The Case

In 2008, Penn State University entered into a contract with Ionadi Corporation for steel work on the Millenium Science Center Complex at Penn State’s University Park Campus, and International Fidelity Insurance Company (IFIC) issued a payment bond for Ionadi (the bond). Ionadi then subcontracted with Eastern Steel Constructors, Inc. for installation services of the steel reinforcing material. While the project was ongoing, Eastern notified IFIC of Ionadi’s default based on Ionadi’s failure to pay them pursuant to the terms of their subcontract and made a claim on the payment bond, which IFIC denied.

As a result of Ionadi’s failure to pay, Eastern commenced a successful arbitration against Ionadi, resulting in an award against Ionadi. However, IFIC refused to pay the arbitration award and Eastern filed suit to enforce it and asserted a claim for bad faith against IFIC. The jury returned a verdict in favor of Eastern and against IFIC. IFIC then appealed to the Pennsylvania Superior Court, which found that IFIC was bound by the arbitration award. In doing so, the Superior Court also addressed a few unsettled areas of surety law in Pennsylvania.

Takeaway One: A surety who has full knowledge of arbitration proceedings and an opportunity to participate in and defend against the arbitration claims will be bound by the arbitration award.

The court confirmed that a surety will be bound by a judgment against its principal where the surety had notice of the arbitration proceedings and chose not to appear or to defend itself despite having the opportunity to do so.

Takeaway Two: If a surety is liable for “all sums due” a subcontractor, the surety is also liable for attorneys’ fees incurred in connection with an action by the subcontractor against the principal.

The bond contained language making IFIC responsible for “all sums due” from Ionadi to its subcontractors. The court held that this language made IFIC liable for the attorneys’ fees stemming from the claim between Eastern and Ionadi.

In reaching this conclusion, the court clarified that a surety will not be held responsible for attorneys’ fees stemming from a subcontractor’s payment bond claim against the surety unless the bond or subcontract contains specific language to that effect.

Takeaway Three: An award against a surety will be subject to the statutory prejudgment rate of interest rather than the rate of interest specified in the underlying subcontract unless the surety is specifically bound by such a subcontract provision.

Absent a provision in the payment bond in which the surety is required to pay the prejudgment interest rate specified in the subcontract between a principal and its’ subcontractor, the court held that a surety will only be assessed the statutory prejudgment rate of interest. In Pennsylvania, the statutory prejudgment interest rate is 6%.

Takeaway Four: A surety cannot be held liable for bad faith because a surety is not considered an insurer.

In Pennsylvania, the cause of action for bad faith exists under a statutory provision that applies to “insurers” and allows a party to recover punitive damages and attorneys’ fees if a court finds that the “insurer” has acted in bad faith toward the insured. The Superior Court recognized that a surety is not considered an insurer and, therefore, cannot be held liable for bad faith. While many federal courts had reached this same conclusion previously, this is the first case where a Pennsylvania appellate court addressed the issue.

In light of the Superior Court’s decision, it is expected that sureties will review the language of their payment bonds and tailor the language to further limit their exposure for prejudgment interest and attorneys’ fees. This case should also serve as a warning to sureties to avoid being idle while the dispute plays out between the principal and the claimant on the bond. However, this decision may further incentivize sureties not to pay claims now that the Superior Court has determined that there are no bad faith claims against sureties and no risk of punitive damages or attorneys’ fees based on the surety’s conduct toward the claimant.

Navigating payment bond claims can be complicated for even the most experienced contractors. Beyond what is and is not recoverable under the terms of the bond, notice and timing are critical. Fortunately, the lawyers at Cohen Seglias can guide you through this process to obtain payment.