On certification to the Superior Court, Appellate Division.
For affirmance -- Chief Justice Wilentz, and Justices Clifford, Handler, Pollock, O'Hern, Garibaldi and Stein. For reversal -- None.
The central dispute in this case is whether a surety to a defaulted performance bond can be bound by an arbitration award entered against its principal and confirmed on appeal when the surety did not appear in the arbitration proceedings. Resolving this dispute calls upon us to consider and determine the standards that should govern the notice and opportunity to appear in such arbitration proceedings that must be given the surety in order to render the resulting arbitration award binding upon it.
Defendant-respondent First Indemnity of America Insurance Company (FIA) was surety for two performance and payment bonds supporting its principal's subcontracts with plaintiff-appellant, Raymond International Builders, Inc. (Raymond). The principal failed to complete the performance secured by either bond. After default notices were sent to the principal and
demand for completion was made unsuccessfully on the surety, Raymond completed the work and served an Arbitration Demand, pursuant to the subcontract, on the principal and its Assignee for the Benefit of Creditors. No Arbitration Demand was served on FIA. FIA was not named as a party to the arbitration. FIA was not served at that time with a copy of the Demand on its principal. At the same time, Raymond instituted suit against FIA to recover default damages on the surety bonds; its complaint made no mention of arbitration.
While FIA was answering Raymond's complaint and filing a third-party action for indemnity against the principal, Raymond was filing an Order to Show Cause to compel arbitration and to appoint an arbitrator in the principal's stead. On the return date of the Show Cause Order, the court appointed an arbitrator to serve as the principal's designee and directed that arbitration begin. Despite Raymond's awareness of the principal's assignee's intention not to appear, FIA was notified of none of the arbitration-related occurrences.
Approximately three weeks prior to the arbitration, Raymond invited FIA by letter to "attend and participate at the aforesaid arbitration proceeding as surety. . . ." Attached to this letter was the Demand for Arbitration served upon the principal. After further communication to the surety about a change in the location of the hearing, arbitration proceeded in the absence of the principal, the principal's assignee, and the surety.
The arbitrators awarded Raymond $568,611.22 plus interest, which award was converted to a judgment pursuant to Raymond's motion; FIA had no notice of the confirmation application. Raymond then filed a motion for summary judgment based on the arbitration award for the relief sought in its complaint against FIA. Despite certifications that the arbitration award was based on work not covered by the FIA bond, that damages could have been mitigated, and that costs were greatly overstated, the trial court granted Raymond's motion.
The trial court's decision turned on its reading of the implications of this Court's decision in Monmouth Lumber Co. v. Indemnity Insurance Co. of North America, 21 N.J. 439 (1956), which held that a surety "who has merely undertaken to be responsible for the debts or defaults of the principal and who has not been given the opportunity to defend" is not conclusively bound by a judgment against the principal. Monmouth Lumber Co., supra, 21 N.J. at 446, quoted in Raymond Int'l Builders v. First Indemn. of Am. Ins. Co., No. L-62208-83, slip op. at 1-2 (Law Div. Nov. 8, 1984). A corollary, however, of the duty to afford an opportunity to defend, the trial court reasoned, is the duty to defend when there is an opportunity. Because the surety in this case was not a direct party to the arbitration agreement, the trial court concluded that it was not subject to compulsory joinder; because the surety was aware of the arbitration proceeding, however, and could have joined that proceeding but did not, the trial court concluded that it had violated its duty to defend when it had notice and an opportunity to defend.
The Appellate Division, in an unreported opinion, reversed and remanded for trial on the grounds that FIA was afforded neither adequate notice of its principal's failure to participate in the arbitration, nor sufficient opportunity to defend its claim in the arbitration proceeding. The court below found that "the trial judge overlooked any obligation on the part of the plaintiff-creditor to advise the defendant-surety, the only true obligor . . . that the principal was not honoring the arbitration clause and that it would not defend the arbitration claim." The primary duty imposed by this Court in Monmouth Lumber, the Appellate Division concluded, was the duty of the plaintiff-creditor to afford adequate and timely notice to the surety, which in this case, "[i]n view of [the principal's] default under the arbitration clause," entailed joining ...