Friends, underwriters, bond claim managers: lend me your eyes, and behold the saga of a surety that accepted collateral security from a financially unstable principal as an inducement for the issuance of new Miller Act performance & payment bonds. The drama unfolds when the principal files for bankruptcy protection within 90 days of the collateral transfer and the bankruptcy trustee — that most formidable of foes! — seeks to avoid the transfer as preferential. Fear not, dear readers! Our hero fights gallantly in In re ESA Environmental Specialists, Inc., and is richly rewarded in this Fourth Circuit Court of Appeals production.
Category Archives: Surety Law
4th Circuit Stages “The Collateral Battle” Between A Contract Surety & Its Principal’s Trustee in Bankruptcy
Yesterday my Twitter feed delivered a pair of tweets about a rash of fraudulent contract surety bonds in Tennessee:
The owner/obligee got “lucky” in the case of the Regency Hotel demolition project at the Memphis International Airport, in that it discovered the fraud before contract award; that at least provided an opportunity to rebid the contract and award it to a properly bonded prime contract. Goes without saying that the discovery of a forged or otherwise fraudulent bond during contract performance can be a much messier proposition.
What can owners/obligees do to protect themselves? Verify your bonds. How? I suggest utilizing the resources furnished by the Surety & Fidelity Association of America (@SuretyFidelity) on its “Verify Your Bond” webpage. There you will find information needed to locate a particular bonding company and inquire about the authenticity of a specific bond. You’ll also find a current list of surety companies participating in the Association’s Bond Authentication Program.
Stay vigilant, owners/obligees.
This past summer, the N.C. General Assembly passed and Governor McCrory signed into law groundbreaking legislation authorizing the use of design-build, design-build bridging and public-private partnerships in the delivery and financing of public construction projects in the state. The legislation is sure to alter North Carolina’s public procurement landscape drastically and influence the complexion of the state’s construction industry, particularly at the design and prime contractor levels.
Last Wednesday, October 23, I attended an excellent panel discussion covering key aspects of House Bill 857 (“HB 857″) sponsored by Carolinas AGC Foundation, AIA North Carolina (@AIA_NC), the Professional Engineers of NC (@ProfEngNC), United Minority Contractors of North Carolina and the American Council of Engineering Companies of North Carolina. Based on that discussion and my own review and analysis of the legislation, here are my top ten observations:
Alright, faithful readers, it’s time to launch a new feature here at N.C. Construction Law, Policy & News, a little something I’m christening the “Construction Tweets of the Week.”
The construction industry at all levels — local, state and national — enjoys an increasingly vibrant presence on Twitter. I aim to showcase some of the voices that left an impression on me in the preceding week, as well as to facilitate ongoing discussion, whether in the Comments section of this blog and/or in the Twitterverse beyond.
You’ll note the tweets embedded here are fully interactive, with hotlinks to each Tweep’s profile, linked content and “Follow” button. The reply, retweet and “favorite” functions are also fully operational. Click early, click often, and become a part of the Construction Twitterati.
Without further ado, here are the Construction Tweets of the Week for the week ending Saturday, October 5, 2013:
1. Dave Simpson of CarolinasAGC blasted out this tweet about six not-to-be-missed, CAGC-sponsored seminars concerning the North Carolina Legislature’s recent adoption of the design-build and public-private partnership (“P3″) project delivery systems for public projects in North Carolina:
Design-Build/Public Private Partnerships Educational Events to be Held in Six Regions – NC Construction News ncconstructionnews.com/architects/des…—
CAGC NC Building Div (@CAGCNCBldgDiv) October 01, 2013
The good folks at Bricker & Eckler, an Ohio law firm, recently blogged about a New York appellate decision concering subcontract default insurance (“SDI”), often referred to as “SubGuard” based on a Zurich SDI product of the same name. The case involves a private owner who alleged it was misled by its construction manager (presumably at-risk) into believing that the SDI policy the CM had procured from the project’s largest subcontractor provided coverage to the owner in the event of that sub’s default. Turns out the policy only named the CM, but not the owner, as an insured, and when the owner discovered it had no coverage after the sub’s default, it sued the CM for fraud, among other claims.
