Payment and Performance Surety Bonds and
Subguard Insurance in Construction Projects
Asserting and Defending Surety Bond Claims and Exploring a Cost Effective Alternative for Owners, Contractors and Sureties to Protect Rights or Maximize Recovery
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Surety Bonds and Subcontractor’s
Default Insurance
October 23, 2012
Lawrence C. Melton Nexsen Pruet, LLC
Columbia, South Carolina Jonathan Burwood
Hinshaw Culberston Boston, Massachusetts
Ira Schulman
1976 J.D. Washington & Lee Law School
Admitted: Virginia, DC, South Carolina
1979 Representing Contractors on D.C. Metro System
1997 Returned to South Carolina
1998 Teaching Construction Law at University of
South Carolina School of Law
2001 Joined Nexsen Pruet – 7 offices in North and
Owner Contractor
Wants Building
Has Money
Can Build
Wants Money
Build First
Pay Later
Pay First
Negotiated Schedule of
Bill based on % of work in place
Owner GC
Payment based on approved % of work (self performs 0% of work)
less retainage
Subs Suppliers
Subs and suppliers invoice full price. GC paid for work in place less retainage. GC never has enough to pay subs/ suppliers in full. GC subject to Prompt Payment Acts.
Subs may agree to retainage
• Suppliers probably will not agree to retainage Owner may agree to pay upfront: mobilization;
general conditions; special equipment acquisition
• Owner will not agree to front end loading
• GC Subject to False Claims Acts (31 U.S.C. §3729 et seq.) 29 States and D.C.
Every construction contract or subcontract is
an extension of credit.
Subs/suppliers Risk not getting paid/not paid on time
GC Risk of subs/suppliers filing liens/non-performance/failure/bankruptcy
Owner Risk of GC non-performance; technical incompetence; underbidding; dishonesty; mismanagement; liens tie up financing Eliminate Risks Do Not build
Mechanics’ Liens: An American Solution to a Universal Problem: Laws of Maryland 1791, Chap. XLV, X : “. . . for all sums due and owing, on written contracts, for the
building of any house in the said city . . . the undertaker . . . employed by the person for whose use the house shall be built, shall have a lien on the house and the ground on
which the same is erected. . . and shall have the remedy as upon a mortgage . . .”
Mechanics’ Liens do not apply to Government projects absent express waiver of sovereign immunity.
Being surety has ruined many men who were prosperous . . .”
Ecclesiasticus, 29:18 (circa 180 B.C.)
3 Parties:
Contract for construction
Owner (bond obligee) GC (bond principal)
promise to pay GAI premiums
INSURANCE - “A contract whereby one undertakes to indemnify another or pay a specified amount upon determinable contingencies.” S.C. Code § 38-1-20.
• Funded by a pool of premium paying risk takers • Underwriting based on actuarial tables
• No indemnity of insurer by insured
SURETY BOND - Promise to pay the debt of another
• Funded by the Bond Principal
• Underwriting based on performance record of Bond Principal
and personal assets
• Principal indemnifies the Surety – General Agreement of
Indemnity (“GAI”)
PAYMENT BOND: 3 PARTY AGREEMENT
Surety promises owner to pay subs/suppliers if not paid by GC PERFORMANCE BOND: 3 PARTY AGREEMENT
STATUTORY BONDS
MILLER ACT: Act of August 24, 1935, 49 Stat. 793 (40 U.S.C. § 3131, formerly 40 U.S.C. §270a). Applies to projects > $100K.
LITTLE MILLER ACTS: See, Bransdorfer’s 50-State Little Miller Act
Compilation (bransdorfer.net) or contact the American Subcontractor’s Association, (asa.org), in Alexandria, VA.
NOTE: Some States have more than one Little Miller Act, e.g., S. C. has three, § 29-5-440 (payment bonds required on all State projects), § 11-1-120
(payment & performance bonds required on most contracts by agencies subject to State Consolidated Procurement Code), § 29-6-210 (SC DOT Bonds).
The Miller Act Bond: FAR 53.301-25-A Standard Form 25-A, Payment Bond:
OBLIGATION:
We, the Principal and Surety(ies), are firmly bound to the United States of America (hereinafter called Government) in the above penal sum. For payment of the penal sum, we bind ourselves, our heirs, executors, administrators, and successors, jointly and severally. However, where the Sureties are corporations acting as co-sureties, we, the Sureties, bind ourselves in such sum “jointly and severally” as well as “severally” only for the purpose of allowing a joint action or actions against any or all of us. For all other purposes, each Surety binds itself, jointly and severally with the Principal for the payment of the sum shown opposite the name of the Surety. If no limit of liability is indicated, the limit of liability is the full amount of the penal sum.
