Automobile Dealer Surety Bonds: What Constitutes A Breach of Condition’

By | January 14, 2002

Many surety bonds are tailored for particular relationships or statutory requirements—one such example is the motor vehicle dealers bond required by Section 503.033 of the Texas Transportation Code.

While there are few recent Texas cases discussing fidelity or surety bonds of any nature, there are several cases interpreting the statute, and the conditions necessary to recover under the motor vehicle dealer surety bond.

The statute states that the bond is to be conditioned on (a) the payment by the applicant of all valid bank drafts, including checks, drawn by the applicant to buy motor vehicles; and (b) the transfer by the applicant of good title to each motor vehicle the applicant offers for sale. It statute further provides that a person may recover against a surety bond if the person obtains a judgment against the dealer assessing damages and reasonable attorney’s fees “based on an act or omission on which the bond is conditioned . . . .”

Most bonds will track the language of the statute. Nevertheless, in Geters v. Eagle Ins. Co., 834 S.W.2d 49 (Tex. 1992), the Texas Supreme Court concluded that, recited or not, the statutory language was made part of the bond and was controlling.

At the time of the Geters case, the controlling statute was Art. 6686(a)(1-A)(vii) (Vernon Supp. 1992). The court in Geters also addressed the nature and extent of damages recoverable under the statute. While the surety had argued that only rescission damages were recoverable, the court concluded that all damages awarded for failure to deliver title, whether under the common law or the DTPA, were recoverable against the bond.

Section 503.033 addressed this issue, limiting the surety’s liability to the amount of the valid bank drafts, including checks, drawn by the applicant to buy motor vehicles, or the amount paid to the applicant for a motor vehicle for which the applicant did not deliver good title, and attorney’s fees incurred in recovery of the judgment.

What implicates a bond?
In Gramercy Ins. Co. v. Arcadia Financial Limited, 32 S.W.3d 402 (Tex. App. – Houston [14th Dist.] 2000, no pet.), the court courts analyzed what constitutes a breach of condition necessary to implicate the bond when it addressed two separate claims brought against Gramercy seeking recovery under a statutory motor vehicle dealer bond.

The claimant, Arcadia Financial Limited, was a financing company that helped finance car purchases for customers of First Financial—Fleet Lease Corp., a used car dealer. Customers entered into retail installment contracts with First Financial, and First Financial, in turn, assigned the contracts to Arcadia. In exchange, Arcadia compensated First Financial according to the terms of a master dealer agreement, which provided that, under certain circumstances, Arcadia could require First Financial to repurchase installment contracts.

At issue were two contracts First Financial assigned to Arcadia. The “Dovia” contract involved a suit against First Financial for fraud and DTPA violations for selling a car with an altered odometer. The purchaser was successful in the suit, and subsequently refused to make payments on the purchase contract.

The “Bratton” contract, involved the purchase of a car from First Financial for the combination of cash, trade-in value, and an installment contract. First Financial assigned the contract to Arcadia, but failed to deliver the certificate of title to the purchaser. Ultimately, Arcadia paid the outstanding amount owed to BMW Preventive Maintenance, obtained clear title, and registered the title in the purchaser’s name. Again, Arcadia asked First Financial to repurchase the Bratton contract, and First Financial refused.

Arcadia asked First Financial, without success, to repurchase both contracts, in accordance with the master dealer agreement.. Arcadia then sued First Financial for its failure to repurchase the contracts, and received a default judgment for the principal amount, attorney’s fees and post-judgment interest.

Arcadia then sued the surety, Gramercy Insurance Company, demanding payment on the judgment. But Gramercy contended, in part, that for both contracts First Financial’s liability did not arise under the statute, but from a violation of the master dealer agreement, or other acts not specifically covered by the statute or the bond.

In regard to the “Bratton” contract, Gramercy claimed that the statute was intended to protect only consumers, and that the failure to deliver good title to a dealer did not implicate the bond. Gramercy also argued that Arcadia was not paying First Financial for the purchase of the vehicle, but for an installment contract. The court rejected this argument, concluding that the statute was not limited to consumers in its application and did not require that the person who obtained a judgment against the dealer be the same person who paid the dealer for delivery of good title. Because Arcadia paid to clear title and transfer title to the Brattons, it was protected by the statute.

The court also rejected an argument that the suit was for breach of the dealer agreement, rather than a failure to deliver good title. The court concluded that, while the conduct constituted a breach of the dealer agreement, it was nonetheless a claim “based on” failure to deliver good title.

