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.
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
Image by Larisa Koshkina / PublicDomainPictures.net
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.
Danielle Rodabaugh of SuretyBonds.com
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.
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.