ performance of contracts․” (Ins. Code, §105, subd.(a).)  Surety insurance may not be sold unless the insurer is authorized by the Department of Insurance to transact business in that class of insurance.  (Ins.Code, § 700;  see also California Financial Responsibility Co. v. Pierce (1991) 226 Cal.App.3d 1663, 277 Cal.Rptr. 663.)   Transamerica is so authorized,⁴ and its activities in this regard are regulated by the Department of Insurance.

In Amwest Sur. Ins. Co. v. Wilson (1995) 11 Cal.4th 1243, 48 Cal.Rptr.2d 12, 906 P.2d 1112, the Supreme Court determined that Proposition 103, which was intended to reduce the rates for regulated insurance and to establish a new system of regulation, applied to surety insurance, and that a legislative attempt to exempt surety insurance was invalid since it did not further the purposes of the proposition.  (Id. at p. 1265, 48 Cal.Rptr.2d 12, 906 P.2d 1112.)   The Court found that “Surety bonds generally are considered a form of casualty insurance.”  (Id. at p. 1249, fn. 5, 48 Cal.Rptr.2d 12, 906 P.2d 1112;  General Ins. Co. of America v. Mammoth Vista Owners Ass'n, Inc. (1985) 174 Cal.App.3d 810, 825, 220 Cal.Rptr. 291.)

Other authorities are in accord.  “Bonds guaranteeing the contracts of third persons, given by paid surety companies to indemnify the owners of property against loss from the failure of contractors to perform the conditions of building or other similar contracts, have been considered to be essentially contracts of insurance, although they may resemble in form contracts of suretyship.”  (13 Couch on Insurance (2d ed. 1982) § 47:5, p. 227;  Pacific Employers Ins. Co. v. City of Berkeley (1984) 158 Cal.App.3d 145, 152-153, fn. 3, 204 Cal.Rptr. 387.) Appleman's Insurance Law and Practice agrees:  “It has frequently been held that contracts of suretyship are regarded as those of ‘insurance,’ where a corporate surety engages in the business for a profit, and that the rights and liabilities of the parties are governed by the rules applicable to contracts of insurance.”  (Appleman, Insurance Law and Practice (1981 ed.) § 5273, p. 173.)

General Ins. Co. of America v. Mammoth Vista Owners Ass'n, Inc, supra, 174 Cal.App.3d 810, 220 Cal.Rptr. 291, Downey Savings and Loan Ass'n v. Ohio Cas. Ins. Co. (1987) 189 Cal.App.3d 1072, 234 Cal.Rptr. 835, and Pacific-Southern Mortg. Trust Co. v. Insurance Co. of North America (1985) 166 Cal.App.3d 703, 212 Cal.Rptr. 754 support our conclusion.

Mammoth Vista, supra, 174 Cal.App.3d 810, 220 Cal.Rptr. 291, allowed tort remedies for breach of the insurer's statutory duties under the Unfair Practices Act. (Ins.Code, § 790 et seq.)   In that case, General Insurance was the surety on a construction performance bond.   The contractor defaulted, General Insurance refused to complete the project, and Mammoth Vista, the obligee, sued General Insurance on a cross-complaint, bringing causes of action for bad faith under the Unfair Practices Act and the common law.   The jury awarded Mammoth Vista compensatory damages and punitive damages.   On appeal, General Insurance contended that a surety could not be liable in tort for breach of the implied covenant of good faith and fair dealing or for breach of statutory duties under the Unfair Practices Act.   The Court of Appeal, concluding that the Unfair Practices Act was a codification of the implied covenant, considered only whether an action could be brought against the surety for violation of the Unfair Practices Act.   The court found that it could, and affirmed the judgment.

Citing Insurance Code sections 22, 100, and 105, the court determined that General Insurance was engaged in the business of insurance and was subject to the Unfair Practices Act.   The court concluded, “We recognize liability insurance is not identical in every respect with suretyship.   But we are not concerned with the differences between suretyship and liability insurance.   We are concerned with whether the Legislature included suretyship among the classes of businesses it intended to regulate under the Insurance Code.   It clearly did so.  [¶] The subjection of surety insurance to the provisions of [the Unfair Practices Act] is consistent with the purpose of deterring unfair and deceptive practices in the business of insurance.   As demonstrated by this case, obligees under surety contracts are as susceptible to deceptive and unfair claims settlement practices as insurers and claimants under liability insurance contracts.”  (Id. at pp. 824-825, 220 Cal.Rptr. 291.)

Moradi-Shalal v. Fireman's Fund Ins. Companies (1988) 46 Cal.3d 287, 250 Cal.Rptr. 116, 758 P.2d 58, which determined that there is no private right of action under the Unfair Practices Act, does not require us to disregard Mammoth Vista.  Mammoth Vista considered both statutory and common law theories of bad faith.   The Court of Appeal in Mammoth Vista decided that it was unnecessary to decide whether the obligee could pursue a common law tort action because the Unfair Practices Act “sets forth standards of conduct substantially similar to those at common law.”  (Mammoth Vista, supra, 174 Cal.App.3d at p. 823, 220 Cal.Rptr. 291.)   The effect of the case, and the clear import of its reasoning, is that surety insurers are subject to the common law tort of breach of the implied covenant of good faith.  Moradi-Shalal affirmed the continued existence of that common law theory when it noted that “courts retain jurisdiction to impose civil damages or other remedies against insurers in appropriate common law actions, based on such traditional theories as ․ (as to the insured) ․ breach of the implied covenant of good faith and fair dealing.”  (Moradi-Shalal, supra, at pp. 304-305, 250 Cal.Rptr. 116, 758 P.2d 58.)  “[T]hat part of the Mammoth decision in which the court held that a surety is subject to a bad faith action under common law is not overruled by Moradi-Shalal.”  (Conners, California Surety & Fidelity Bond Practice [Update Mar 1995] §§ 12.2 to 12.3, p. 111.)

Here, Talbot, the obligee, was in the position of the insured, defined in the Insurance Code as “the person indemnified.”  (Ins.Code, § 23.)   Under the surety insurance contract before us, Talbot was to be indemnified in the event that the insured contingency, non-performance by Cates, took place.   Moradi-Shalal does not bar Talbot from bringing a common law cause of action for breach of the implied covenant of good faith and fair dealing.

Downey Savings and Loan Ass'n v. Ohio Casualty Insurance Co., supra, 189 Cal.App.3d 1072, 234 Cal.Rptr. 835 and Pacific-Southern Mortgage Trust Co. v. Insurance Co. of North America, supra, 166 Cal.App.3d 703, 212 Cal.Rptr. 754 applied basic insurance bad faith concepts to fidelity bonds.   Fidelity bonds, which guarantee “behavior of persons,” are a form of surety insurance.   (Ins.Code, § 105 subd. (a);  Sumitomo Bank of Cal. v. Iwasaki (1968) 70 Cal.2d 81, 87, fn. 5, 73 Cal.Rptr. 564, 447 P.2d 956;  Croskey, Kaufman et al., Cal.Practice Guide:  Insurance Litigation (Rutter 1995) P 6:1748, p. 6l-11.)   Both cases affirmed awards of punitive damages for breach of the implied covenant of good faith in those bonds.

In Downey Savings, Downey sued for bad faith denial of benefits under a savings and loan fidelity bond which covered losses caused by dishonest acts of Downey's employees, and additionally promised to indemnify Downey for the cost of defending lawsuits brought by a third party arising out of such a dishonest act.  (Downey Savings, supra, at pp. 1080-1081, 234 Cal.Rptr. 835.)   The Court of Appeal affirmed an award of compensatory and punitive damages.   The opinion draws no distinction between the fidelity bond and any other form of insurance.   In affirming the award, Justice Kennard wrote “The law implies a covenant of good faith and fair dealing in every insurance contract.   (Gruenberg v. Aetna Ins. Co. (1973) 9 Cal.3d 566, 575, 108 Cal.Rptr. 480, 510 P.2d 1032.)   Therefore, when an insurer unreasonably and in bad faith withholds payment on a claim of its insured, it is subject to liability in tort.  (Egan v. Mutual of Omaha Ins. Co. [1979] 24 Cal.3d 809, 818 [169 Cal.Rptr. 691, 620 P.2d 141].)   An insurer may also breach the covenant of good faith and fair dealing when it fails to properly investigate its insured's claim.  (Id., at p. 817 [169 Cal.Rptr. 691, 620 P.2d 141].)   Under this implied promise, in determining whether to settle a claim, the insurer must give ‘at least as much consideration to the welfare of its insured as it gives to its own interests.’  (Id., at p. 818 [169 Cal.Rptr. 691, 169 Cal.Rptr. 691].)”  (Downey Savings, supra, 189 Cal.App.3d at p. 1096, 234 Cal.Rptr. 835.)

Pacific-Southern Mortgage, supra, 166 Cal.App.3d 703, 212 Cal.Rptr. 754, affirmed an award for tortious breach of the covenant of good faith in a commercial blanket bond in which INA promised to indemnify Pacific-Southern for fraudulent acts committed by its employees.  (Id. at p. 708, 212 Cal.Rptr. 754.)   The Court of Appeal considered and rejected a challenge to the sufficiency of the evidence, finding substantial evidence that INA had breached its duty to attempt to effectuate a prompt settlement of the claim.   The court cited Gruenberg v. Aetna Ins. Co., supra, for the rule that “[a]n insurer is under an obligation to act fairly and in good faith in discharging its contractual responsibilities.   If it fails to deal fairly and act in good faith, by refusing, without proper cause, to compensate the insured for a loss covered by the policy, such conduct may give rise to a cause of action in tort for breach of the implied covenant of good faith and fair dealing.”   (Pacific-Southern Mortgage Trust Co., supra, at p. 715, 212 Cal.Rptr. 754)

Transamerica disputes the relevance of Downey Savings and Pacific-Southern Mortgage.   It argues that the cases are not applicable because fidelity bonds, unlike performance bonds, involve only two parties, and because the bonds agreed to answer for fraudulent or criminal conduct, not breach of contract.   The first point is an important one, to which we will return.   As to the second point, however, Transamerica fails to advance any logical reason why the difference in the risk which is shifted should lead to a different result regarding the law of bad faith.