A Grim Tale
Once upon a time, Best General Contracting, Inc. hired Able Electric Services Co. to perform the $900,000 electrical scope of work on a library project for a local college. Having not worked with Able before, and in light of the value of the electrical scope, Best required Able to obtain subcontractor performance & payment bonds for Best’s benefit, agreeing, of course, to reimburse Able for the $13,500 bond premium. As fate would have it, the library project proved one too many for the not-so-able Able, who ran into cash flow problems, sought bankruptcy protection and abandoned the project. Best immediately fired off a notice of default letter to Superior Surety and hoped that the claims handling process would match previous, positive experiences with subcontractor sureties and culminate in a quick, fairy-tale resolution to this project setback.
To Best’s surprise, it would not. Continue reading
It was an honor and pleasure to speak at last week’s surety and fidelity claims conference in Philadelphia hosted by the American Conference Institute. Mark Oertel, a surety attorney from Los Angeles, and I closed out the conference on Thursday, October 18 with a presentation entitled “The Interplay Between Equitable Subrogation and the General Agreement of Indemnity’s Assignment Clause.”
Our remarks focused on two of the tools sureties use to minimize loss after satisfying claims made under payment and performance bonds. One of those tools, equitable subrogation, allows the surety to step into the shoes and assert the rights of those entities to whom or on whose behalf the surety has performed or made payment. That means after it performs its bond obligations, a surety becomes “subrogated” to the owner’s right to apply contract funds to completion costs, to the bond principal’s right to recover against poor-performing and/or late-performing subcontractors, and to the subs’ and suppliers’ rights to payment. Since the courts have held that the surety’s equitable rights trump the rights of bankruptcy trustees, lenders and taxing authorities, equitable subrogation is undoubtedly the most powerful weapon in the surety’s salvage arsenal.
That’s MOST powerful. Not ALL powerful.
I’m excited to be one of five North Carolina lawyers participating in a series of seminars sponsored by CarolinasAGC aimed at helping the construction industry understand the significant lien and bond revisions passed by the General Assembly and signed into law by Governor Perdue earlier this summer.
Over the coming weeks, CAGC is sponsoring five such seminars in Durham, Wilmington, Greensboro, Charlotte and Asheville. CAGC’s website describes each seminar as follows:
This two hour seminar will cover the major, recently enacted revisions to North Carolina’s lien and public bond law statutes. House Bill 1052 and Senate Bill 42 were signed into law this July, and will take effect respectively in January and April 2013. The new laws substantially modify the steps that all parties will have to take to protect their interests — regardless of whether they are an owner, buyer, contractor or sub/supplier. In particular, the new laws impose significant new notice requirements for both public and private work. This seminar will be taught by attorneys that were intimately involved in passing the legislation and will cover in detail what the changes are and what you’ll need to do to protect your interests starting in 2013. Attendees will receive a written summary of the lien laws as amended and a copy of the Power Point
presentation presented and have ample opportunity to ask questions from the presenting attorneys.
UPDATED: Lien Law Revisions Bill Cruises Through State Senate, Followed by “Hidden Lien” Legislation
Most recent update: Thursday, June 28, 2012 9:22 p.m.Both the lien law revisions bill and the “hidden lien” legislation sought by the title insurance industry flew through the N.C. Senate yesterday with flying colors.
The lien law revisions bill (House Bill 1052), which among other things would (1) provide “double payment” protection for general contractors under North Carolina’s public payment bond statute and (2) permit subs and suppliers to serve a Notice of Claim of Lien Upon Funds even after a party above them in the contractual chain files for bankruptcy protection, passed unanimously 49-0, with one Senator not voting.
The bill was amended prior to the vote to remove treble damages liability for misrepresentations made in lien waivers. I was listening to the Senate’s deliberations on the amendment, and Senators Brunstetter, Clodfelter, Tillman and Nesbitt all spoke about the dangers of introducing potential unfair and deceptive trade practices liability into a construction project’s payment cycle. The amendment was unanimously approved by the House on Thursday, June 28. The revised bill, as amended, can be found here.
