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December 15, 1993

RACHMAN BAG COMPANY, a Partnership Composed of PLAINS BAG AND BAGGING CO., INC., and RACHMAN BAG CO., INC., Plaintiff,

The opinion of the court was delivered by: EDWARD R. KORMAN

 Korman, J.

 Plaintiff Rachman Bag Co. ("Rachman") brought this action against Liberty Mutual Insurance Co. ("Liberty") seeking to enforce a surety bond issued by Liberty which names plaintiff as obligee. Both sides have moved for summary judgment. The issue presented by this case is when, if at all, an obligee of a suretyship contract must disclose to its surety facts known to the obligee which materially affect the nature of the risk undertaken by the surety.

 At the heart of this dispute is a surety bond in the amount of $ 350,000 issued by Liberty on December 9, 1988, naming Textiles of America, Inc. ("TOA") as principal and Rachman as obligee. When first issued, the bond purported to secure TOA's performance under a December 9, 1988 "written agreement" with Rachman "for Delivery of Institutional Textiles." See Ex. B to Affidavit of Kimberly S. Penner, June 17, 1993 ("Penner Aff."). Although the bond provided that the secured agreement could be attached thereto for reference, no such agreement was attached when the bond was first issued in December 1988. Id.

 The reason for this omission was that there was no written agreement between Rachman and TOA at that time. Rather, according to Rachman, in December 1988 the parties had reached merely an oral agreement. It was not until January 12, 1989 that the parties signed a written contract ("January 12 Contract"). Rachman contends that this contract memorialized the earlier oral agreement.

 The January 12 Contract between TOA and Rachman was styled both as repayment of a prior $ 350,000 indebtedness owed by TOA to Rachman and as a vendor-vendee sales agreement. See Ex. D to Penner Aff. Under the terms of the agreement, TOA was responsible for paying to Rachman $ 10,000 per month for the first two years of the contract and almost $ 13,000 per month for the third year. TOA, at its own option, could satisfy the amount due each month in one or more of three possible ways: i) by direct shipment to Rachman of institutional textiles; ii) by cash payment; or iii) by procuring new business for Rachman. With respect to the third method of payment, the contract envisioned TOA soliciting orders for institutional textiles from its own customers, which would be filled by Rachman. The profits Rachman realized from these sales would then be applied toward reducing TOA's indebtedness.

 The source of TOA's indebtedness stemmed not from monies advanced willingly by Rachman, but rather from the thievery of TOA president Ronald Halpern. The undisputed facts show that TOA and Rachman had done business together for over one year prior to issuance of the bond. During that time, TOA had accumulated a debt to Rachman of almost $ 400,000, as a result of several unscrupulous practices, including: i) writing checks to Rachman from accounts with insufficient funds; ii) receiving and retaining payments, owed to Rachman, from third party customers; and iii) wrongfully receiving and retaining rejected orders of textiles, shipped to customers originally by Rachman. In addition, TOA had already defaulted on a similar agreement it had made with Rachman dated January 15, 1988.

 Sometime after the execution of the January 12 Contract, Rachman's counsel, Neal Factor, contacted Liberty to inquire whether Liberty had in fact issued a bond covering TOA's performance with Rachman. It was evidently Factor's intention to make sure that the bond which Liberty had issued on December 9, 1988 actually did ensure the contract of January 12, 1989 between TOA and Rachman. To that end, in February 1989 both Factor and Ronald Halpern, president of TOA, prevailed upon one Adrian Marshall, a sales representative at Liberty, to append a copy of the January 12 Contract to the back of the bond in Liberty's possession. Subsequently, Factor further persuaded Marshall to alter the face of the bond so that it purported to secure a "Contract between Rachman Bag Company and Textiles of America, Inc. dated January 12, 1989." See Ex. C to Penner Aff.

 Although Marshall had obtained the approval of Liberty underwriter William Chess to affix the contract to the bond, see Deposition of Adrian Marshall at 58, Marshall did not have actual authority to alter the face of the bond. Nonetheless, after he altered the bond, Marshall's supervisors at Liberty were informed of what he had done, and they took no steps to repudiate the bond.

 On February 15, 1989, Rachman and TOA signed another agreement ("February 15 Contract"), intending to supplement the January 12 Contract. Under this latest agreement, Rachman advanced TOA an additional $ 20,000, which was to be repaid at the rate of $ 1000 per week, in the same fashion as the earlier advances -- by textiles, cash, and/or profits from new sales contracts. See Ex. D to Affidavit of Neal Factor, July 17, 1991.

 On March 1, 1989, TOA defaulted under the January 12 contract, and one month later Rachman reported this fact to Liberty, demanding payment on the bond. When Liberty refused, Rachman commenced this action in the United States District Court for the Northern District of Texas. The case was transferred to the Eastern District of New York, see Rachman Bag Co. v. Liberty Mutual Ins. Co., No. CA5-89-0237-W, slip op. (N.D. Texas June 26, 1990) (Order), and plaintiff then moved for summary judgment. I denied plaintiff's motion without prejudice and with leave to renew after discovery.

 In a Memorandum and Order dated July 10, 1991, which was entered prior to the pretrial discovery that Liberty had ratified the alteration of the bond by Marshall, I identified the central issue in this case as whether plaintiff knew that it was Adrian Marshall who altered the bond:

The bond itself contains a power of attorney expressly authorizing Mary Catherine Walters to execute it on behalf of Liberty Mutual. If plaintiff knew that Mr. Marshall made the alteration, then it was incumbent on plaintiff to make further inquiry as to Mr. Marshall's authority to make the alteration. If such an inquiry was not made, plaintiff may succeed here only if it can demonstrate that Liberty Mutual had cloaked Mr. Marshall with the apparent authority to make the alteration. . . . On the other hand, if plaintiff did not know that Mr. Marshall made the alteration, and assumed in good faith that it had been made by Mary Catherine Walters, then plaintiff may be entitled to prevail.

 Rachman Bag Co. v. Liberty Mutual Ins. Co., No. CV-90-2412 (ERK), slip op. at 2 (E.D.N.Y. July 10, ...

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