To summarize, Mammoth Vista, supra, tells us that surety insurance is subject to the common law of bad faith, and that a bad faith suit may be brought by the obligee.  Pacific-Southern Mortgage Trust Co. v. Insurance Co. of North America, supra, and Downey Savings & Loan, supra, indicate that insurance bad faith remedies need not be limited to liability or property polices.   Again, commentators agree.  “A ‘bad faith’ claim can be based on a surety's unreasonable failure (‘without proper cause’) to pay its obligation on a surety bond.   The same implied covenant of good faith and fair dealing applicable to insurance contracts generally applies to surety bonds.”   (Croskey, Kaufman et al., Cal.Practice Guide:  Insurance Litigation (Rutter 1995) P 6:2049, p. 6I-63;  see also Conners, California Surety & Fidelity Bond Practice [Update May 1995] §§ 12.2 to 12.3, pp. 112-117.)

In support of its argument that a surety bond is not insurance and that bad faith remedies are not available, Transamerica cites Lumbermens Mutual Casualty Co. v. Agency Rent-A-Car, Inc. (1982) 128 Cal.App.3d 764, 180 Cal.Rptr. 546, Airlines Reporting Corp. v. United States Fidelity and Guaranty Co. (1995) 31 Cal.App.4th 1458, 37 Cal.Rptr.2d 563, Schmitt v. Insurance Co. of North America (1991) 230 Cal.App.3d 245, 281 Cal.Rptr. 261 and U.S. for Benefit and Use of Ehmcke Sheet Metal Works v. Wausau Ins. Companies (E.D.Cal.1991) 755 F.Supp. 906.   We do not find the cases authority for the result Transamerica seeks.

Lumbermens held that a motor vehicle financial responsibility bond was not insurance for purposes of a statute determining priority of coverage when two or more automobile liability insurance policies apply to the same loss.⁵  Airlines Reporting, supra, concerns a surety bond which covered certain defaults of the principal, a travel agent.   Using contract principles, the court determined that the bond did not cover theft losses for which Airlines Reporting, the obligee, was seeking payment.   However, both courts also compared the surety contract at issue with liability insurance and concluded, in dicta, that a surety bond is not insurance.

Both Lumbermens and Airlines Reporting noted several differences between surety insurance and liability insurance.   Unlike liability policies, the bonds at issue were written to protect the obligee (in Lumbermens, members of the public) and not the principal.   The principal on a bond is not in the same position as an insured in a liability policy, since the surety is entitled to recover from the principal.  Lumbermens further noted that the bond did not require the surety to provide a defense to the principal or to pay to settle a claim unless the principal had defaulted.  Airlines Reporting drew another distinction, that an insurer undertakes to indemnify against loss, damage, or liability arising from an unknown or contingent event, while a surety promises to answer for the debt, default, or miscarriage of another.   (Lumbermens, supra, at pp. 769-770, 180 Cal.Rptr. 546;  Airlines Reporting, supra, at p. 1464, 37 Cal.Rptr.2d 563.)

That analysis is of limited relevance to the issue before us, since it largely focuses on the relationship between surety and principal, while we are concerned with the relationship between surety and obligee.   Further, the distinction between indemnification for loss and the promise to answer for default drawn by Airlines Reporting does not seem to us to comport with the Insurance Code, which does not distinguish between kinds of risk, but speaks only of shifting risk.

Neither Lumbermens nor Airlines Reporting referred to the fact that surety contracts are insurance for regulatory purposes under the Insurance Code, and both cases were decided before Amwest Surety Insurance Company, supra, 11 Cal.4th 1243, 48 Cal.Rptr.2d 12, 906 P.2d 1112.   The cases thus do not change our conclusion, that a surety bond is insurance and that the law of bad faith applies.

Transamerica argues that Schmitt v. Insurance Co. of North America, supra, 230 Cal.App.3d 245, 281 Cal.Rptr. 261 establishes that there can be no cause of action against a surety for bad faith.   We disagree.  Schmitt involved a complex set of facts concerning a statutory bond issued by INA, the surety, to a used-car dealer, the principal.   The obligees were customers who purchased a used car and later made a claim on the bond.   Both the dealer and the customers sued INA for, inter alia, breach of the implied covenant of good faith and fair dealing.   In the holdings relevant to the question before us, Schmitt found that the principal was not an insured, and that INA could not be liable to the dealer for bad faith.   In this regard, the court said, “it is not the duty of the surety to protect the principal as if the principal were an insured under an insurance policy.   The surety's duty runs to the third-party obligee․”  (Id. at p. 258, 281 Cal.Rptr. 261.)   The court then concluded that the customer-obligees had not produced evidence that INA acted in bad faith.   We thus do not read the case to hold that there can be no cause of action for bad faith by an obligee against a surety, but only that such a case was not stated in Schmitt.

Schmitt discussed Mammoth Vista, supra, Downey Savings and Loan, supra, and Pacific-Southern Mortgage, supra, and summarily distinguished them, noting that in both Downey Savings and Pacific-Southern Mortgage the courts referred to the contracts at issue as ones of insurance.   The court concluded that, unlike the bond in Schmitt, those bonds must have had sufficient incidents of insurance so that they could be dealt with under the law of insurance.  (Schmitt, supra, at pp. 261-263, 281 Cal.Rptr. 261.)

As to Mammoth Vista, the court distinguished that case from the facts of Schmitt, finding that the case “must be read in the context of the particular tripartite relationship that existed from the very beginning of the execution of the owner's completion bond, one involving a specific project to be completed by a certain time and giving rise to reasonable expectations in all three parties involved concerning these known factors.   The date and scope of nonperformance by the principal and the existence and extent of loss experienced by the named obligee due to the nonperformance are readily ascertainable in a case such as Mammoth Vista.   A simple visit to the site after the date completion was due would have established the conditions necessary to give rise to the surety's obligation due to the principal's failure to complete the contract.”  (Id. at p. 260, 281 Cal.Rptr. 261.)   Thus, Schmitt impliedly acknowledged that a bad faith cause of action could be maintained by the obligee on a performance bond.   We note that Schmitt ' s analysis of performance bond litigation matches the facts of the case before us.   As Justice Eagleson and the jury found, Cates's duties were clear to Cates, Talbot, and Transamerica.   Cates's nonperformance was easily ascertainable, as was Transamerica's duty, and the losses suffered by Talbot.

Finally, we consider U.S. for Benefit and Use of Ehmcke Sheet Metal Works v. Wausau Ins. Companies, supra, 755 F.Supp. 906, which concerned a labor and materials payment bond governed by the Miller Act.  (40 U.S.C. §§ 270a et seq.)   Subcontractors were permitted to sue on the bond in the name of United States, the bond obligee, for sums due from the contractor.  (Id. at p. 908.)   Ehmcke, a subcontractor, sued the contractor for breach of contract and sued the surety for breach of the covenant of good faith and fair dealing in the bond.   The federal court determined that the California Supreme Court would not allow the bad faith suit.   In making its determination, the court reviewed the factors the California Supreme Court relied on when deciding, in Moradi-Shalal, supra, 46 Cal.3d 287, 250 Cal.Rptr. 116, 758 P.2d 58, that the Unfair Practices Act did not allow a third party claimant to sue an insurer for violation of the statute.   Those factors included the possibility of multiple litigation, the possibility of inflated settlement demands, the possible conflict of interest for the insurer, and the existence of administrative sanctions under the statutory scheme.

We do not find the federal court's reasoning persuasive.   First, the court summarily dismissed Mammoth Vista, Downey Savings, and Pacific-Southern Mortgage.   Further, the case ignores the fact that Moradi-Shalal did not eliminate an insured's common law cause of action for bad faith, despite the possibility of increased settlement demands or the availability of administrative remedies.   Moreover, Ehmcke Sheet Metal analogized the obligee on a performance bond to the third party claimant on a liability policy.   We do not see that the analysis is apt.   The obligee is not in the position of a third party claimant in liability insurance, who is stranger to the contract.   The obligee is the insured, that is, the party which sought to shift risk and to be compensated in the event of loss.   (Ins.Code, § 23.)   To analogize to a common liability insurance scenario, the obligee on a performance bond is not in the position of the purchaser of a defective product, but of an insured manufacturer which understood the risk of defect (as Talbot understood the risk that Cates might breach its contract) and sought protection.   As Schmitt noted “[t]he surety's duty runs to the third party obligee.”  (Schmitt, supra, 230 Cal.App.3d at p. 258, 281 Cal.Rptr. 261.)

We have determined that under the Insurance Code and relevant case law, a surety bond is insurance, and like other kinds of insurance is subject to the law of insurance bad faith.   We have also determined that under existing case law, a bond obligee may bring a cause of action for breach of the implied covenant of good faith and fair dealing.   Our conclusion is reinforced by our examination of the rationale for the bad faith law enunciated by the Supreme Court.   The functions and attributes of the bond before us fall under that rationale.