The hidden lien legislation (Senate Bill 42), which among other things would require potential lien claimants to preserve their lien rights by providing a “Hi, I’m here” pre-notice to the project owner’s designated lien agent on residential and commercial projects, also passed unanimously 49-0, but not without some heartburn. In particular, Senator Tommy Tucker of Waxhaw spoke about how the legislation was only before the General Assembly “under a veiled threat” by the title insurance industry, thereby representing a “you’d better!” bill that would leave subcontractors “holding the bag again.” He expressed his support for the bill since the homebuilding industry supported it, but expressed his desire that the General Assembly re-visit the legislation early in the 2013 session to improve it before its April 1, 2013 effective date.
The version of SB 42 passed by the Senate contained several revisions to the version passed in the House on June 21. In the intervening week, a group of construction industry stakeholders — yours truly included, in the interest of full disclosure – worked to propose several modifications that would remove some of the rough edges from the House-passed bill. Those proposed modifications included the following:
- The requirement of pre-notice will not apply where the improvements in question are to be made to an existing single-family residential dwelling unit that is used by the owner as a residence.
- The failure to provide lien agent information to a supplier not expected to perform on-site labor will not result in triple damages exposure under North Carolina’s unfair and deceptive trade practices statute.
- Higher tiered contractors will no longer be able to cut off the lien rights of lower tiered contractors through lien waivers once the lower tiered contractor (1) files pre-notice to the lien agent and (2) serves a notice of claim of lien upon funds up the entire contractual chain and upon the lien agent (under existing law, a higher tiered contractor’s ability to waive the rights of lower tier contractors is only shut off when the lower tiered contractor files a lien enforcement action in court).
- Where a lien agent is not designated prior to the provision of design services by an architect or engineer, the design professional will be deemed to have met the requirement of pre-notice upon the owner’s designation of the lien agent.
These modifications and others are contained in a conference report that was adopted by both the House and Senate yesterday that you can find here. Legislative action on the hidden lien bill is complete, subject to the bill potentially being “tweaked” early in the next legislative session.
Both bills are on their way to Governor Perdue for her approval, which is expected before the end of the month.
Many thanks to Representative Sarah Stevens of Mount Airy for reaching out to me yesterday with news of these developments, and for all of her efforts in shepherding these important bills to the finish line.
Dave Simpson of Carolinas AGC informs me that HB 1052, the study commission’s lien law revision bill, as well as SB 42, the most recent version of the “hidden lien” legislation, were approved this afternoon by the House of Representatives of the North Carolina General Assembly. Neither bill was amended prior to passage.
Senate action is still required before the bills reach Governor Purdue’s desk; I’ll keep you posted on developments.
Monday is upon is, the beginning of what is likely to be the penultimate week of the General Assembly’s 2012 short session.
As my regular readers know, I’ve been tracking two key pieces of construction-related legislation: the lien law revision bill recommended by a legislative study commission, and the bill advanced by the title insurance industry to address the “hidden lien problem.”
This post provides an update on where those two bills stand, and also reports on a third construction-related bill that hit my radar last week.
I’m thrilled to welcome my first guest blogger, Danielle Rodabaugh, to N.C. Construction Law, Policy & News. Danielle is chief editor at SuretyBonds.com, a nationwide surety provider that issues construction bonds to contractors every day. As a part of the company’s educational outreach program, Danielle writes articles to help construction professionals understand the intricacies of surety bonds and the underwriting process. You can keep up with Danielle on Google+.
Whether you’re new to the construction industry or have decades of experience under your belt, you probably have some questions about surety bond acquisition and what goes into the underwriting process. Before we go much further, though, I’d like to review the basics of how surety bonds work and why they’re required.
Surety bonds ensure project completion.
When surety bonds are used on projects, they’re known as “contract bonds” or “construction bonds.” Project owners require them to ensure construction professionals work according to terms laid out in contracts.
There are a number of different contract bond types. Some of the most common ones are license bonds, bid bonds, performance bonds and payment bonds. No matter what kind of surety bond you need, it will function as a legally enforceable contract that binds together three parties:
- The individual contractor or contracting firm that buys the bond is the principal.
- The project owner, which is typically a state agency, that requires the contractor to be bonded is the obligee.
- The insurance company that issues the bond bond is the surety.
If a contractor fails to fulfill the bond’s terms, then the obligee can make a claim on the bond’s sum to gain reparation for any damages or financial losses.
