United States Court of Appeals, Second Circuit

Case no.: 23-7944
Date filed: September 9, 2025

The Pennsylvania Supreme Court has ruled that sureties are not subject to the state insurance bad faith statute; bonds on construction contracts are not insurance policies. Although the payment surety avoided the punitive damages of the statute, it was responsible for an arbitration award in favor of an unpaid subcontractor.

Pennsylvania State University awarded a contract to Ionadi Corporation to construct a new science center on its campus. Ionadi obtained a payment bond from International Fidelity Insurance Company (Fidelity) in the amount of $10.125 million. The bond guaranteed payment of parties furnishing labor, materials or equipment for use in the performance of the construction contract. The bond called for litigation of disputes in a court of competent jurisdiction and incorporated the construction contract by reference.

Ionadi awarded a subcontract to Eastern Steel Constructors Inc. to furnish and install steel reinforcing material. Eastern performed for several months but then started experiencing payment problems. Ionadi explained it had a cash-flow issue. The contractor made partial payment to its sub, but Eastern claimed it was still owed $253,788 under the subcontract, exclusive of interest and attorney fees.

Eastern Steel demanded binding arbitration of the payment dispute, as called for in the subcontract. Eastern gave Fidelity timely notification of the arbitration proceeding, but the surety declined to participate. When arbitration began, Ionadi promptly filed for bankruptcy.

The bankruptcy court eventually lifted the automatic stay and allowed arbitration to proceed. Fidelity continued to refuse participation despite repeated notifications, and Ionadi did not appear to defend itself. The arbitrator awarded Eastern the full amount it demanded under the subcontract. Neither Fidelity nor Ionadi challenged the arbitration award, but Fidelity refused to make payment under the bond.

Eastern filed suit against Fidelity in the Centre County Court of Common Pleas, demanding payment of the arbitration award under the payment bond. Eastern also sought punitive damages for insurance bad faith. The trial court ruled that the insurance bad faith statute did not apply to surety bonds on construction contracts. There was no state precedent on this issue, and the matter went all the way to the state’s highest court.

The Supreme Court of Pennsylvania said the insurance bad faith statute, Pa. C.S. section 8371, refers to bad faith actions of “insurers” with regard to an “insurance policy.” Eastern Steel had argued that a bond on a construction contract was essentially a form of insurance, so the statutory punitive damages should apply to bonds. The court was not convinced. Although the statute does not define “insurance policy,” there are fundamental differences between an insurer and a surety.

“With both insurance and surety bonds, there is a shifting of risk in exchange for a premium.” However, an insurer “undertakes to indemnify against losses” and an insured party is “the person or entity whose insurable interest is protected by a contract with an insurer.”

“In contrast, a ‘payment bond,’ which is the type of surety bond at issue in this case, is ‘[a] bond given by a surety to cover any amounts that, because of the general contractor’s default, are not paid to a subcontractor or materials supplier.’ A ‘surety’ is ‘[s]omeone who is primarily liable for paying another’s debt or performing another’s obligation.’”

“Section 8371 clearly and unambiguously does not encompass a surety bond. Insurance and surety bonds are terms that have their own distinct definitions, and in practice operate in distinct ways, as Fidelity argues. Insurance is intended to protect the party to the contract (the insured), whereas suretyship is intended to protect others from the default of the party to the contract (the principal)” (emphasis provided by the court).

While the bonding company avoided statutory punitive damages for refusal to pay, it was held responsible for the arbitration award in favor of the subcontractor. Even though the payment bond had stipulated litigation of disputes, that clause applied to disputes between the surety and its principal, Ionadi. It did not apply to disputes between Ionadi and its subcontractors.

“Fidelity had every reason to know that the details of the breach and the extent of damages were issues that would be resolved in arbitration under the Subcontract for which it had agreed to be jointly and severally responsible. Fidelity chose to take on this obligation and then chose to disregard the arbitration proceedings that would determine the extent of Ionadi’s obligations, for which Fidelity unambiguously shares liability.”

The subcontractor in this case was wise to inform the surety, early and often, of the arbitration proceedings. The surety subsequently contended that certain legal technicalities prevented its participation. These arguments were feeble and ineffective.

Participants: No attorneys of record listed.

Before: Justices Todd, Donohue, Dougherty, Wecht, Mundy, Brobson, and McCaffery

Opinion by: Justice Todd

Outcome: Affirmed in part, reversed in part

Source: Please click here to read the complete opinion.