 Insurance Bad Faith

The Supreme Court has explained that the rule of law which allows recovery of tort damages for breach of the implied covenant of good in faith in insurance contracts, as distinct from other contracts, is based on the unique characteristics of insurance.   In Foley v. Interactive Data Corp. (1988) 47 Cal.3d 654, 254 Cal.Rptr. 211, 765 P.2d 373, the Supreme Court said:  “In Egan v. Mutual of Omaha Ins. Co. [1979] 24 Cal.3d 809 [169 Cal.Rptr. 691, 620 P.2d 141], we described some of the bases for permitting tort recovery for breach of the implied covenant in the insurance context.  ‘The insured in a contract like the one before us does not seek to obtain a commercial advantage by purchasing the policy-rather, he seeks protection against calamity.’   (Id., at p. 819 [169 Cal.Rptr. 691, 620 P.2d 141].)   Thus, ‘As one commentary has noted, “The insurers' obligations are ․ rooted in their status as purveyors of a vital service labeled quasi-public in nature.   Suppliers of services affected with a public interest must take the public's interest seriously, where necessary placing it before their interest in maximizing gains and limiting disbursements․  [A]s a supplier of a public service rather than a manufactured product, the obligations of insurers go beyond meeting reasonable expectations of coverage.   The obligations of good faith and fair dealing encompass qualities of decency and humanity inherent in the responsibilities of a fiduciary.”  (Goodman & Seaton, Foreword:  Ripe for Decision, Internal Workings and Current Concerns of the California Supreme Court (1974) 62 Cal.L.Rev. 309, 346-347.)’  (24 Cal.3d at p. 820 [169 Cal.Rptr. 691, 620 P.2d 141].)[¶]  In addition, the Egan court emphasized that ‘the relationship of insurer and insured is inherently unbalanced:  the adhesive nature of insurance contracts places the insurer in a superior bargaining position.’  (24 Cal.3d at p. 820 [169 Cal.Rptr. 691, 620 P.2d 141].)”  (Foley, supra, 47 Cal.3d at pp. 684-685, 254 Cal.Rptr. 211, 765 P.2d 373.)

Later, in Hunter v. Up-Right, Inc. (1993) 6 Cal.4th 1174, 26 Cal.Rptr.2d 8, 864 P.2d 88, the Court compared insurance contracts with employment contracts.   The Court said “In the insurer-insured relationship, the parties' interests are financially at odds:  if the insurer pays a claim, it diminishes its own fiscal resources.   By contrast, the interests of employer and employee are typically aligned:  if there is a job to be done, the employer must pay someone to do it.   A breach in the employment relation does not place the employee in the same economic dilemma that an insured faces when an insurer in bad faith refuses to pay a claim or to accept a settlement offer within policy limits.   If an insurer takes such actions, the insured cannot turn to the marketplace to find another insurance company willing to pay for the loss already incurred.   A terminated employee, on the other hand, can (and must, in order to mitigate damages) make reasonable efforts to find alternative employment.”  (Id. at p. 1181, 26 Cal.Rptr.2d 8, 864 P.2d 88.)

We take each of these factors in turn, considering its application to the surety insurance before us.   First, the Supreme Court tells us that the law of bad faith is applied to insurance in part due to the “economic dilemma” faced by the purchaser of insurance when the insurer refuses in bad faith to perform.   At the time the insured suffers a loss, it has fully performed;  that is, it has paid the premiums.   It can do no more than trust that the insurer will perform in turn.   If the insurer does not, however, the insured is left without the recourse open to the non-breaching party to other kinds of contracts.   It cannot turn to the marketplace to procure other protection against the loss, in the way an employee can secure a new job or the purchaser of goods can secure substitute goods if the supplier breaches a sales contract.  (Foley, supra, 47 Cal.3d at p. 692, 254 Cal.Rptr. 211, 765 P.2d 373;  Hunter, supra, 6 Cal.4th at p. 1181, 26 Cal.Rptr.2d 8, 864 P.2d 88.)   As to this factor, Talbot was in the position of any other insured.   It could not seek new protection against the loss caused by Cates's nonperformance, which was already incurred, but was limited to the protection it had already purchased from Transamerica.

Next, like other kinds of insurance, this performance bond was not purchased for a profit, but to protect from calamity.  (Foley, supra, 47 Cal.3d at pp. 684-685, 254 Cal.Rptr. 211, 765 P.2d 373.)   An obligee does not hope to profit from the purchase of the bond, as it might hope to profit from the purchase of an item for resale.   Instead, it hopes only to be protected from the misfortune and loss which would be caused by the principal's nonperformance.   In an insurance policy, “peace of mind and security are the principle benefits for the insured.”  (Love v. Fire Ins. Exchange (1990) 221 Cal.App.3d 1136, 1148, 271 Cal.Rptr. 246.)   Those are the benefits Talbot sought through purchase of the performance bond.

The Supreme Court has articulated another reason for allowing tort damages for breach of the implied covenant of good faith in an insurance contract:  in insurance, unlike other contracts, the economic interests of the parties are at odds.  (Hunter v. Up-Right, supra, 6 Cal.4th at p. 1181, 26 Cal.Rptr.2d 8, 864 P.2d 88;  Foley v. Interactive Data Corp., supra, 47 Cal.3d at p. 693, 254 Cal.Rptr. 211, 765 P.2d 373.)   Here, too, surety insurance is like other kinds of insurance, and unlike any other form of contract.   When a surety insurer pays a claim, it diminishes its own financial resources.   It is not in the position of an employer which must hire someone to do the job.   It is precisely in the position of an insurer which has collected its premiums with the understanding that no pay-out may ever be necessary, and which may be tempted to place its own interests ahead of its legal obligation when a claim is made.

The Supreme Court has also repeatedly emphasized the quasi-public nature of the insurance industry.  Barrera v. State Farm Mut. Auto. Ins. Co. (1969) 71 Cal.2d 659, 79 Cal.Rptr. 106, 456 P.2d 674 explains:  “It has long been recognized that “the business of insurance is quasi public in character”․   The purpose and nature of (life) insurance (contracts), and the duties which the insurer assumes under such contracts, and the manner in which such contracts are negotiated, impress such contracts and the relationship of the parties, even during the negotiations, with characteristics unlike those incident to contracts and negotiations for contracts in ordinary commercial transactions.”  (Id. at p. 668, fn. 5, 79 Cal.Rptr. 106, 456 P.2d 674, internal citations omitted.)  Barrera was concerned with the motor vehicle financial responsibility law, but it is clear that the quasi-public nature is not limited to insurance required by statute to protect members of the public.   The payment of benefits on life insurance, for example, does not raise concerns about the protection of the public, yet life insurance companies are said to conduct business of a quasi-public nature.  (Wells v. John Hancock Mut. Life Ins. Co. (1978) 85 Cal.App.3d 66, 71, 149 Cal.Rptr. 171;  see also Loree v. Robert F. Driver Co., Inc. (1978) 87 Cal.App.3d 1032, 1036-1037, 151 Cal.Rptr. 557 [suit against broker for failure to procure SBA guaranty on performance bond supported by law regarding quasi-public nature of insurance business].)   Bad faith remedies apply to that kind of insurance, as they do to a homeowner's insurance against theft, to health insurance, and to other forms of insurance which do not involve the compensation of third parties for loss.   (Croskey, Kaufman et al., Cal.Practice Guide:  Insurance Litigation (Rutter 1995) P 12:4, p. 12A-1.)

The quasi-public nature of the insurance industry arises from the purpose and nature of the contracts and the duties which the insurer assumes.   That is, the quasi-public nature arises from the contingent nature of the contract and the public's interest in promoting the conduct of business and personal affairs with confidence that in the event of calamity, there is protection.   These factors apply equally to performance bond surety insurance, which is vital to real estate development.   The participants in such a transaction-here, the developer and lender-conduct themselves with the expectation that if a contractor cannot or will not perform, the surety will step in.

 Transamerica argues that the rationale of the bad faith law does not apply to this bond, and that, even if the performance bond is insurance, it is a different kind of insurance, and should exempt from the law of bad faith.   We see no distinction between this performance bond and other forms of insurance which would justify an exemption from the law of bad faith.

First, Transamerica argues that the bond was not purchased to protect against calamity, but as part of a “commercial profit-making venture.”   The argument misunderstands the concept.  “Protection from calamity” does not mean protection from personal disaster as opposed to financial loss.   Insurance is routinely purchased to protect against financial loss in commercial ventures.   Even a homeowner may purchase insurance in part to protect an anticipated profit on the eventual sale of the home.   It is no less insurance for that reason, and the bad faith tort is allowed.

 Transamerica similarly argues that, unlike the underlying loss suffered by an insured, Talbot's loss was “purely economic,” and that Talbot, or another performance bond obligee, is not as vulnerable after a principal breaches as an insured would be after other kinds of losses.   It is true that when Talbot sought benefits from Transamerica no individual was as personally vulnerable as, for instance, a sick or disabled insured confronting the bad faith of a health or disability insurer.   However, the bad faith remedy is not limited to individual insureds or to health or disability policies, but is available to all insureds, including those who seek to protect against economic loss.   In fact, the Supreme Court has characterized the quasi-public insurance company (as distinct from an employer) as one “with whom individuals contract specifically in order to obtain protection from potential specified economic harm.”  (Foley, supra, 47 Cal.3d at p. 692, 254 Cal.Rptr. 211, 765 P.2d 373, emphasis added.)

When Talbot asked Transamerica to perform, it owed substantial sums on its loans, it faced a declining real estate market in which the value of its investment was diminishing, and it risked the loss of the project to foreclosure.   It had fully performed on its contracts with Cates and Transamerica and depended on Transamerica to perform in turn, so that it might be saved from ruin.   In the context of insurance law, this is vulnerability.   It arises from the contingent nature of the contract and the fact that the insurer is not called on to perform until, from the point of view of the insured, something has gone amiss.