CONDITIONS:
§ 2. If the Contractor promptly makes payment of all sums due to
Claimants, and defends, indemnifies and holds harmless the Owner from claims, demands, liens or suits by any person or entity seeking payment for labor, materials or equipment furnished for use in the performance of the Construction Contract, then the Surety and the Contractor shall have no obligation under this Bond.
§ 3. If there is no Owner Default under the Construction Contract, the Surety’s obligation to the Owner under this Bond shall arise after the Owner has promptly notified the Contractor and the surety of claims, demands, liens or suits against the Owner or the Owner’s property by any person or entity seeking payment for labor, materials or equipment furnished for use in the performance of the Construction Contract and tendered defense of such claims, demands, liens or suits to the
Contractor and the Surety.
§ 3. “If there is no Owner Default [defined in § 16.4 as non-payment] under the Construction Contract . . . after the Owner has promptly notified the Contractor and the Surety. . .”
§ 5 Notice requirements for subcontractors and remote claimants – claim must be for work
done/material furnished “within ninety (90) days after having last performed labor or last furnished materials or equipment included in the Claim” – NOTE §15 “Upon request by any person or entity
appearing to be a potential beneficiary of this Bond, the Contractor and Owner shall promptly furnish a copy of this Bond or shall permit a copy to be made.” DON’T WAIT UNTIL THE INVOICE IS OVERDUE TO REQUEST A COPY OF THE BOND!!!! Also NOTE § 16.1 - .8 – definitions of “Claim”
§ 7.1 [Surety to respond within sixty (60) days after receipt of the Claim]
§ 7.3 Bond obligee (Owner) entitled to attorneys’ fees if Surety fails to pay amounts agreed to be owed § 8 Surety’s obligation limited to amount of the Bond
§ 10 Surety not liable for obligations unrelated to the Construction Contract § 12 One year statute of limitations (not enforceable in many states, e.g. SC)
1.
RTB!! Read the Bond.
2.RTS!! Read the Statute.
3.
RTB2!! Read the Book. See, Kevin L. Lybeck, et
al.,
The Law of Payment Bonds
(2d ed.), ABA
(2011). 921 Pages!!!!
Prime Contractor
Materialman
(proper bond claimant) (proper bond claimant) Subcontractor
Subcontractor (NOT a proper bond claimant) Materialman (NOT a proper bond claimant)
Who can make a claim on Miller Act projects?
Sub-Subcontractor (proper bond claimant provided
notice to Prime Contractor within 90
days of last work)
1st Tier 2nd Tier (Remote Claimant) 3rd Tier Materialman (proper bond claimant provided notice to Prime Contractor within 90
days of last work)
Sub-Sub-Subcontractor (NOT a proper bond claimant) Materialman (NOT a proper bond claimant) Materialman (NOT a proper bond claimant)
Proper Bond Claimant
Never a Proper Bond Claimant (i.e., out of luck)
AIA A312 – 2010, § 16.2 definition of Claimant includes: “any individual or entity that has rightfully asserted a claim under an applicable mechanic’s lien or similar statute against the real property upon which the Project is located.”
B. BONDING CAPACITY (NOT EVERBODY HAS IT). C. INSOLVENCY OF THE SURETY.
D. TIMELINESS OF THE SURETY’S RESPONSE. E. CLAIMS ARE SUBJECT TO SURETY DEFENSES:
1. OWNER DEFAULT.
2. OWNER OVERPAYMENT (POTENTIAL LIABILITY FOR A/E)
3. SUBROGATION: RIGHT TO ASSERT PRINCIPAL’S DEFENSES, E .G. NON-PERFORMANCE, POOR PERFORMANCE, FAILURE TO MITIGATE DAMAGES.
4. LACK OF NOTICE
Lawrence C. Melton
Nexsen Pruet, LLC
803.771.8900
© 2012 Hinshaw & Culbertson LLP, an Illinois Limited Liability Partnership. All rights reserved. 31
SURETY PERFORMANCE BONDS
INTRODUCTION & GENERAL CONSIDERATIONS
►
The Tripartite Relationship
SURETY PERFORMANCE BONDS
RT(F)B: “READ THE @*$%# BOND!”
