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Courts Give Surety Regulations Teeth

When evaluating a lawsuit on a surety bond, whether as the claimant or as the surety, one of the very first questions that attorneys always ask is “Is it timely?” If the answer is no, then that usually is the end of the lawsuit, as courts have consistently held that in order to recover on a surety bond, the lawsuit must be brought within the applicable statutory time limits. However, in certain circumstances, failure to bring a lawsuit within those time periods may not be the death blow that you might think. And it all comes down to whether the surety has followed the Insurance Regulations promulgated by the Insurance Commissioner.

The Los Angeles Superior Court recently ruled on cross-motions for summary adjudication that the surety would not be permitted to rely on a statute of limitations defense where it failed to comply with certain Insurance Regulations. The plaintiff in the case was a subcontractor that performed work on a public project. When it did not get paid for all of its work, it submitted a claim to the surety that had issued a payment bond for the project. The surety acknowledged receipt of the claim and began its investigation. During the course of the surety’s investigation, the time limit for the subcontractor to file its lawsuit on the bond passed. Not surprisingly, the surety denied the claim on the basis that it was not timely. Shortly thereafter, the subcontractor filed suit.

Both the surety and the subcontractor filed motions for summary adjudication. The surety argued that the claim was time-barred and so, as a matter of law, the subcontractor could not recover. The subcontractor argued that because the surety failed to comply with a particular Insurance Regulation that required the surety to provide written notice to a bond claimant of the applicable statute of limitations period, the surety could no longer avail itself of its statute of limitations defense. The court agreed with the subcontractor and concluded that because the surety failed to comply with the Insurance Regulations, it lost its ability to bring its key defense to the claim. Stripped of its primary defense, the surety ended up paying out on the claim.

The reason that this ruling is so significant to both bond claimants and sureties is that the Insurance Regulations themselves do not provide for any remedy to the claimant should the surety not comply with them. Rather, the only penalty provided for in the Insurance Regulations is for the Insurance Commissioner to impose monetary penalties and adverse licensure action. As one court noted in evaluating similar regulations in an insurance context, the Insurance Commissioner’s “regulatory power is punitive, not remedial.” (Spray, Gould & Bowers v. Associated International Ins. Co. (1999) 71 Cal.App.4th 1260, 1270.) But, as that court ultimately concluded, it is the court, through its equitable powers, that give these regulations their real teeth. (Id. at pp 1270-1271.) The Los Angeles Superior Court agreed, and provided a remedy for the surety’s failure to comply with the Insurance Regulations by prohibiting the surety from raising otherwise valid defenses.

The lesson here for bond claimants and sureties alike is to take a close look at the Insurance Regulations and to make sure that all of them are being complied with. A surety’s failure to do so could result in some very serious consequences that could end up making or breaking your case.