Transamerica contends that unlike an insured which must depend on its insurer, Talbot was not dependent on it, because Talbot had a remedy against Cates, the breaching principal.   The insured's lack of other recourse is not one of the reasons the Supreme Court has given for allowing bad faith claims on insurance contracts, no doubt because that is not necessarily a characteristic of the insurer-insured relationship.   For instance, an individual injured in an accident has the right to seek funds from the tortfeasor who caused the accident, rather than from its health insurance carrier.   And, the insurer has the right through subrogation to seek such recovery from that tortfeasor, just as Transamerica had the right, through its indemnification agreement, to seek recovery from Cates.   These facts do not change insurer's obligation to its insured.

We note, too, that for an obligee, the need for a construction performance bond may rest in part in uncertainty about the financial reliability of a principal, and a fear that in the event of a breach, the principal might be unable to respond in damages, or that it might be difficult or expensive to obtain those damages from the principal.   That was certainly true in this case.   Talbot might have had a remedy against Cates from a legal point of view, but as a practical matter, the remedy was a mirage.   It ill becomes a surety which is the beneficiary of the obligee's uncertainty about the principal to assert the principal's potential liability to the obligee as a defense against bad faith.

Transamerica similarly argues that in the insurance context, the insured will turn to the insurer as the only source of relief from disaster and that “it would be against public policy for insurers to take advantage of an insured's plight and either deny a claim outright or force the insured to settle for considerably less than the circumstances warrant.”   As we understand the case, that is exactly what the jury found here.  “As demonstrated by this case, obligees under surety contracts are as susceptible to deceptive and unfair claims settlement practices as insurers and claimants under liability insurance contracts.”  (Mammoth Vista, supra, 174 Cal.App.3d at pp. 824-825, 220 Cal.Rptr. 291.)

Another distinction raised by Transamerica concerns the fact that while many insurance policies are written on forms drafted by the Insurance Services Organization (“ISO”), there is no indication that this performance bond was written on such a form.  (Montrose Chemical Corp. of California v. Admiral Ins. Co. (1995) 10 Cal.4th 645, 671, fn. 13, 42 Cal.Rptr.2d 324, 913 P.2d 878;  Garcia v. Truck Ins. Exchange (1984) 36 Cal.3d 426, 438, 204 Cal.Rptr. 435, 682 P.2d 1100.)   Moreover, Transamerica argues, while most insureds have no ability to negotiate the contracts or define the obligations of the insurer, Talbot had the ability to bind its surety and to protect itself through the negotiation of the underlying contract.

Nothing in the record indicates that the performance bond at issue was written on an ISO form.   However, the bond is on a printed form which bears Transamerica's name, and the record does not establish that Talbot negotiated any term, or indeed that Transamerica was open to negotiation.   We have not been directed to any case which holds that bad faith damages are not available where the insurance contract is a negotiated, rather than a form, document, and we know of none.  (See California Insurance Law & Practice, Matthew Bender, 1997, § 13.02[2][b], p. 13-11.)   Further, we do not see how, through negotiation of the underlying contract, Talbot could have prevented either Cates's breach or Transamerica's.   In negotiating the underlying contract an obligee can attempt to insert terms which make the principal's breach less likely or which provide specific remedies if breach occurs, but even the most carefully drafted contract cannot guarantee performance.   It is for that reason that an obligee obtains surety insurance.   In this way, too, this insurance is like other forms of insurance.   An insured manufacturer attempts to prevent loss by selling safe products, and an insured homeowner may take fire prevention precautions for the same reason, but both will obtain the relevant insurance.   Similarly, an insurer may decline to write products insurance for the manufacturer of unsafe products or to bond an unreliable contractor.

Transamerica raises other arguments which it contends are determinative of the question before us.   These generally concern the special provisions regarding surety contracts in the Civil Code.   We note in this regard that the fact that the contracts are governed in part by statutes outside the Insurance Code is not of critical importance.   Certain aspects of a liability insurer's obligation to its insured, concerning the appointment of counsel, are regulated in the Civil Code (Civ.Code, § 2860) and motor vehicle insurance is highly regulated in the Vehicle Code.   We look to the substance of the regulation, and not the mere fact of regulation.

First, Transamerica argues that allowing bad faith damages is inconsistent with the rule that a surety may assert against the obligee all the defenses available to the principal.  (Kalfountzos v. Hartford Fire Ins. Co. (1995) 37 Cal.App.4th 1655, 1658, 44 Cal.Rptr.2d 714;  Civ.Code, §§ 2809, 2810.)   We see no inconsistency.   No insurer commits bad faith by asserting legitimate defenses to coverage where those defenses are appropriate (see Neal v. Farmers Ins. Exchange (1978) 21 Cal.3d 910, 921-922, 148 Cal.Rptr. 389, 582 P.2d 980), and a surety insurer does not commit bad faith by asserting, in good faith, the defenses legitimately available to it.

There is, however, a meaningful point in this regard.   Unlike the traditional insurance relationship, a performance bond involves a tripartite relationship.  (Airlines Reporting Corp. v. U.S. Fidelity and Guar. Co., supra, 31 Cal.App.4th at p. 1464, 37 Cal.Rptr.2d 563.)   A surety may owe duties to both the obligee and the principal.  U.S. for Benefit and Use of Ehmcke Sheet Metal, supra, 755 F.Supp. at p. 911, expressed a legitimate concern, that the application of insurance bad faith remedies to surety insurance could result in problems for a surety which sought to honor its obligation to both its principal and its obligee.   We do not, however, believe that this problem is sufficiently serious so that we must disregard the rest of our analysis and hold that surety insurance is exempted from the law of tortious bad faith.   Similar problems face insurers in other areas.   In Egan v. Mutual of Omaha Ins. Co. (1979) 24 Cal.3d at p. 819, 169 Cal.Rptr. 691, 620 P.2d 141, the Court said that “[a]lthough we recognize that distinguishing fraudulent from legitimate claims may occasionally be difficult for insurers, ․ an insurer cannot reasonably and in good faith deny payments to its insured without thoroughly investigating the foundation for its denial.”   As is the case with other forms of insurance, what is required is reasonable, good faith behavior consistent to the obligee with the terms of the contract and the promises made.

It is outside the scope of this opinion to delineate the scope and nature of the surety's duty to the principal.   The questions actually presented to us leave us fully occupied.   We emphasize, however, that a surety does not commit bad faith to its obligee merely by fulfilling, in good faith, its legal obligation to its principal.

Next, Transamerica cites the rule that the liability on a surety cannot exceed that of the principal (Civ.Code, § 2809), and argues that the award of bad faith damages and punitive damages against a surety would violate this rule.   This argument was considered and rejected in Mammoth Vista, supra, 174 Cal.App.3d 810, 220 Cal.Rptr. 291.   That case interpreted cases such as U.S. Leasing Corp. v. duPont (1968) 69 Cal.2d 275, 70 Cal.Rptr. 393, 444 P.2d 65, which hold that a surety's liability cannot exceed that of the principal.  Mammoth Vista held that U.S. Leasing “merely stated the principle that the surety's obligation to cover losses occasioned by the breach of the principal is limited to those losses it expressly agreed to guarantee.   U.S. Leasing does not hold a surety cannot be held liable in tort for its independent violation of statutory or common law duties in the handling of a claim under the bond.”  (Mammoth Vista, supra, at p. 826, 220 Cal.Rptr. 291;  emphasis in the original.)   Similarly, Mammoth Vista held that Civil Code section 2809 expresses “only the rule enunciated in U.S. Leasing that the surety's express contractual liability may not exceed that of the principal.  Section 2809 does not purport to restrict the surety's independent liability for violation of duties imposed by law.”  (Ibid.)

Finally, Transamerica argues that the doctrine of efficient breach should apply, that is, that the interests of society lie in discouraging contract performance when the cost of performance exceeds the expected benefit to the promisee, and that allowing bad faith damages for breach of the implied covenant of good faith in a surety bond would discourage sureties from breaching their obligations under those bonds, contrary to those societal interests.

We do not see that the doctrine has application here.   Presumably, Talbot paid Transamerica $27,000 because it recognized the doctrine and wished to be protected in the event Cates efficiently breached, to Talbot's detriment.   If efficient breach were acceptable to the obligee, there would be no need to purchase a performance bond as insurance.

The resolution of the question is by no means simple.   However, having examined the nature of the performance bond before us, the rationale of the insurance bad faith law and the public interest in assuring performance of surety bonds, expressed by the Legislature when it included surety insurance in the Unfair Practices Act and in other regulatory provisions of the Insurance Code, we can but conclude that the surety insurance here is like insurance, and unlike other kinds of contracts, in all the relevant ways, and that an obligee may bring a cause of action for breach of the implied covenant of good faith and fair dealing in surety insurance.⁶

B. Jury instructions**

C. Sufficiency of the evidence for punitive damages

 Transamerica contends that the evidence is insufficient for the jury findings of malice and oppression, by clear and convincing evidence.   (Civ.Code, §§ 3294, subd. (c)(1) and (c)(2).)   Viewing the evidence in the light most favorable to the judgment, we find that the record contains sufficient evidence to support the jury's findings.  (Patrick v. Maryland Cas. Co. (1990) 217 Cal.App.3d 1566, 1576, 267 Cal.Rptr. 24.)

Transamerica argues that the record establishes only that it was “caught in the middle” of a dispute between Talbot and Cates, and that it did not perform under the bond because it did not know whether it was Talbot or Cates which was in default.   Transamerica states Talbot's case as one alleging only that Transamerica negligently failed to investigate Talbot's claim.   That was not Talbot's case.   Talbot's theory was that Transamerica conducted a sham investigation, withheld information, delayed, and deliberately avoided coming to a conclusion about Cates's default and Talbot's performance, despite its knowledge of Talbot's impending loss of the project, all so that it could avoid its obligations under the bonds and could instead collect on Cates's mechanic's lien, which had been assigned to Transamerica and which Transamerica contended was superior to the Bank's lien.   Transamerica argues that there is no evidence that it concluded that Cates was at fault, but still refused to perform.   Talbot's case, however, was that Transamerica deliberately avoided acquiring the knowledge which would require it to perform.   That is sufficient.

