by Joshua A. Gildea and Brennen A. McCurdy
The construction industry is inherently risky. With supply chain issues, safety hiccups, and multiple trades working together to make things happen, there are many opportunities for disputes. Every contractor is familiar with having to fight to get paid. This is where an experienced construction litigation attorney comes through. One area that requires tenacity and careful attention to all rules and requirements is making a claim against a surety bond. The Pennsylvania Superior Court has clarified claims a subcontractor can bring against a surety.
A SUBCONTRACTOR’S RIGHTS AGAINST A SURETY IN THE EVENT OF NONPAYMENT
In Eastern Steel Constructors, Inc. v. International Fidelity Insurance Company, Ionadi Corporation, a prime contractor, failed to pay one of its subcontractors, Eastern Steel Constructors, Inc., for the work performed under a subcontract. After submitting payment requests, Ionadi failed to pay the full amount, citing problems with its cash flow. Pursuant to the terms of the contract, Eastern Steel initiated arbitration proceedings. In so doing, Eastern Steel contacted and notified International Fidelity Insurance Company (IFIC or surety) of the arbitration, which had issued a payment bond for Ionadi. IFIC declined to participate in the arbitration.
Eastern Steel commenced arbitration against Ionadi as prime contractor. At the outset of arbitration, the prime contractor filed for bankruptcy protection, and the plaintiff motioned for the bankruptcy court to lift the automatic stay of claims against the prime contractor, again, giving notice to the surety who also attended the hearing on the plaintiff’s motion for relief from the automatic stay. The automatic stay was lifted, and the subcontractor obtained an arbitration award. However, IFIC refused to pay the arbitration award.
As a result, the subcontractor filed suit against the surety, arguing that it was primarily and jointly liable for the prime contractor. The case proceeded to trial. 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. The decision has some important lessons for surety law in Pennsylvania.
As framed by the Superior Court, the issues were:
- whether a surety, who had notice of an opportunity to participate in arbitration proceedings against the principal, is bound by an arbitration award rendered against the principal and,
- separately, whether a surety is subject to the bad faith statute codified at 42 PA.C.S.A. § 8731.
The rights and responsibilities of surety companies
As to the first issue, the Superior Court began by referencing century-old Pennsylvania case law which provides that “arbitration against a contractor is conclusive and binding upon the surety where the surety was notified of the time and place of the arbitration hearing and chose not to appear and defend when it had the opportunity to do so.” (citing Conneaut Lake Agricultural Assc. v. Pittsburg Surety Co., 74 A. 620 (Pa. 1909)). Similarly, in the case at issue, the Superior Court found that “the record, without any doubt, demonstrates that [the surety] was kept apprised of all critical proceedings with respect to the arbitration and confirmation of the arbitration award and judgment rendered in favor of [the subcontractor].” Importantly, a claimant should make sure a surety has full knowledge of arbitration proceedings and an opportunity to participate in and defend against the claims so that it will be bound by the arbitration award.
The Superior Court further established that the existence of an arbitration award is more than merely prima facie evidence of the amount owed by a surety. The Superior Court instead held the arbitration result to be final and binding.
As for the plaintiff’s claims for attorney’s fees and interest, the Court found that the surety owed the subcontractor for “all claims due” from the prime contractor, but with respect to the litigation against the surety, the subcontractor was not entitled to its attorney’s fees for that proceeding. The Court reached this conclusion because the subcontract did not expressly provide that the defendant would cover such expenses if the prime contractor breached the contract. However, the Court did grant the subcontractor prejudgment interest. Since the payment bond did not require the surety to pay the prejudgment interest rate specified in the subcontract between a principal and its subcontractor, the Court instead held that a surety would only be assessed the statutory prejudgment rate of interest. In Pennsylvania, the statutory prejudgment interest rate is 6%. 41 P.S. § 202. Some years that is more than commercially available loans; others, it is less.
THE SURETY CANNOT BE HELD LIABLE FOR BAD FAITH AS IT IS NOT AN INSURER
The Court then turned to the issue of whether a surety can be subject to a claim of bad faith. Specifically, the Court considered whether the term “insurance policy” includes a surety contract. Using the Statutory Construction Act as a guide and relying on the precedent established by the United States District Court in Superior Precast, Inc. v. Safeco Ins. Co of America, 71 F.Supp.2d 438 (E.D. Pa. 1999), the Court concluded that “the term “insurance policy” does not include surety contracts and that, as a result . . . [the plaintiff] may not bring a bad faith claim against a surety, such as [the defendant].”
The Court also discussed the differences between the role of a surety and an insurer, including the fact that a surety is a contractual relationship with two parties that often have conflicting interests and the surety bond is a financial credit product, not an insurance indemnity product.
NAVIGATING SURETY, NONPAYMENT AND OTHER CONSTRUCTION INDUSTRY ISSUES
Whether you’re a developer, owner, contractor or supplier in the construction industry, no one wants to deal with disputes over bids, quality of construction, payment or contract interpretation – just like Eastern Steel Contractors likely didn’t want to pursue their case against the surety.
If you’re facing or bringing a claim over a construction industry issue, our experienced construction litigation attorneys are committed to understanding current construction law and representing you. Please reach out to our team for support.
