HALTERMAN v. UNITED STATES FIDELITY GUARANTY COMPANY (1990)

OPINION

In a tort and contract action filed by subcontractor Ron Halterman, dba Big Bear Masonry (plaintiff), against United States Fidelity and Guaranty Co. (defendant) based on defendant's payment bond issued to indemnify plaintiff's principal, Encon Construction Company (Encon), plaintiff has appealed from a judgment on the pleadings in favor of defendant.   The first impression issue presented by this case is whether a beneficiary of a payment bond can state a cause of action against the surety solely for breach of the covenant of good faith and fair dealing.   We hold the beneficiary cannot state such a cause of action, and, therefore, the trial court properly granted defendant's motion for judgment on the pleadings.

BACKGROUND

Plaintiff and Encon executed a written agreement which provided that plaintiff would perform masonry work on a building for the Lake Arrowhead Community Services District (the District) for $23,500.   As part of its contracting for this project, Encon, acting as a general contractor for the District, had purchased a so-called payment bond from defendant, required as part of the public contracting procedures provided for by statute.

Almost two years after the agreement between plaintiff and Encon had been executed, plaintiff filed a two-count complaint against defendant.   The complaint was titled “COMPLAINT AGAINST SURETY ON LABOR AND MATERIAL PAYMENT BOND.”   In count one plaintiff alleged, in relevant part, that:  (1) Encon and defendant had executed a payment bond (the bond) for the protection of all persons supplying labor and materials for the District's building;  (2) plaintiff had provided all the labor and materials required by its contract with Encon;  (3) plaintiff had also supplied extra labor and materials pursuant to change orders requested by Encon;  (4) plaintiff had performed all of its obligations “to the value of $27,254.40”;  (5) plaintiff had been paid only $21,378.40;  (6) plaintiff had demanded from Encon and defendant the $5,876 owing to it, and its demands had been refused;  (7) plaintiff had incurred $7,500 in attorney's fees, and was entitled to recover such fees from defendant.¹

In count two plaintiff incorporated the allegations of count one and also alleged that:  (1) the bond contained an implied covenant of good faith and fair dealing and defendant had impliedly agreed that it would in good faith deal fairly and honestly with claimants under the bond, such as plaintiff;  (2) defendant had breached the covenant by:  (a) refusing to pay plaintiff the benefits due it pursuant to the provisions of the bond;  (b) failing to make an adequate investigation before such refusal;  (c) failing to provide plaintiff with any reasonable basis for the refusal;  (d) compelling plaintiff to initiate litigation to recover such benefits, and (e) representing to plaintiff that its claim would be paid, all for the purpose of lulling plaintiff into inaction until such time as plaintiff's claim would be barred.

In count one plaintiffs sought $5,876 in compensatory damages and $7,500 in attorney's fees.   In count two plaintiff sought, in addition to the foregoing, damages for loss of credit and interest on borrowed money, damages for emotional distress, and punitive (exemplary) damages.

Seven months later, plaintiff filed a first amended complaint against defendant.   The later pleading added a paragraph to the earlier count two and also added a third count.   The paragraph added to count two alleged:  “After the original complaint in this action was filed, and after defendant was notified of this action, defendant filed a separate suit against the Plaintiff alleging that Plaintiff's work was negligently performed.   The suit filed by defendant was and is specious, filed for the purpose of intimidating and causing Plaintiff to withdraw his suit against defendant and for the purpose of harassment and to save money for defendant by depriving Plaintiff of his rights under the bond.”

The new count three incorporated the allegations of the previous counts, and alleged that defendant's acts constituted a violation of Insurance Code section 790.03, subdivision (h) (unfair settlement practices).

Defendant noticed a demurrer to count three (on the ground that it was barred by the statute of limitations) and to plaintiff's request for exemplary damages.   After a hearing, the demurrer was overruled.   Defendant answered the complaint, denying its allegations and alleging several affirmative defenses.

Plaintiff and defendant then executed a “MUTUAL RELEASE,” whereby defendant paid plaintiff $8,447.17, representing the $5,876 which plaintiff alleged had been owing to him, plus interest, and plaintiff agreed to dismiss count one of its complaint.

Thereafter, the matter proceeded to trial on the bad faith and statutory causes of action.   At the outset of trial, defendant moved for judgment on the pleadings as to count two, the bad faith cause of action.   The motion was denied.