Talbot introduced evidence in support of its theory.   Under the fund control agreement between Cates, Talbot, and Transamerica, Surety Disbursements was to receive disbursements from the Bank, confirm the progress of work, and obtain lien releases before disbursing funds to Cates or to subcontractors.   Talbot's accounting expert, Henry Stostenberg, testified that a thirty minute review of Surety Disbursements' cash journal and backup documentation revealed that the October 1989 payment of $255,000 to Cates was suspect, that the post-dated backup for the request was “bogus,” and that other draw requests revealed “double-dipping” by Cates and overpayments of Cates's fee.   It took Stostenberg less than a week to calculate the Cost of Work from Surety Disbursements' records, but Transamerica never did so.   Similarly, Transamerica never reviewed many of the relevant documents, and never made a determination of how much Talbot owed Cates, or how much Talbot had paid.

Talbot's expert witness on insurance industry practices testified that Transamerica had access to everything needed to make prompt decisions and that nothing in the claims file showed Transamerica's reason for not performing on the bonds.   Talbot presented evidence that it repeatedly requested performance from Transamerica, forwarding documents, financial information and analyses, and information about subcontractors who had not been paid.   Talbot repeatedly informed Transamerica that Cates had refused to give Talbot its records, that Cates had diverted money from the job, that the work was not complete, that the existence of liens made it impossible to refinance or sell the project, that the liens and the fact that the project was incomplete had rendered futile Talbot's attempts to sell individual units, and that foreclosure was an increasing possibility.   In February, Talbot also informed Transamerica that the City of Malibu would soon come into existence, potentially delaying by months the issuance of a certificate of occupancy.

In response to Talbot's repeated requests, Transamerica engaged in “dilatory fumbling,” requested additional documentation and information, much of which had already been provided, and told Talbot that “we can't take the position and decide who's right and who's wrong.” ⁸  Transamerica knew that Cates's financial and accounting records were inaccurate and unreliable, but did not inform Talbot of that fact, and continued to assert that there was a legitimate dispute, based in part on those records.

Transamerica also responded by advising Talbot that its failure to market individual units constituted a breach of its duty to mitigate damages, and by demanding all contract receivables or retention funds due or to become due to Cates.   For example, in early February, Transamerica informed Talbot that Transamerica was in the process of investigating the claims and asked Talbot for information about the amount of contract funds being held by Talbot, “and, if the project is not completed, the amount of contract funds available for completion, and your estimated time and cost for completion.”   Talbot had already repeatedly informed Transamerica that the project was not complete, that marketing attempts had proved futile, and that no funds were due to Cates.

Transamerica refused Talbot's request that it perform under a reservation of rights, saying “Transamerica can't take the risk of putting its money forward if we can't get it back.”   Even after March 1, 1991, when Transamerica agreed to do some work on the project, Transamerica told Talbot that it would not complete the project ready for occupancy.

Transamerica also took the position that neither Cates's abandonment of the job in December nor Cates's February 14, 1990 letter of voluntary default meant that Cates was in default.   At trial, Transamerica witnesses testified that the February letter only protected Transamerica's right to any receivables.   Talbot argued that Transamerica took this position only to avoid payment.

Also in support of its theory that Transamerica willfully refused to investigate, Talbot produced evidence regarding Cates's mechanic's lien.⁹  That evidence was that prior to the time the suit to foreclose on the lien was filed, Talbot had informed Transamerica that the amount of the lien bore no resemblance to any sum Cates had previously claimed to be owed.   A Transamerica claims specialist testified that he then authorized filing of the lawsuit without investigating the validity of the lien, despite the fact that the complaint's factual allegations regarding the amounts Talbot owed were not in accord with Transamerica's own calculations.   The Transamerica attorney who filed the suit testified that he took the amount from Cates's lien without further investigation.

In denying Transamerica's motion for new trial, Judge Burby summarized the evidence in support of the jury finding of malice:  “․ Transamerica could not explain how they came up with that number as alleged in that pleading ․ they had nothing to back it up, they just pulled it out of thin air․   They come up with this number and go after Talbot with it, and nothing to back it up.   No numbers, no nothing.” ¹⁰  Judge Burby also said, “The jury could have very well found that that investigation was a sham.   It's just a coverup.   That's what they could have found.”

Transamerica argues that punitive damages cannot be assessed because there was no evidence that it had established policies or practices of bad faith claims handling, and that its performance on Cates's other projects establishes that its treatment of Talbot was an isolated incident which should not give rise to punitive damages.   The argument cannot prevail.   Evidence of policies or practices is often cited by appellate courts reviewing punitive damages in insurance bad faith cases (Mock v. Michigan Millers Mut. Ins. Co. (1992) 4 Cal.App.4th 306, 329, 5 Cal.Rptr.2d 594), but it is not required.   In Neal v. Farmers Ins. Exchange, supra, 21 Cal.3d 910, 148 Cal.Rptr. 389, 582 P.2d 980, the Supreme Court upheld an award of punitive damages, citing evidence from which the jury could have concluded that the defendant had made a calculated attempt to take advantage of a series of tragedies affecting the insured in order to effect a settlement at a bargain price and retain money rightfully due the insured.  (Id. at pp. 928-929, 148 Cal.Rptr. 389, 582 P.2d 980.)   Similarly, Talbot presented evidence that Transamerica made a deliberate decision to take advantage of Talbot's financial weakness, so that it could retain the money rightfully due Talbot.   Further, as Talbot argues, Transamerica's own evidence was that its actions were a matter of deliberate company policy.   Transamerica's claims specialist testified that he treated this claim as he did other surety claims, in accordance with Transamerica policies.   Transamerica's expert witness testified that Transamerica's practices were in accord with standard industry practices.

Talbot cites the evidence that the obligees on the other Cates projects bonded by Transamerica were governmental entities, as were the obligees on the majority of Transamerica's other performance bonds, and argues that Transamerica dared not default on those projects for fear of losing future business.   Transamerica knew from Talbot's own description of its plight and from a Dun & Bradstreet financial report which it obtained that Talbot posed no such risk, and did not even have the resources to defend the mechanic's lien suit.   With this information about Talbot's financial weakness, Transamerica made a calculated decision to treat Talbot as it did.   Thus, Talbot presented evidence that Transamerica chose to honor its obligations only where it was in its long-term financial interest to do so, and to hurt the obligee with the least ability to fight back.   All this evidence states a case of malice and oppression, and supports the jury finding.

 Tomaselli v. Transamerica Ins. Co. (1994) 25 Cal.App.4th 1269, 31 Cal.Rptr.2d 433, cited by Transamerica, does not compel another result.   There, the Court of Appeal found insufficient evidence to support an award of punitive damages.   The court found that the insurer's conduct was negligent, in that it failed to follow up on information provided by the insured;  over-zealous, in that it took an unnecessary deposition of the insured;  legally erroneous, in that it relied on an endorsement which had not been delivered;  and callous, in that it failed to communicate with the insured.  (Id. at p. 1288, 31 Cal.Rptr.2d 433.)   Here, in contrast, Talbot presented evidence that Transamerica used tactics of deliberate delay and sham investigation to avoid its obligations to Talbot and to recoup some of its losses on Cates's other projects.   Transamerica did so while fully aware that a business was being destroyed.   The jury was entitled to find that Transamerica's conduct was not mere error, negligence, callousness, or excess of zeal.

D. The amount of the punitive damage award 11

Transamerica contends that the $28 million punitive damage award must be reversed under California law, since it is grossly excessive, and under federal law, since it violates federal guarantees of due process under BMW of North America v. Gore (1996) 517 U.S. 559, 116 S.Ct. 1589, 134 L.Ed.2d 809. We examine the award under all applicable standards.

 California standards

 Under California law, we review an award of punitive damages to determine whether the award is excessive as a matter of law or raises a presumption that it is the product of passion or prejudice.   We evaluate the award under three criteria:  the nature of the defendant's wrongdoing, the actual harm to the plaintiff, and the defendant's wealth.  (Neal v. Farmers Ins. Exchange, supra, 21 Cal.3d 910, 928, 148 Cal.Rptr. 389, 582 P.2d 980;  Adams v. Murakami (1991) 54 Cal.3d 105, 109-110, 284 Cal.Rptr. 318, 813 P.2d 1348.)   These factors are not evaluated under a rigid formula.   Calculation of punitive damages “involves, instead, ‘a fluid process of adding or subtracting depending on the nature of the acts and the effect on the parties and the worth of the defendants.   Juries within this framework have a wide discretion in determining what is proper.’  [Citation.]”  (Devlin v. Kearny Mesa AMC/Jeep/Renault, Inc. (1984) 155 Cal.App.3d 381, 387-390, 202 Cal.Rptr. 204.)

 Whether punitive damages should be awarded and the amount of such an award are issues for the jury and for the trial court on a new trial motion.   All presumptions favor the correctness of the verdict and judgment.  (Finney v. Lockhart (1950) 35 Cal.2d 161, 164, 217 P.2d 19.)   Nevertheless, impartial review of a punitive damage award by an appellate court is an important part of the procedural due process to which a defendant subject to punitive damages is entitled under both the state and federal constitutions.  (Pacific Mut. Life Ins. Co. v. Haslip (1991) 499 U.S. 1, 15-16, 111 S.Ct. 1032, 1041-42, 113 L.Ed.2d 1;  Las Palmas Associates v. Las Palmas Center Associates (1991) 235 Cal.App.3d 1220, 1256-1258, 1 Cal.Rptr.2d 301.)   Appellate review for passion and prejudice provides defendants with an additional safeguard to ensure that the award does not exceed an amount necessary to accomplish the societal goals of punishment and deterrence.   (Las Palmas Associates, supra, at p. 1257, 1 Cal.Rptr.2d 301.)  “[T]he key question before the reviewing court is [thus] whether the amount of damages ‘exceeds the level necessary to properly punish and deter.’  [Citations.]”  (Adams v. Murakami, supra, at p. 110, 284 Cal.Rptr. 318, 813 P.2d 1348.)

