payment and performance surety bonds and subguard insurance in construction...

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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TUESDAY, OCTOBER 23, 2012

Presenting a live 90-minute webinar with interactive Q&A

Lawrence Melton, Partner, Nexsen Pruet, Columbia, S.C.

Jonathan Burwood, Partner, Hinshaw Culbertson, Boston

Ira Schulman, Partner, Pepper Hamilton, New York

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Surety Bonds and Subcontractor’s Default Insurance

October 23, 2012

Strafford Seminar October 23, 2012

Lawrence C. Melton Nexsen Pruet, LLC

Columbia, South Carolina

Jonathan Burwood Hinshaw Culberston

Boston, Massachusetts

Ira Schulman Pepper Hamilton, LLP New York, New York

Strafford Seminar October 23, 2012 6

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 South Carolina; General Commercial Practice; 12 in construction practice group

2005 Published South Carolina Construction Law- 2ed. 2012.


Owner Contractor

Wants Building

Has Money

Can Build Wants Money


Owner Contractor

Build First

Pay Later

Pay First Build Later


Negotiated Schedule of Values, e.g. AIA A201 (2007) §9.2

Applications for Payment Based on % of Completion

Architect’s Certificate of Payment

Retainage/Substantial Completion/Punch List/Final Acceptance

11 Strafford Seminar October 23, 2012

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.

Survey Equipment

Clearing & Grading Redi-mix

Foundation Steel

Rebar Windows

Concrete Tile

Framing Paint

Electrical Bricks

Mechanical Etc.

Roofing

Painting

Landscaping

Etc.


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

Manage the Risk Bonds and Insurance


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

Surety (Bond Obligor)


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 Surety promises owner to complete project in event of GC default SUB-CONTRACTOR DEFAULT INSURANCE: 2 PARTY AGREEMENT Insurer reimburses the contractor for the direct costs incurred arising from subcontractor or supplier default.


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:

The above obligation is void if the Principal promptly makes payment to all persons having a direct relationship with the Principal or a subcontractor of the Principal for furnishing labor, material or both in the prosecution of the work provided for in the contract identified above, and any authorized modifications of the contract that subsequently are made. Notice of those modifications to the Surety(ies) are waived.


§ 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)

CAVEAT: PRIVATE BONDS MAY BE SUBJECT TO STATE REGULATION AS TO NOTICE, ETC.,

e.g., S.C. CODE § 29-5-440.


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!!!!


A. Coverage: Miller Act


Prime Contractor

Materialman

(proper bond claimant)

Subcontractor

(proper bond claimant)

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) 25

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 F. PENAL SUM IS LIMIT OF LIABILITY.


Lawrence C. Melton

Nexsen Pruet, LLC

803.771.8900

[email protected]


© 2012 Hinshaw & Culbertson LLP, an Illinois Limited Liability Partnership. All rights reserved. 31

SURETY PERFORMANCE BONDS

INTRODUCTION & GENERAL CONSIDERATIONS

► The Tripartite Relationship

► The Indemnity Agreement

► Surety ≠ Insurance



RT(F)B: “READ THE @*$%# BOND!”

► Public Projects & Statutory Bonds

Federal Miller Act

State ‘Little Miller Acts’

► Private Projects

Terms of the Bond Control

► Bonds Are Contracts



NOTICE

TERMINATION DEFAULT

PERFORMANCE BOND CLAIMS: MAGIC WORDS?



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 D.Conn. 2003); Enter. Capital, Inc. v. The San-Gra Corp., 284 F.Supp.2d 166 (D.Mass. 2003).