The following month, before the evidentiary phase of the trial had begun, the California Supreme Court issued its opinion in Moradi–Shalal v. Fireman's Fund Ins. Companies (1988) 46 Cal.3d 287, 250 Cal.Rptr. 116, 758 P.2d 58.   In Moradi–Shalal, the court held that a private civil litigant could not state a cause of action under Insurance Code section 790.03.

Shortly afterwards, defendant moved for non-suit, judgment on the pleadings, and dismissal.   The trial court continued the trial to allow plaintiff to brief the issue.   At the continued hearing, defendant narrowed its motion to one for judgment on the pleadings.   After hearing argument, the trial court granted the motion as to counts two and three.   As to count two, the bad faith count, the court reasoned that Moradi–Shalal barred common law actions by third party claimants, and that plaintiff was such a claimant in the case here.

Thereafter, judgment was entered in favor of defendant, and this appeal followed.

DISCUSSION

Plaintiff concedes that its third cause of action, for breach of Insurance Code section 790.03, subdivision (h), is barred by Moradi–Shalal.   Plaintiff contends, however, that its second cause of action, for breach of the covenant of good faith and fair dealing, is not barred by Moradi–Shalal, and, moreover, that the cause of action is “expressly preserved” by the following language in that case:

“[T]he courts retain jurisdiction to impose civil damages or other remedies against insurers in appropriate common law actions, based on such traditional theories as fraud, infliction of emotional distress, and (as to the insured ) either breach of contract or breach of the implied covenant of good faith and fair dealing.”  (Moradi–Shalal v. Fireman's Fund Ins. Companies, supra, 46 Cal.3d 287, 304–305, 250 Cal.Rptr. 116, 758 P.2d 58, emphasis added.)

In its opening brief on appeal, plaintiff did not argue that it was an “insured” within the meaning of the foregoing language in Moradi–Shalal.   Instead, it argued that it was entitled to pursue its second cause of action against defendant because there was a “special relationship” between it and defendant, and, under Seaman's Direct Buying Service, Inc. v. Standard Oil Co. (1984) 36 Cal.3d 752, 206 Cal.Rptr. 354, 686 P.2d 1158, the aggrieved party in such a relationship may pursue a bad faith cause of action against the other party.

Defendant responded to plaintiff's argument by pointing out that the “special relationship” test used in Seaman's and its progeny did not apply to the case here, because those cases involved parties to the contracts, and, in the case here, plaintiff was not a party to the contract between defendant and Encon, its indemnitee.

In its reply brief, plaintiff argued for the first time that “[t]he relationship between the parties [to the action] is that of insurer and insured, Halterman being an express beneficiary of the policy.”   However, “[a] third party [beneficiary] ․ is not a contracting party [i.e., an insured];  his right to performance is predicated on the contracting parties' intent to benefit him.”  (Murphy v. Allstate Ins. Co. (1976) 17 Cal.3d 937, 944, 132 Cal.Rptr. 424, 553 P.2d 584;  see also Zephyr Park v. Superior Court (1989) 213 Cal.App.3d 833, 262 Cal.Rptr. 106:  “The reference [in Moradi–Shalal ] to actions retained by the insured, ․ is of course [to] the first party․”  (Id., at p. 837, fn. 5, 262 Cal.Rptr. 106.)  “First parties are in privity with the insurance carrier and typically have regular contract claims, including common law ‘bad faith’ claims, which can be pursued.”)   (Id., at p. 837, 262 Cal.Rptr. 106.)

Alternatively, plaintiff argues in its reply brief that its relationship to defendant is controlled by Civil Code section 3247, et seq.   However, those sections do not help plaintiff.   More specifically, section 3247 requires a contractor for any public work to file a payment bond.   Subdivision (c) of section 3248 recites that the payment bond shall, “[b]y its terms inure to the benefit of any of the persons named in Section 3181 so as to give a right of action to such persons or their assigns in any suit brought upon the bond.”   On the facts here, plaintiff is a person named in section 3181 (actually, in section 3110, which is referred to in section 3181).