►
Public Projects &
Statutory Bonds
Federal Miller Act
State ‘Little Miller Acts’
© 2012 Hinshaw & Culbertson LLP, an Illinois Limited Liability Partnership. All rights reserved. 33
SURETY PERFORMANCE BONDS
NOTICE
TERMINATION DEFAULT
SURETY PERFORMANCE BONDS
DEFAULT/NOTICE:L&A Contracting Company v. Southern Concrete Services, Inc., 17 F.3d 106 (5th Cir. 1994).
Balfour Beatty Construction, Inc. v. Colonial Ornamental Iron Works, Inc., 986 F.Supp. 82 (D.Conn. 1997).
Dragon Construction, Inc. v. Parkway Bank & Trust, 678 N.E.2d 55 (Ill.App.Ct. 1997).
TERMINATION:
Elm Haven Const. v. Neri Const., LLC, 281 F.Supp.2d 406
© 2012 Hinshaw & Culbertson LLP, an Illinois Limited Liability Partnership. All rights reserved. 35
SURETY PERFORMANCE BONDS
Tender Do
Nothing Surety
Options
Takeover
BASIC SURETY OPTIONS: CHOOSE WISELY
SURETY PERFORMANCE BONDS
IMPORTANT ECONOMIC ISSUES
►
Financing The Principal
►The Contract Proceeds
►Liquidated Damages
© 2012 Hinshaw & Culbertson LLP, an Illinois Limited Liability Partnership. All rights reserved. 37
SURETY PERFORMANCE BONDS
COMMON SURETY DEFENSES
►
Principal Defenses
►
Coverage Issues
►
Conditions Precedent
►Limitations Provisions
SURETY PERFORMANCE BONDS
BEST PRACTICES: CLAIMANTS
►
Read The Bond / Read The Contract
►Satisfy All Conditions
© 2012 Hinshaw & Culbertson LLP, an Illinois Limited Liability Partnership. All rights reserved. 39
SURETY PERFORMANCE BONDS
BEST PRACTICES: SURETIES
►
Read The Bond / Read The Contract
►Investigate & Document
Jonathan C. Burwood
Hinshaw & Culbertson LLP
Office 617-213-7009
Ira M. Schulman October 23, 2012
An Introduction To
Subcontractor’s
Background
• A surety bond is a three-way agreement whereby the
surety guarantees to one party the performance and/or payment of another party.
• SDI (issued by Zurich Insurance under the name of
SubGuard) is a two-party agreement between the contractor and the insurer that reimburses the
contractor for the direct costs incurred arising from subcontractor or supplier defaults.
• With SDI the contractor prequalifies the
43
Candidates For SDI
• High Annual subcontractor volume
• Financial strength, management expertise, and
willingness to accept the financial risk associated with SDI.
Surety Bonds
• Bid, performance, and payment bonds.
• The bonding rate is calculated based upon contract
amount
• Protection in the event of a refusal or failure to
perform
• Potential refusal of surety to take over work of
defaulted contractor
• Negative Impact to project schedule and budget
45
Advantages of Surety Bonds
• Objective prequalification
• Available to lower tier subcontractors/suppliers
• Penal Sum Limits
• No Deductible
• Established body of law regarding interpretation and
implementation
• Available to entities that may otherwise not qualify for
Concerns Regarding SDI
• It’s the new kid on the block
• No guarantee of Project Completion
• Expensive deductibles
• Only available to high performing general contractors
or at-risk construction managers
• Provides post-default funding that can prevent
domino-style project-wide delays
• Limit of liability may not be congruent with total
47
Subcontractor Default Insurance
• Shifts burden of defaulting contractor to the insurance
company
• Covers all subcontractors for the project
• Reimburses all direct costs incurred to complete the
defaulting subcontractor’s work, including the cost of attorneys and consultant fees incurred to remedy the default
• Policy exclusions
• The contractor absorbs the deductible
Contractor Advantages
• Coverage limit
• Flexibility
• Potential Cost Savings
• Reimbursement of Attorney’s fees and other non-brick
and mortar costs that are not covered by standard surety bonds
• Allows use of Subcontractors that may not have
established bonding lines
49
Contractor Disadvantages
• Financial Risk
• Increased Responsibility
• Absence of settled case law
Subcontractor/Supplier Perspective
• Preservation of Bonding line
• No indemnity required
• Default without termination
• Continuation of payments
51
Owner Perspective
• Many owners do not fully understand SDI
• Large lending Institutions favor SDI
• SDI helps keep the Project on time
• Subcontractor Defaults do not impact project budget
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