A Tip For Performance Bond Obligees: For Maximum Protection, Obtain Increase Riders With Change Orders
You’re the authorized agent of a North Carolina county that has entered into an $8 million contract with a general contractor for the construction of a new administrative building. The performance bond issued on behalf of the GC is in the statutory form, and therefore applies not only to base scope, but also to “any and all duly authorized modifications of said contract…notice of which modifications to the Surety being hereby waived[.]“ N.C. Gen. Stat. § 44A-33(a). The penal sum of the bond corresponds to the contract’s original value — i.e., $8 million.
As the GC begins mobilization, you’re informed that the county has obtained the funding necessary to build an additional wing to the building. That work had been an alternate in the bidding process, but was rejected by the county when the bids came in higher than the architect’s estimate, leading the county to award a contract to the GC for base bid work only. Now that the additional funding has been appropriated to the project, the $500,000 additional wing can be added to the GC’s scope of work by change order.
You discuss the scope change with the GC, who’s excited about the additional work. A change order is executed, and requires the GC to provide notice of the change to the surety. You’re told such notice has been given. The County now has $8.5 million in protection under the performance bond, right?
Not so fast, Sparky.
Consider the following hypothetical:
You are claims counsel for a large surety company who has spent the better part of last December preparing for and participating in eight days of arbitration hearings arising from the termination of your bonded principal in late 2010. Back then, you had made the decision to contest liability under the performance bond on several grounds, not the least of which was the owner’s retention of a replacement general contractor without surety consent and otherwise in violation of the conditions precedent set forth in the AIA-A312 form of performance bond utilized on the project. Your bonded principal is now in bankruptcy, and you were required to take a leading role in the arbitration proceeding as a result.
Your outside counsel is now on the phone, announcing that the Award of the Arbitrator has been issued. Unfortunately, it’s not pretty. The arbitrator has awarded the owner virtually the entire completion premium it had been seeking in the arbitration proceeding, minus a few adjustments here and there. Adding insult to injury, the award is completely devoid of any reference to your A312 conditions precedent defense, which from day one you believed to be a winner, based on your interpretation of the prevailing legal authorities.
“That can’t be right,” you complain to your outside counsel. “That’s clear error by the arbitrator. Doesn’t the Federal Arbitration Act give me a right to challenge his obvious failure to apply the law?”
“Well,” outside counsel begins, “likely not. Generally speaking, the FAA only permits a judge to vacate an arbitration award upon proof of gross misconduct by the arbitrator. I’m talking about partiality or corruption, or misconduct in refusing to hear evidence pertinent to the dispute, that kind of stuff. And frankly, proving any of those statutory grounds would be a steep uphill battle for us.”
“Okay, let’s put the FAA to the side for a moment,” you respond. “If I’m right, and the arbitrator completely blew it on our A312 defenses, aren’t there cases out there that allow us to challenge this award if we can prove that it demonstrates a manifest disregard of the law by the arbitrator?”
Ah, manifest disregard of the law. For over fifty years, this common law doctrine has represented the last best hope for parties seeking to challenge the enforceability of an arbitration award. But ever since the U.S. Supreme Court’s decision in Hall Street Associates v. Mattel, Inc. in 2008, there’s been a decided split in the federal courts — and therefore a tremendous amount of confusion – as to whether manifest disregard still exists.
Last week, the U.S. Court of Appeals for the Fourth Circuit, which handles appeals from the North Carolina’s federal trial courts (as well as from the federal trial courts in MD, VA, WV and SC), finally took its stance in the ongoing mess. And at least in this jurisdiction, manifest disregard lives on.
Did the Court of Appeals Unwittingly Increase the Risk of Surety Companies Issuing Payment Bonds in North Carolina?
My recent musings about the Court of Appeals’ December 6, 2011 Southern Seeding decision (my original blawg post about the case is here; a longer treatment in this quarter’s Change Order, published by the Construction Law Section of the North Carolina Bar Association, can be found here) neglect to address the opinion’s implications for surety companies issuing payment bonds in North Carolina.
Those implications are profound and potentially far-reaching, and certainly worthy of discussion. So for those of you, like me, who have a keen interest in North Carolina suretyship law, you’ll definitely want to keep reading.