Clearly, the import of the foregoing statutes is that:  (1) plaintiff is a beneficiary of the contract between Encon and defendant and as such has a right to maintain an action against defendant for payments thereunder, but (2) plaintiff is not a party to the contract between Encon and defendant, and, because he is not in contractual privity with defendant, he has no right to maintain an action against defendant for breach of the covenant of good faith and fair dealing implied therein.   The indispensable predicate for maintaining such a cause of action is contractual privity.  (Murphy v. Allstate Ins. Co., supra, 17 Cal.3d 937, 943–944, 132 Cal.Rptr. 424, 553 P.2d 584.) ²

Plaintiff argues that sections 3247 et seq. impose upon defendant a duty to act with good faith and fair dealing towards the entities the statutes were intended to protect.   For this proposition, plaintiff relies on General Ins. Co. v. Mammoth Vista Owners' Assn. (1985) 174 Cal.App.3d 810, 220 Cal.Rptr. 291.   In that case, the property-owner beneficiary of a surety bond between the developer and the surety had obtained a judgment against the surety in an action on the bond for breach of the implied covenant of good faith and fair dealing and for violation of Insurance Code section 790.03, subdivision (h).   In responding to the surety's contention on appeal that it was not subject to liability under those theories, the General Ins. court addressed only the section 790.03 issue, reasoning that:

“We note initially it is unnecessary for us to decide as to each theory whether the obligee under a surety bond may sustain a tort action against the surety.   The actionable wrong contained in Insurance Code section 790.03, subdivision (h), is merely a codification of the tort of breach of the implied covenant of good faith and fair dealing as applied to insurance.   (Richardson v. GAB Business Services, Inc. (1984) 161 Cal.App.3d 519, 524, 207 Cal.Rptr. 519.)  ‘Section 790.03 merely enumerates those practices which are actionable and extends the cause of action to third party claimants, ․’  (Ibid.;   see Royal Globe Ins. Co. v. Superior Court (1979) 23 Cal.3d 880, 888 [153 Cal.Rptr. 842, 592 P.2d 329].)”  (Id., 174 Cal.App.3d at pp. 822–823, 220 Cal.Rptr. 291.)

In other words:  (1) the plaintiff in General Ins. was a third party beneficiary of the contract between the developer and the surety;  (2) section 790.03, as interpreted by the California Supreme Court in Royal Globe, gave third party claimants a cause of action against insurers, and (3) the section 790.03 cause of action was merely a codification of the common law action for breach of the implied covenant of good faith and fair dealing which had been available to first party claimants.   However, when the private cause of action against insurers under section 790.03 was abolished by Moradi–Shalal, third party claimants did not, as plaintiff implies, retain a common law cause of action against insurers for breach of the implied covenant, because such a cause of action had never been available to those claimants.

As a unanimous California Supreme Court stated in Murphy v. Allstate Ins. Co., supra, 17 Cal.3d 937, 132 Cal.Rptr. 424, 553 P.2d 584:  “A third party should not be permitted to enforce covenants made not for his benefit, but rather for others.   He is not a contracting party;  his right to performance is predicated on the contracting parties' intent to benefit him.  [Citations.]  ․ Because, as we have seen, the duty to settle is intended to benefit the insured and not the injured claimant, third party beneficiary doctrine does not furnish a basis for the latter to recover.   Moreover, Allstate having paid plaintiff the policy limits, she has already received all benefit contemplated by the policy.”  (Id., at p. 944, 132 Cal.Rptr. 424, 553 P.2d 584.)

In Murphy, the plaintiff had sued Allstate's insured for the wrongful death of her son.   Allstate had rejected settlement demands and the plaintiff had received a jury verdict in excess of the $25,000 policy limit.   Allstate had paid the plaintiff the policy limit plus interest and costs, and the plaintiff had sued Allstate for breach of the duty of good faith to its insured by refusing to settle within policy limits.   The insured had not assigned any cause of action against Allstate to the plaintiff.   Allstate had obtained a judgment on the pleadings in the trial court and the Supreme Court affirmed the judgment.

The plaintiff in Murphy had sought recovery under Insurance Code section 11580, subdivision (b)(2), which authorizes direct action against the insurance company by a judgment creditor.   In rejecting the plaintiff's claim under that section, the court reasoned that section 11580, subdivision (b)(2) made the plaintiff a third party beneficiary of the contract between the insured and Allstate, and, because Allstate's duty to settle ran to the insured and not to the third party beneficiary, the plaintiff did not have the right to recover from Allstate for the breach of the duty to settle.

