|April 23, 2014|
Previously published on April 11, 2014
Counterintuitive as it may seem, courts can exert significant influence by deciding not to consider a case. The Supreme Court of Pennsylvania did just that on April 1, 2014 when it decided not to consider an appeal in the Berks Products Corp. v. Arch Insurance Co. case (Berks). The underlying case involved a material supplier’s payment bond claim against a surety who issued bonding for the general contractor (GC) on a public school project for the Wilson Area School District.
The Berks Decision and the “Safe Harbor” Provision
In Berks, the surety, Arch Insurance Company (Arch), was ordered to pay the bond claim of a supplier, Berks Products Corp. (Berks), even though the GC had paid its subcontractor for all of the materials that Berks supplied on the project. The subcontractor did not pay Berks in full for its materials and eventually went bankrupt, which led Berks to file its claim against the payment bond that Arch issued on behalf of the GC.
The Commonwealth Procurement Code (Code), which governs the award and administration of most public construction projects in Pennsylvania, contains a provision commonly referred to as the Safe Harbor Provision. The Safe Harbor Provision protects GCs and sureties from future claims if the GC has paid its subcontractor in full, even if the subcontractor has failed to pay a supplier.
The Berks decision is monumental (perceived by some members of the construction industry positively and, by others, negatively) because the Commonwealth Court concluded that the specific language in the GC’s payment bond required Arch to pay Berks’ claim even though the GC paid its subcontractor for all of Berks’ materials. In other words, according to the Court, the language in the payment bond waived the protection of the Code’s Safe Harbor Provision.
With the Supreme Court’s recent denial of Arch’s Petition for Allowance of Appeal, the practical implications of Berks will now become a permanent reality in the absence of new legislation. The implications for public projects are likely to include the following, some of which could increase the costs and risks of doing business for companies at all tiers in the construction industry:
In light of the perception of sureties that the Safe Harbor Provision could be under attack, they will likely reexamine the language of their payment bonds to make sure the language is in lockstep with the Safe Harbor Provision and does not contain the Berks language . Sureties may also reevaluate the risks and costs of providing bonding in Pennsylvania.
Sureties and GCs may even take steps to pursue legislative changes because of what they perceive as unintended consequences of Berks on the Bond Law and the Safe Harbor Provision.
Second-tier contractors/suppliers like Berks are obviously pleased with the result and will continue to assert bond claims even where GCs have paid subcontractors in full, using Berks as their authority.
GCs may take additional steps to avoid the fate that Arch (as indemnified by the GC) has suffered in Berks that include: (i) confirming that their payments are making their way to lower-tiered subcontractors by way of releases and actual verification of payment, (ii) increasing their use of joint check agreements, and (iii) requiring their subcontractors to obtain bonding for the project.
We will be expanding our coverage of this case and the effects it may have on the construction industry in the next volume of our newsletter, Construction in Brief, which will be available electronically within the next couple of months.