 Federal standards

 In BMW v. Gore, supra, 517 U.S. 559, 116 S.Ct. 1589, 134 L.Ed.2d 809, the United States Supreme Court affirmed the principle that “punitive damages may properly be imposed to further a State's legitimate interest in punishing unlawful conduct and deterring its repetition.”   The Court further found that “[o]nly when an award can fairly be characterized as ‘grossly excessive’ in relation to these interests does it enter the zone of arbitrariness that violates the Due Process Clause of the Fourteenth Amendment” of the federal Constitution.  (Id. at p. ----, 116 S.Ct. at p. 1595.)   The Court held that a federal excessiveness inquiry must begin with an examination of the state interests that the punitive damages were designed to serve.   (Ibid.)  The Court went on to identify three “guideposts” to be applied in determining whether a defendant received fair notice, consistent with due process, of the conduct which could result in punishment and of the severity of the punishment which might be imposed.¹²  These guideposts are similar to the standards set out in California law.   They are the degree of reprehensibility of the conduct, the disparity between the harm suffered and punitive damage award, and the difference between the award and the civil penalties authorized or imposed in similar cases.  (--- U.S. at pp. ---- - ----, 116 S.Ct. at pp. 1598-99.)

 The state's interest

In California, the principle purpose of a punitive damage award is to “deter acts deemed socially unacceptable and, consequently, to discourage the perpetuation of objectionable corporate policies.”  (Egan v. Mutual of Omaha, supra, 24 Cal.3d 809, 820, 169 Cal.Rptr. 691, 620 P.2d 141.)  “[T]he quintessence of punitive damages is to deter future misconduct.”  (Adams v. Murakami, supra, 54 Cal.3d at p. 110, 284 Cal.Rptr. 318, 813 P.2d 1348.)   The jurisprudence of insurance bad faith establishes that California has a strong interest in deterring bad faith conduct by insurance companies.  “The availability of punitive damages is thus compatible with recognition of insurers' underlying public obligations and reflects an attempt to restore balance in the contractual relationship.”  (Egan, supra, at p. 820, 169 Cal.Rptr. 691, 620 P.2d 141.)   The state's interests strongly apply to performance bonds such as this one.   As we have previously discussed, participants in a real estate development rely, as they must, on surety insurance to guarantee timely completion of a project.   Indeed, in this case Talbot presented testimony that if it had been unable to locate a contractor which could procure a performance bond guaranteeing timely completion, it would have sold the land rather than develop it, and that it had had an opportunity to sell the land at a $2 million profit.   The state has an interest in assuring that parties are able to make such decisions with confidence, and can reliably predict that a surety will perform if it is required to do so.

In contrast, the state interest in BMW was in protecting consumers by assuring that automobile dealers selling new cars fully disclose small presale repairs.   Nothing in BMW suggests that Alabama, the state in question, held that interest dear.

 Nature of the wrongdoing

 The United States Supreme Court found that “Perhaps the most important indicium of the reasonableness of a punitive damage award is the degree of reprehensibility of the defendant's conduct.”  (BMW v. Gore, supra, 517 U.S. at p. ----, 116 S.Ct at p. 1599.)   Transamerica argues that this was a “run-of-the-mill” dispute and that it committed no affirmative act of misconduct, but merely omitted to act in good faith.   Transamerica argues that the worst conclusion that can be drawn from its conduct is that it should have “investigated the dispute more quickly and jumped in sooner to take Cates's place.”  BMW does draw a distinction between cases which involve “deliberate false statements, acts of affirmative misconduct, or concealment of improper motive,” and those which do not.  (Id. at p. ----, 116 S.Ct. at p. 1600.)   However, where, as here, the essence of the defendant's duty is a duty to act, a failure to act is hardly blameless.   Moreover, Talbot presented evidence from which the jury could properly have concluded that Transamerica committed affirmative acts relating to delay, continued requests for information, and continued false assertions that the dispute was legitimate and the investigation underway.   Even when Transamerica “jumped in,” and began to work on the project, its conduct, according to the unchallenged finding of Justice Eagleson, was not adequate or prompt, was inconsistent with its contractual obligations, and caused Talbot's loss of the project through foreclosure.

 Transamerica was required by its contract with Talbot to investigate Talbot's claim and to pay on the bond.   Transamerica ignored the fact that it had, for a fee, assumed a risk, and instead took the position that “Transamerica can't take the risk of putting its money forward if we can't get it back.”   This is precisely the position that California has clearly forbidden for almost forty years.   An insurer may not put its own interests ahead of the interests of its insured.  (Comunale v. Traders & General Ins. Co., supra, 50 Cal.2d 654, 659, 328 P.2d 198.)   This is a factor which weighs against Transamerica, and which supports a finding that the conduct was truly reprehensible.

Transamerica argues that Talbot was not damaged by its bad faith, but only suffered harm through Cates's breach of the construction contract.   Not so.   Talbot presented evidence that as a result of Transamerica's bad faith, it was forced to spend all that remained of its own funds in an attempt to keep work on the project going until Transamerica fulfilled its duties under the bond.   Justice Eagleson specifically found that Transamerica's bad faith caused the project to be at a standstill for three months and that Transamerica's breaches caused the loss of the project.   Transamerica not only breached its duty to clear the mechanic's liens on the project, it exacerbated its breach by taking assignment of Cates's lien and authorizing a lawsuit to foreclose on that lien, which had been assigned to Transamerica, without conducting any investigation of the lien amount.   This bad faith conduct disabled Talbot from taking any positive action in its own behalf, since the liens and the lawsuit made it impossible for Talbot to refinance the project or to sell those individual units which had been completed.   Further, Transamerica engaged in this conduct after ascertaining that Talbot no longer had the funds to defend a mechanic's lien suit.   Transamerica did not in good faith investigate the dispute between principal and obligee, but it did obtain a Dun & Bradstreet report on its obligee, that is, its insured.   These factors, too, weigh in favor of finding reprehensible conduct.

However, under BMW, there are facts in Transamerica's favor on this point.  “[E]vidence that a defendant has repeatedly engaged in prohibited conduct while knowing or suspecting that it was unlawful would provide relevant support for an argument that strong medicine is required to cure the defendant's disrespect for the law.  [Citation.]   Our holdings that a recidivist may be punished more severely than a first offender recognize that repeated misconduct is more reprehensible than an individual instance of malfeasance.”  (BMW v. Gore, supra, at pp. ---- - ----, 116 S.Ct. at p. 1599-1600.)   As Transamerica argues, there is no evidence that its treatment of Talbot was other than an isolated incident.   Further, Transamerica argues that other facts indicate that no “strong medicine” is required to deter future misconduct.   Those facts are that the employee responsible for the Talbot claim no longer works for Transamerica, that Transamerica has undergone a corporate reorganization, and that it no longer writes construction performance insurance.   We consider those facts.

The United States Supreme Court in BMW also noted as a factor indicating that the defendant's conduct was not particularly reprehensible evidence that the plaintiff's damages in that case were purely economic, and that the conduct did not endanger public health or safety.   Those factors are true of Transamerica's conduct here.   We note, however, that Talbot produced evidence that it was financially vulnerable, and that Transamerica acted deliberately and willfully in reliance on Talbot's weakening financial condition.  BMW also found that “infliction of economic injury, especially when done intentionally through affirmative acts of misconduct [citation] or when the target is financially vulnerable, can warrant a substantial penalty.”  (BMW v. Gore, supra, at p. ----, 116 S.Ct. at p. 1599.)

 Comparison to actual harm

 Both California and federal law require us to examine the reasonableness of the ratio between the punitive damages and the actual harm suffered by the plaintiff, although no fixed ratio or simple mathematical formula is determinative of reasonableness.  (BMW v. Gore, supra, at p. ----, 116 S.Ct. at p. 1601;  Finney v. Lockhart, supra, 35 Cal.2d 161, 164, 217 P.2d 19;  Neal v. Farmers Ins. Exchange, supra, 21 Cal.3d at p. 928, 148 Cal.Rptr. 389, 582 P.2d 980.)

 Transamerica argues that the relevant ratio is between the $28 million in punitive damages and the one dollar stipulated as compensatory bad faith damages.   We do not agree.   Rather, we examine the punitive award in comparison to the actual harm Talbot suffered.   Transamerica conceded as much at trial.   There, in light of the fact that Transamerica had prevailed on its motion to keep from the jury the results of the breach of contract trial, and in order to avoid re-trying damage issues, Talbot offered to waive bad faith damages above one dollar.   The parties stipulated to that sum as bad faith damages, and at the bad faith phase of the trial the jury was instructed that “If you find that Transamerica breached the implied covenant of good faith and fair dealing, then the parties have stipulated that the damages caused by the breach are one dollar.”   However, when the jury was asked to determine the amount, if any, of punitive damages, it was not directed to assess damages in comparison to the stipulated dollar.   Instead, at the request of both parties, the jury was instructed that “If you determine that punitive damages should be assessed ․ in arriving at the amount of such an award, you must consider ․ (3) That the punitive damages must bear a reasonable relation to the injury, harm, or damage actually suffered by the plaintiff.”

