The News Story
The Times-Tribune reports that a Lackawanna County insurance agent recently pleaded guilty to fraud for accepting premiums for payment bonds from contractors but never actually procuring those payment bonds from a surety. This resulted in situations where public works projects were performed without any payment bond providing security for the subcontractors. Pennsylvania’s Public Works Contractors’ Bond Law of 1967 (i.e. the “Little Miller Act”) requires payment bonds for public projects but imposes no penalty on the public project owner for failing to ensure the requisite bonds are posted. Thus, Pennsylvania public project owners have no incentive to check to make sure its primes post the required bonds and things like the fraud described in the letter can easily go undetected.
The Practical Lesson for Subcontractors
Accordingly, this story is a good reminder to subcontractors in Pennsylvania about the need to obtain a copy of the payment bond for a public project at the time of subcontract formation rather than waiting until when a dispute arises. Such action will help protect against the type of fraud described in the Times-Tribune report by revealing the lack of payment bond before the subcontractor finds itself in a compromised position.
An August 21, 2017 article in the The Legal Intelligencer, co-authored by Babst Calland Attorneys Dave White and Esther Soria Mignanelli, addresses the impacts of the new Pennsylvania Mechanics’ Lien State Construction Notices Directory on oil and gas infrastructure projects. To view the full article, click here.
In United States ex rel. Marenalley Constr., LLC v. Zurich American Ins. Co., et al, Civil Action No. 14-4581 (E.D. Pa. March 13, 2015), a subcontractor filed suit under the Miller Act to recover against the prime contractor’s payment bond for additional work performed at the VA Medical Center in Philadelphia, PA. The Miller Act provides a subcontractor the right to bring suit against the surety that issued the prime contractor’s payment bond if the subcontractor is not paid within ninety days of the completion of its work.
Prior to the commencement of the action, the prime contractor sought additional compensation from the VA in an administrative proceeding, which included the additional compensation sought by the Subcontractor. The VA had not approved payment for the additional work at the time the subcontractor filed suit. The prime contractor and its surety moved to dismiss, or in the alternative, to stay the action pending the outcome of the prime contractor’s claim against the VA.
The court denied the motion to dismiss, and held that the administrative procedure between the prime contractor and VA provides no direct remedy to a subcontractor for any claim it has against the prime contractor. The Court explained, “When a subcontractor and prime contractor have a dispute about the amount due the subcontractor, that dispute is not resolved in the [administrative] proceeding.”
Finally, the Court refused to grant a stay. Citing to non-Miller Act cases, the prime contractor and surety argued that the surety’s liability is “derivative” of the prime contractors and the prime contractor’s liability is being determined in the administrative proceeding. The Court disagreed, and explained that the surety’s “liability on a Miller Act bond must be at least coextensive with the obligations imposed by the Miller Act if the bond is to have its intended effect.” As such, “a subcontract term that conflicts with the Miller Act is ineffective in a suit against the surety on the payment bond.” The practical takeaway from this case is the reminder the Miller Act permits a subcontractor to seek payment against the payment bond once the requisite ninety-day period has elapsed regardless of other administrative procedures that may be contractually required. Those Miller Act rights, however, may be waived, if: (1) the waiver is in writing; (2) signed by the person whose right is waived; and (3) executed after the person whose rights are waived has furnished labor or materials for use in the performance of the contract.
A recent decision by the Pennsylvania Commonwealth Court casts doubt on the “safe harbor” provision of Pennsylvania’s Procurement Code. Section 3939(b) of the Commonwealth Procurement Code provides, “Once a contractor has made payment to the subcontractor according to the provisions of this chapter, future claims for payment against the contractor or the contractor’s surety by parties owed payment from the subcontractor which has been paid shall be barred.” The clear language of this section of the Procurement Code has provided a complete defense to contractors and their sureties on projects to which the Procurement Code applies when payment can be established. However, in Berks Products Corp. v. Arch Ins. Co., No. 1457 C.D. 2012, the plaintiff-claimant on the payment bond issued by defendant-surety claimed that the language of this particular bond was broad enough to effectively waive the protection of section 3939 of the Procurement Code. The Commonwealth Court found that while the “safe harbor” provisions of the Procurement Code are incorporated by operation of law into the bond, the bond language can waive the protection of that statute. In this case the operative language of the bond provided that the bond will remain “in force and effect” until such time as both the principal and any of its subcontractors makes full payment for any labor or materials supplied for the school project at issue. Based on that language the Commonwealth Court concluded that the principal and surety had waived the “safe harbor” protection of section 3939 of the Procurement Code.
The United States District Court for the Western District of Pennsylvania recently issued an opinion in a diversity action dismissing with prejudice a principal’s claims for tortious interference with a contractual relationship, breach of fiduciary duty and bad faith against its surety.
In Reginella Construction Company, Ltd. v. Travelers Casualty and Surety Company of America, Civ. A. No. 12-1047, 2013 WL 2404140 (W.D. Pa. May 31, 2013), Reginella Construction Company, Ltd (“Reginella”) sued its surety, Travelers Casualty and Surety Company of America (“Travelers”) for breach of fiduciary duty, tortious interference with a contractual relationship and bad faith. The court, however, granted Travelers Motion to Dismiss all claims against Travelers with prejudice.
Regarding Reginella’s breach of fiduciary duty claim, the court looked to Pennsylvania case law regarding sureties, insurers, and commercial guarantees, and concluded that (1) surety bond agreements are standard commercial contracts; (2) imposing a fiduciary duty relationship between parties to a contract is the exception rather than the rule; and (3) a surety is not an insurer. Based upon these conclusions, the court predicted that the Pennsylvania Supreme Court would not find a fiduciary relationship between a surety and its principal. Therefore, the court concluded that Travelers owed no fiduciary duty to Reginella.
The court then turned to Reginella’s tort claims (i.e. its bad faith and tortious interference with a contractual relationship claims) and held that Pennsylvania’s gist of the action doctrine barred Reginella’s ability to assert either claim. Specifically, Pennsylvania’s gist of the action doctrine bars tort claims (1) that arise solely from a contract between the parties; (2) where the duties allegedly breached were created and grounded in the contract itself; (3) where the liability stems from a contract; or (4) where the tort claim essentially duplicates a breach of contract claim or the success of which is wholly dependent on the terms of a contract. The court found that the relationship between Reginella and Travelers was purely contractual in nature, and therefore, the gist of the action contract barred Reginella’s tort claims.
Although the Pennsylvania Supreme Court has not yet ruled upon the issue, Reginella suggests and supports the notion that a principal’s only cause of action against its surety under Pennsylvania law is one for breach of contract. Therefore, pursuant to Reginella, the terms of the contract between a principal and its surety will strictly govern the relationship and obligations between the parties.