Pennsylvania’s Supreme Court has ruled that surety companies are not subject to the state’s insurance bad faith law, but they must participate in arbitration when disputes arise. The decision came on February 18, ending a legal battle that started more than 15 years ago over a construction project at Penn State University.
Back in 2008, Penn State hired Ionadi Corporation to install steel for its Millennium Science Center Complex. International Fidelity issued a $10.125 million payment bond to guarantee that subcontractors would be paid. Ionadi subcontracted part of the steel work to Eastern Steel Constructors.
Eastern worked from early 2009 until September 2010. Ionadi paid for the first five months but then stopped. Eastern claimed $622,182.90 under the bond. Fidelity paid part of it but left about $253,788 unpaid. In November 2010, Eastern started arbitration to resolve the dispute and repeatedly invited Fidelity to join. Fidelity declined every time.
After Ionadi filed for bankruptcy in 2011 and the automatic stay was lifted, arbitration went ahead without Ionadi or Fidelity defending themselves. The arbitrator ordered Fidelity to pay $433,489.42, which included unpaid work, interest, penalties, and legal fees. The award was confirmed by a court in 2012. When Fidelity refused to pay, Eastern sued, adding a claim under Pennsylvania’s bad faith statute.
The courts eventually agreed that the arbitration award was binding on Fidelity but decided the bad faith law doesn’t apply to surety bonds. Justice Wecht, for the Supreme Court majority, explained that the bad faith statute only covers insurance policies, not surety bonds. Insurance protects the buyer of a policy, while surety bonds protect third parties from a principal’s default. The law clearly excludes suretyship from this statute.
However, the court made it clear that surety companies like Fidelity can’t ignore arbitration. The bond made Fidelity and Ionadi both responsible for payments to subcontractors. Under the subcontract, disputes had to be settled through arbitration. Fidelity had notice and chances to participate but chose not to. A case from 1909 supports the rule that arbitration awards bind sureties who do not appear when given a chance.
Fidelity argued that Eastern set unreasonable conditions for joining arbitration, but the court found later communications invited Fidelity without restrictions. The court also ruled that interest and attorney fees in the arbitration award were valid parts of the debt under the bond. Still, Fidelity is not responsible for legal fees Eastern had to pay to sue Fidelity itself. Interest on Fidelity’s debt is limited to the state’s 6% annual rate, not the subcontract’s 1.5% monthly rate.
Chief Justice Todd and three other justices agreed with the majority, while two justices partially dissented.
For surety companies, this ruling offers some relief by shielding them from bad faith claims, but serves as a reminder: ignoring arbitration can lead to costly outcomes. Eastern originally sought about $254,000 for unpaid work, but the final arbitration award topped $433,000 after adding interest, penalties, and legal fees.
Surety companies might want to review their bond language carefully to manage what counts as "all sums due" and to avoid unexpected obligations. And when arbitration comes calling, it’s clear that showing up really does matter.