The instruction was correct.  “[T]o meaningfully apply the ‘reasonable relation’ rule, the trier of fact (and reviewing court) should not focus on some bottom-line amount of an award of compensatory damages but on the nature and degree of the actual harm suffered by the plaintiff․  [Citation.]”   (Gagnon v. Continental Cas. Co. (1989) 211 Cal.App.3d 1598, 1604, 260 Cal.Rptr. 305.)

Transamerica argues that this case is similar to BMW v. Gore in that in both cases the harm was de minimis.   In BMW the plaintiff suffered a potential loss of $4,000 in the eventual resale of his luxury automobile.   Here, the evidence was that Talbot Partners was a family-owned business which had invested $3.2 million of family funds in the Portico project, that Talbot lost the project through foreclosure, that as of the date of Talbot's claim on the bond, Talbot owed the Bank $7.2 million, and that after the foreclosure Talbot's ability to do business as a developer was finished.   That is not de minimis damage.

 Statutory penalties

“Comparing the punitive damage award and the civil or criminal penalties that could be imposed for comparable misconduct provides a third indicium of excessiveness.”  (BMW v. Gore, supra, at p. ----, 116 S.Ct. at p. 1603.)   A reviewing court must accord substantial deference to legislative judgments concerning appropriate sanctions for the conduct at issue.  (Ibid.)

In BMW, the maximum civil penalty which could have been imposed on the defendant was $2,000.   Here, the applicable penalties are found in the Insurance Code, which gives the Commissioner of Insurance the power to examine and investigate the affairs of any person engaged in the business of insurance to determine whether that person is engaged in any unfair or deceptive act or practice (Ins.Code, § 790.04), to issue an order to show cause and hold hearings (Ins.Code, §§ 790.05, 790.06), and to issue cease and desist orders and require the insurer to pay penalties not to exceed $10,000 for each willful act.  (Ins.Code, § 790.035;  10 Cal.Code Regs. §§ 2695.1 et seq.)   Willful violation of a cease and desist order subjects the offender to a fine of up to $55,000.  (Ins.Code, § 790.07.)   The Commissioner also has the power to suspend an insurer's license to engage in the business of insurance in California.  (Ins.Code, § 704.)

 Wealth

 Under California law, “[w]ealth is an important consideration in determining the excessiveness of a punitive damage award.   Because the purposes of punitive damages are to punish the wrongdoer and to make an example of him, the wealthier the wrongdoer, the larger the award of punitive damages.  (Bertero v. National General Corp. (1974) 13 Cal.3d 43, 56, 118 Cal.Rptr. 184, 529 P.2d 608.)”  (Downey Sav. and Loan Ass'n v. Ohio Cas. Ins. Co., supra, 189 Cal.App.3d 1072, 1099-1100, 234 Cal.Rptr. 835.)   The evidence on this subject was that Transamerica had $2 billion in annual income;  total assets of $6.3 billion, invested in a solid, safe portfolio;  and a net worth, considering assets, liabilities, and reserves, of $1.4 billion.   Operating expenses, totaling about $575 million a year, and claims, totaling about $1 billion a year, were paid from annual income.   In an SEC filing, Transamerica stated that a $40 million refund to California policyholders would not have a material adverse effect on its financial position.   The jury's award was less than one week's worth of gross income, approximately 3.5 weeks of net income, and 2 percent of net worth.  (See Neal v. Farmers Ins. Exchange, supra, 21 Cal.3d at p. 929, 148 Cal.Rptr. 389, 582 P.2d 980 [affirming award of less than one week's net income];  Moore v. American United Life Ins. Co. (1984) 150 Cal.App.3d 610, 197 Cal.Rptr. 878 [award of 3.4 weeks of defendant's net income not excessive];  Downey Sav. and Loan, supra, 189 Cal.App.3d 1072, 234 Cal.Rptr. 835 [award of one percent of net worth and 3.64 weeks of net income not excessive].)

 Analysis

Considering all these factors, we cannot agree with Transamerica that the award must be vacated in its entirety, but neither can we agree with Talbot that the award must be affirmed in full.

California has a strong state interest in deterring insurance bad faith.   Transamerica's conduct was reprehensible, in that it took advantage of Talbot's financial plight and in that it was in direct contravention of long-standing California law.   Talbot's damages were substantial.   Transamerica's great wealth justifies an award which is sufficiently large to “punish the wrongdoer.”   However, even if those factors mean that the award was not the result of passion and prejudice so that it could be affirmed under California law, federal due process requirements mandate a reduction in the amount.

Like the actual harm in BMW, the damage here was purely economic and did not endanger the public health or safety.   There was no evidence that Transamerica was a recidivist which had previously engaged in bad faith behavior similar to the behavior in this case, and there was some evidence that Transamerica has made efforts to reduce the likelihood that it will offend again.   The Insurance Commissioner has great power to investigate and penalize, but the punitive damages awarded by the jury are much higher than the monetary penalties which may be imposed.   Neither the ratio between $28 million and the loss of a $3.2 million project, and indeed the ability to do business, nor the ratio between $28 million and the $3.1 million in compensatory damages ¹³ approaches the “breathtaking” five hundred to one ratio which caused the Supreme Court in BMW v. Gore to “ ‘raise a suspicious judicial eyebrow’ [citation].”  (BMW v. Gore, supra, at p. ----, 116 S.Ct. at p. 1603.)   Nonetheless, a ratio in the order of nine to one, as this is, can be said to be “close to the line” of federal constitutional impropriety.  (Id. at p. ----, 116 S.Ct. at p. 1602.)

On balance, then, the facts justify a substantial penalty which is sufficient to punish an entity of great wealth for an egregiously wrongful act, but not an award which so far exceeds the applicable statutory penalty and the actual harm done to the plaintiff as this one does.   We conclude that the amount awarded by the jury is in excess of the sum necessary to satisfy the state's “legitimate interests in punishing unlawful conduct and deterring its repetition.”  (BMW v. Gore, supra, at p. ----, 116 S.Ct. at p. 1595.)

We believe that an award of $15 million is commensurate with Transamerica's wrong-doing, Transamerica's wealth, Talbot's injury, and the state's interest in good faith performance of insurance contracts, as expressed in the jurisprudence of insurance bad faith and the statutory penalties adopted by the Legislature.   That amount, slightly more than half the sum awarded by the jury, is roughly five times the actual economic harm caused by the bad faith conduct and represents approximately one percent of Transamerica's net worth.

 Where, as here, punitive damage issues have been fully litigated in the trial court and a punitive damage award is demonstrably excessive, a reviewing court may, in the interests of justice and judicial economy, modify a punitive damage award to that amount which it has determined is the upper limit of a legally acceptable award.  (Las Palmas Associates v. Las Palmas Center Associates, supra, 235 Cal.App.3d at p. 1256, 1 Cal.Rptr.2d 301.)   We do so here, by reducing the award to $15 million.

II. The Contract Judgment

A. Exoneration***

B. Talbot's damages

1. Measure of damages

The court awarded Talbot $2.596 million on its causes of action for Cates's breach of the construction contract, for recovery under the performance bond, and breach of the bond contracts.   That amount is the difference between the fair market value of the project on June 1, 1990, if it had been complete, and the amount which Talbot would have owed the Bank on that date.   Transamerica agrees that the award is correct as to Cates,¹⁶ and does not argue that lost equity is an improper measure of damages, but contends that it is responsible only for damages attributable to its delay in completing construction, and not for damages caused by Cates's failure to timely complete the project.   We disagree.

Transamerica makes two arguments.   First, it argues the rule that the liability of a surety cannot be extended beyond the terms of the bond, citing U.S. Leasing Corp. v. duPont, supra, 69 Cal.2d 275, 70 Cal.Rptr. 393, 444 P.2d 65.   Next, Transamerica points out that Amerson v. Christman (1968) 261 Cal.App.2d 811, 68 Cal.Rptr. 378, which affirmed an award of consequential damages against a surety, is contrary to cases from other states, and asks us to find that consequential damages such as delay damages may not be assessed against a surety.

 Transamerica's argument on U.S. Leasing Corp. v. duPont cannot prevail.   Transamerica was not assessed damages beyond the terms of the bond.   Rather, the trial court applied the rule that the liability of a surety is co-extensive with that of the principal (Civ.Code, § 2809), and the rule that when the principal on a performance bond defaults on the underlying contract, the surety assumes the principal's obligations and is liable to the obligee for all damages resulting from the principal's failure to perform.  (U.S. Leasing Corp. v. duPont, supra, at p. 290, 70 Cal.Rptr. 393, 444 P.2d 65;  Pacific Employers Ins. Co. v. City of Berkeley, supra, 158 Cal.App.3d 145, 204 Cal.Rptr. 387, 13 Couch on Insurance (2d ed. 1982) § 47:12, p. 236;  Croskey, Kaufman et al., Cal.Practice Guide:  Insurance Litigation (Rutter 1995) P 6:1710, p. 6I-3, P 6:1960, p. 6I-46.) The trial court correctly assessed damages on that basis.

Transamerica was also liable for those damages because the bond incorporates the underlying contract by reference.¹⁷  In that situation, “the two instruments must be read together in order to determine the scope of [the surety's] undertaking.”  (Roberts v. Security Trust & Savings Bank (1925) 196 Cal. 557, 575, 238 P. 673, overruled on another ground in Peter Kiewit Sons' Co. v. Pasadena City Jr. College Dist. of Los Angeles County (1963) 59 Cal.2d 241, 245, 28 Cal.Rptr. 714, 379 P.2d 18.)  “ ‘[T]he liability of a surety on a contractor's performance bond does not rest solely on the terms of the bond, but grows out of and is dependent upon the terms of the contractor's contract․’  ( [13] Couch [on Insurance (2d ed. 1982) ] § 47:20, pp. 240-242, fns. omitted.)”  (Pacific Employers Ins. Co. v. City of Berkeley, supra, 158 Cal.App.3d at pp. 150-151, 204 Cal.Rptr. 387 [surety bound by construction contract's liquidated damages clause];  Boys Club of San Fernando Valley, Inc. v. Fidelity and Deposit Co. of Maryland (1992) 6 Cal.App.4th 1266, 8 Cal.Rptr.2d 587 [surety bound by construction contract's arbitration clause].)