Three years after Murphy was decided, a divided Supreme Court issued Royal Globe Ins. Co. v. Superior Court, supra, 23 Cal.3d 880, 153 Cal.Rptr. 842, 592 P.2d 329.   Justice Mosk, writing for a bare majority, distinguished Murphy on the ground that its holding that the third party claimant could not sue the insurer had been based primarily upon contractual principles, whereas the third party plaintiff in Royal Globe had relied on the duty the insured owed her directly as a claimant under section 790.03.  (Id., at pp. 889–890, 153 Cal.Rptr. 842, 592 P.2d 329.)   The dissent in Royal Globe observed:  “As we recently explained in Murphy, supra, California has consistently held that the duty to settle runs to the insured.  Section 790.03, subdivision (h), creates neither a new independent duty nor civil liability which may be extended beyond the insured to third parties.”  (Id., at pp. 895–896, 153 Cal.Rptr. 842, 592 P.2d 329, original emphasis.)

Seven years after Royal Globe, in Coleman v. Gulf Ins. Group (1986) 41 Cal.3d 782, 226 Cal.Rptr. 90, 718 P.2d 77, the Supreme Court, with only Justice Bird dissenting, refused, on the basis of Murphy, to allow a third party plaintiff to sue an insured for breach of the covenant of good faith and fair dealing.   In response to the plaintiff's argument that the Murphy rule had been relaxed by Royal Globe, the Coleman court said:  “Nothing in our Royal Globe decision suggests expansion of the common law cause of action for breach of the covenant of good faith and fair dealing to embrace third party claimants;  on the contrary, in that case we took note of the common law rule and distinguished Murphy as ‘being based primarily on contractual principles.’  [Citation.]   Thus plaintiffs' good-faith-and-fair-dealing theory cannot be sustained.”  (Id., at p. 795, 226 Cal.Rptr. 90, 718 P.2d 77, emphasis in original.)

The rest, as they say, is history.   In Moradi–Shalal, a divided Supreme Court overruled Royal Globe, on the ground, among others, that the adverse social and economic consequences of Royal Globe's holding, that insurers owed a direct duty to third party claimants, could not be justified as a matter of policy.  (Moradi–Shalal v. Fireman's Fund Ins. Companies, supra, 46 Cal.3d 287, 301–302, 250 Cal.Rptr. 116, 758 P.2d 58.)   After enumerating such consequences, the Moradi–Shalal court observed that common law remedies were still available “based on such traditional theories as fraud, infliction of emotional distress, and (as to the insured) either breach of contract or breach of the implied covenant of good faith and fair dealing.”  (Id., at pp, 304–305, 250 Cal.Rptr. 116, 758 P.2d 58.)

As we have already noted, plaintiff argues that its cause of action is “expressly preserved” by the foregoing language in Moradi–Shalal.   On the basis of our analysis, however, we hold that plaintiff's cause of action is neither expressly nor impliedly preserved, either by the foregoing language, by any other language in Moradi–Shalal, or by any language in any other case cited by plaintiff or disclosed by our own research.

In sum, under existing California law, a third party beneficiary to an insurance contract does not have a cause of action against the insurer for breach of the covenant of good faith and fair dealing.   In the case here, plaintiff is a third party beneficiary to the payment bond contract between defendant and Encon.   Assuming, arguendo, that a payment bond contract is an insurance contract (General Ins. Co. v. Mammoth Vista Owners' Assn., supra, 174 Cal.App.3d 810, 823–825, 220 Cal.Rptr. 291), plaintiff cannot state a cause of action against defendant for breach of the implied covenant of good faith and fair dealing.   Accordingly, defendant's motion for judgment on the pleadings, which performs the same function as a general demurrer (Tiffany v. Sierra Sands Unified School Dist. (1980) 103 Cal.App.3d 218, 222, 162 Cal.Rptr. 669), was properly granted.

DISPOSITION

The judgment is affirmed.

FOOTNOTES

1.   Plaintiff attached a copy of its contract with Encon as an exhibit to its complaint.   Plaintiff did not attach a copy of the payment bond as such an exhibit, and there is no copy of the bond in the record.

2.   At oral argument, plaintiff advanced the novel theory that contractual privity can be imposed by statute, i.e., in this case, by Civil Code section 3248, subdivision (c).   However, contractual privity is “[t]hat connection or relationship which exists between two or more contracting parties.”  (Black's Law Dict. (5th ed. 1979) p. 1079, col. 2, emphasis added.)

McDANIEL, Associate Justice.

HOLLENHORST, Acting P.J., and DABNEY, JJ., concur.