The court then turned to the “Dovia” contract. In regard to the claims of an altered odometer in the “Dovia” contract, Arcadia contended that the core of the complaint was failure to deliver good title. It relied upon Tex. Trans. Code §§501.072 and 501.073 (Vernon 1999) which require a dealer to provide a buyer written disclosure of the vehicle’s odometer reading at the time of sale, and provide that a sale made in violation of that provision is void and that title does not pass until the requirements of the chapter are met.

The court, however, disagreed and held that, even in the face of non-compliance, the sale was valid between the parties when the purposes of the Certificate of Title Act were not defeated. Accordingly, the court concluded that the judgment against First Financial was not for failure to deliver good title to Dovia, was not “based on” a statutory condition, and therefore did not implicate the bond.

Financing agreement or purchase of vehicles?
In Gramercy Ins. Co. v. MRD Investments, Inc.,47 S.W.3d 721 (Tex. App. – Houston [14th Dist.] 2001, pet. denied), the same court addressed the relationship between floor plan financing and conditions of the bond and statute.

In MRD Investments, MRD contracted with Reed to provide floor plan financing for Reed’s purchase of motor vehicles in her used car business. Reed was obligated to maintain a $25,000 surety bond and obtained it through Gramercy. Reed issued two sight drafts, drawn on MRD’s account, for the purchase of two separate vehicles. Both drafts were paid upon presentment and MRD took possession of the certificates of title to the two automobiles. Reed then wrote checks to MRD for the same amount as the sight drafts, and MRD released the certificates of title to the automobiles. Both of Reed’s checks were subsequently returned unpaid due to insufficient funds.

MRD sued Reed to recover the aggregate amount of the returned checks, plus interest and attorney’s fees. The trial court granted MRD summary judgment against Reed. MRD then made demand upon the surety, Gramercy, under the bond. MRD claimed that Reed had breached the bond conditions by failing to pay checks for the purchase of motor vehicles. Gramercy refused to pay, asserting that Reed had not violated the bond condition, because the checks were tendered pursuant to a floor plan financing agreement, not to purchase the vehicles.

The court again acknowledged the violation of a bond condition as a predicate to the surety’s liability and the claimant’s recovery on the bond. The court also noted that, while the summary judgment obtained by MRD against Reed created a prima facie case of liability, the surety was still entitled to interpose any valid defenses that could have defeated the plaintiff’s case at the time initial judgment was obtained, where the surety was not made a party or given an opportunity to defend the suit.

Gramercy argued that Reed purchased the vehicles and merely obligated financing from MRD. Thus, MRD never “owned” the vehicles, and did not sell them to Reed. Therefore, Reed did not tender checks to MRD for the purpose of buying motor vehicles, but was merely repaying a loan by reimbursing MRD for “floor planning” the vehicles.

The court concluded that the evidence supported Gramercy’s argument. MRD and Reed had an oral floor plan agreement, under which Reed routinely drafted on MRD’s bank account to purchase vehicles, and repaid MRD upon selling the vehicles to third parties. Reed paid between $5,000 and $6,000 a month to MRD for the use of the draft account. Reed also repaid each draft with a check for the exact amount used to purchase the vehicle. The certificate of title, however, was never transferred to MRD. MRD merely retained possession until Reed sold the vehicles to third parties.

The court strictly construed the statute and the bond, and held that there was no violation of a condition unless the checks were specifically to purchase the vehicles. Because MRD had already financed the purchase, and the checks were merely to repay a loan, there was no violation of the statute or the bond, and therefore no obligation on the part of the surety.

In a subsequent case, Gramercy Insurance Company, Inc. v. Anchor Finance Program, Inc., 52 S.W.3d 360 (Tex. App. – Dallas 2001, pet. denied), the court reached the opposite conclusion, and found that checks delivered under a similar financing agreement, prior to advancement of the purchase funds, were drawn “to buy motor vehicles” and not merely to repay a loan.

Taken together, these cases indicate that the conditions of the bond (and the statute) will be narrowly construed, and only a strict breach of these conditions will result in liability on the part of the surety. Nevertheless, courts do appear willing to look beyond the cause of action asserted to determine if the claims are actually based on a failure to deliver good title, or failure to honor a draft or check, regardless of whether the conduct also constitutes a violation of some contractual agreement between the.

Bradley is a partner in the Dallas office of Thompson, Coe, Cousins & Irons, L.L.P. She is a member of the Insurance Litigation and Coverage Section and leads the firm’s coverage practice. She has represented agents in disputes with policyholders and insurers in evaluating and litigating coverage issues under general and professional liability policies, commercial auto and trucking policies, commercial property policies and homeowners polices.

Topics Lawsuits Auto Texas

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Insurance Journal West January 14, 2002
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