 Transamerica next asks us to reject Amerson v. Christman, supra, 261 Cal.App.2d 811, 68 Cal.Rptr. 378, and determine that a surety cannot be liable for consequential damages caused by a contractor's delay in completion.   In that case, Christman, a contractor, breached his contract to build a home for Amerson.   Hartford, the surety, failed to remedy the default.   The Court of Appeal affirmed an award of damages against Christman or Hartford, jointly, for the cost of completing the project at current prices.  (Id. at p. 823, 68 Cal.Rptr. 378.)   Christman and Hartford were also held liable for all damages proximately caused by the breach, such as loss of use of the house and the additional costs of caring for the Amerson family.   The court cited the rule that the liability of the surety is coextensive with that of the principal, and the language of the bond, which, like the bond here, obliged Hartford to either complete the project or make available sufficient funds to complete the project “including other costs and damages for which the Surety may be liable hereunder․”   The court held that “a fair reading of the terms of the bond indicates an intent to reimburse Amerson for damages consequentially caused by the contractor's breach and the ensuing construction delays.   We therefore hold that Hartford is equally liable, along with Christman, for incidental damages proximately flowing from the breach.”  (Id. at p. 825, 68 Cal.Rptr. 378.)

Transamerica asks us to follow American Home Assur. Co. v. Larkin General Hosp., Ltd. (1992) 593 So.2d 195, in which the Florida Supreme Court specifically rejected the reasoning and result of Amerson.  American Home Assur. Co. reviewed a performance bond which was in pertinent part identical to the one before us, and held, contrary to Amerson, that the surety was not liable for consequential damages caused by delay in completing a project, but only for the cost of completion.  (See also L & A Contracting Co. v. Southern Concrete Services, Inc. (5th Cir.1994) 17 F.3d 106, 111, following American Home Assurance Co;  and New Amsterdam Cas. Co. v. Bettes (1966) 407 S.W.2d 307.)

We believe that Amerson was correctly decided and should be followed.   It is consistent with other California case law and a variety of authorities which hold that both direct and consequential damages are recoverable on a performance bond, and that damages are recoverable against a surety to the same extent that they are recoverable against the principal.   (Burnett & Doty Development Co. v.C.S. Phillips (1978) 84 Cal.App.3d 384, 148 Cal.Rptr. 569;  Roberts v. Security Trust & Savings Bank, supra, 196 Cal. 557, 238 P. 673;  Pacific Employers Ins. Co. v. City of Berkeley, supra, 158 Cal.App.3d 145, 204 Cal.Rptr. 387;  Appleman, Insurance Law and Practice (1981 ed.) §§ 6331, 6333, pp. 69, 74;  Construction Law, Steven G.M. Stein, Ed., Matthew Bender, 1996, Vol. 3, [¶] 17.07[3], pp. 17-78 to 17-79;  Croskey, Kaufman et al., Cal.Practice Guide:  Insurance Litigation (Rutter 1995) P 6:2025, p. 6I-58;  K. Sobel, Owner Delay Damages Chargeable to Performance Bond Surety (1984) 21 Cal. Western L. Rev 128.)

The measure of damages on breach of contract is “the amount which will compensate the party aggrieved for all the detriment proximately caused thereby, or which, in the ordinary course of things, would be likely to result therefrom.”  (Civ.Code, § 3300.)   Here, Transamerica was liable to Talbot for damages caused by Cates's breach of the construction contract, including breach of the provision establishing a completion date for the project.   The measure of damages applied by the trial court was correct, under Amerson, Civil Code section 3300, and other California law cited herein.

 II.B.2.-II.C.†

III. Interest on the Judgments.†

DISPOSITION

The judgment in favor of Talbot and against Transamerica is modified to reduce the amount of punitive damages to $15 million.   The matter is remanded to the trial court for a recalculation of prejudgment interest on the awards to Talbot and to the Bank.   The judgment is in all other respects affirmed.

Talbot Partners and the Bank of Montecito to recover costs on appeal.

FOOTNOTES

1.   Transamerica and Cates also sued an individual, Peter Alevra, as a Talbot general partner.   The case against Alevra was disposed of in Alevra's favor under Code of Civil Procedure section 631.8, and Transamerica was ordered to pay Alevra $80,624 in attorney's fees and costs.   Transamerica has not appealed that portion of the judgment.

2.   Those rulings have not been appealed.

3.   That definition has two elements:  a risk of loss to which one party is subject based on contingent or future events and a contract which shifts that risk to another, and the distribution of that risk among similarly situated persons.  (Metropolitan Life Ins. Co. v. State Bd. of Equalization (1982) 32 Cal.3d 649, 654, 186 Cal.Rptr. 578, 652 P.2d 426.)   The fact that a contract contains these two elements does not in and of itself mean that the contract is one of insurance.   Rather, courts ask whether assumption of the risk is the principal purpose of the contract.   (Title Ins. Co. of Minnesota v. State Bd. of Equalization (1992) 4 Cal.4th 715, 725-726, 14 Cal.Rptr.2d 822, 842 P.2d 121.)   Here, the principal purpose of the contract was to shift from Talbot to Transamerica the risk that Cates would not perform on its contract with Talbot.   Transamerica is a corporate surety engaged in business for a profit.   At the time Transamerica issued the Talbot bonds, it had $45 million outstanding in bonds for Cates, and had distributed sixty percent of this risk through reinsurance.

4.   Talbot's request that we take judicial notice of the authorization is granted.

5.   In response to Lumbermens, the Legislature amended the relevant statute.  Insurance Code section 11580.9 now provides that a surety bond is a policy of liability insurance for purpose of the statute.  (Grand Rent A Car Corp. v. 20th Century Ins. Co. (1994) 25 Cal.App.4th 1242, 1250, 31 Cal.Rptr.2d 88.)

6.   Our conclusion is by no means unique.   This issue had been considered by the courts of several states.   The supreme courts of Arizona (Dodge v. Fidelity and Deposit Co. of Maryland (1989) 161 Ariz. 344, 778 P.2d 1240), North Dakota (Szarkowski v. Reliance Ins. Co. (1987) 404 N.W.2d 502), Alaska (Loyal Order of Moose, Lodge 1392 v. International Fidelity Ins. Co. (1990) 797 P.2d 622), and Montana (K-W Industries, a Division of Associated Technologies, Ltd. v. National Surety Corporation (1988) 231 Mont. 461, 754 P.2d 502) have determined that a surety can be liable to its obligee in tort for violation of the duty of good faith.  (But see Great American Insurance Co. v. North Austin Municipal Utility District No. 1 (1995) 908 S.W.2d 415 [Texas].)

FOOTNOTE.   See footnote *, ante.

8.   It is true that Talbot's attorney told Transamerica's claims specialist that Transamerica faced a “tough decision.”   He also said “You're going to have to pick one or the other, but that's what you're getting paid to do.   That's what the bond was paid for, and you need to make the decision who's right and who's wrong, or tell me what other information you need to know because this project is going to go under if we don't get you on there.”

9.   The jury was instructed that “Transamerica had an absolute right to file a complaint to foreclose on the mechanic's lien recorded by Cates Construction and to use any legal means available to enforce the mechanic's lien.   The privilege to file and prosecute an action to foreclose on a mechanic's lien is absolute.   The only reason the Court let in evidence of the complaint on the mechanic's lien ․ was for the limited purpose of showing the amount of the lien, the Transamerica claims information and investigation.”

10.   Danny Cates's deposition testimony, introduced to impeach Cates in the contract phase of the trial, was that the lien amount was computed from various sums Cates believed were owing, with an “extra couple hundred thousand” added for safety's sake.

11.   Talbot's request that we take judicial notice of the judgment of the Superior Court in Reliance Insurance v. TIG Insurance Company is denied.

12.   We need not dwell on Transamerica's argument that since California law has not permitted punitive damages for breach of the implied covenant of good faith in surety insurance, notice was constitutionally defective.   It should have been clear since 1985 that a surety insurer might be exposed to punitive damages if it engaged in conduct which constituted tortious breach of the implied covenant of good faith and fair dealing.  (General Ins. Co. v. Mammoth Vista Owners Assn, supra, 174 Cal.App.3d 810, 220 Cal.Rptr. 291;  Grimshaw v. Ford Motor Co. (1981) 119 Cal.App.3d 757, 174 Cal.Rptr. 348.)

13.   The ratio would become even lower if we were to consider the $956,845 in attorney's fees Talbot was awarded in the court trial.

FOOTNOTE.   See footnote *, ante.

16.   Cates argues that the trial court erred in using the date of June 1, 1990 to determine fair market value, rather than December 4, 1990, contending that the court found that it breached the contract on the later date.   We see no error.   The court found that Cates should have completed the project by June 1, 1990, and that all delays after that date were attributable to Cates.   Calculation of lost equity with reference to the June 1, 1990 fair market value is the logical result of that finding.

17.   Although Transamerica argues that the performance bond here is not incorporated by reference, the bond specifically provides that the construction contract “is by reference made a part hereof.”

FOOTNOTE.   See footnote *, ante.

ARMSTRONG, Associate Justice.

TURNER, P.J., and GODOY PEREZ, J., concur.