Tender Do

Nothing

Surety

Options

Takeover

BASIC SURETY OPTIONS: CHOOSE WISELY

SURETY INVESTIGATION



IMPORTANT ECONOMIC ISSUES

► Financing The Principal

► The Contract Proceeds

► Liquidated Damages

► Bond Penal Sum



COMMON SURETY DEFENSES

► Principal Defenses

► Coverage Issues

► Conditions Precedent

► Limitations Provisions

► Impairment of Collateral



BEST PRACTICES: CLAIMANTS

► Read The Bond / Read The Contract

► Satisfy All Conditions

► Clear & Unequivocal Communication

► Preserve The Contract Funds



BEST PRACTICES: SURETIES

► Read The Bond / Read The Contract

► Investigate & Document

► Be Aware of the Penal Sum

► Secure The Contract Funds


Jonathan C. Burwood Hinshaw & Culbertson LLP

Office 617-213-7009

[email protected]

www.hinshawlaw.com

Ira M. Schulman October 23, 2012

An Introduction To Subcontractor’s Default Insurance (“SDI”)

42

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 subcontractor/suppliers providing the contractor with flexibility and control unavailable with surety bonds.

43

Candidates For SDI

• High Annual subcontractor volume

• Financial strength, management expertise, and willingness to accept the financial risk associated with SDI.

• Successful history of project completion

44

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

• Personal assets put at risk

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 SDI

46

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 subcontract exposure

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

• No coverage for third-party injury claims

48

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

• Avoids waiting for outcome of dispute resolution before reimbursement of costs to complete

49

Contractor Disadvantages

• Financial Risk

• Increased Responsibility

• Absence of settled case law

• Subcontractor waryness

50

Subcontractor/Supplier Perspective

• Preservation of Bonding line

• No indemnity required

• Default without termination

• Continuation of payments

• Potential “vendex” issue (re: default)

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

SUMMARY

• Established in 1890

• More than 500 lawyers

• Twelve offices in seven states (PA, NJ, DE, NY, MA,

MI and CA) and the District of Columbia

• Practice is approximately 36% commercial / 53%

litigation / 11% intellectual property

• National and international practice (including active

client matters in Europe, the UAE, the Near East, the

Far East, South America, Canada and other parts of

the world)

Firm Facts

Commercial

• Corporate & Securities

• Corporate Restructuring & Bankruptcy

• Employee Benefits

• Financial Services

• Real Estate

• Tax

• Trusts & Estates

Intellectual Property

• Patent Litigation

• Patent Prosecution

Litigation and Dispute Resolution

• Commercial Litigation

• Construction

• Environmental

• Health Effects Litigation

• Labor & Employment

Firm Structure

www.pepperlaw.com

Pepper has expanded from its Philadelphia origins to 12 locations.

Our Locations

BERWYN 400 Berwyn Park

899 Cassatt Road

Berwyn, PA 19312-1183

610.640.7800

FAX 610.640.7835

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Oliver Street Tower

125 High Street

Boston, MA 02110-2736

617.204.5100

FAX 617.204.5150

DETROIT Suite 1800

4000 Town Center

Southfield, MI 48075-1505

248.359.7300

FAX 248.359.7700

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100 Market Street

P.O. Box 1181

Harrisburg, PA 17108-1181

717.255.1155

FAX 717.238.0575

LOS ANGELES Suite 2450

355 South Grand Avenue

Los Angeles, CA 90071-9500

213.943.1356

FAX 213.943.1357

NEW YORK The New York Times Building

37th Floor, 620 Eighth Ave

New York, NY 10018-1405

212.808.2700

FAX 212.286.9806

ORANGE COUNTY Suite 1200

4 Park Plaza

Irvine, CA 92614-5955

949.567.3500

FAX 949.863.0151

PHILADELPHIA 3000 Two Logan Square

Eighteenth and Arch Streets

Philadelphia, PA 19103-2799

215.981.4000

FAX 215.981.4750

PITTSBURGH Suite 5000

500 Grant Street

Pittsburgh, PA 15219-2507

412.454.5000

FAX 412.281.0717

PRINCETON Suite 400

301 Carnegie Center

Princeton, NJ 08543-5276

609.452.0808

FAX 609.452.1147

WASHINGTON Hamilton Square

600 Fourteenth Street, N.W.

Washington, DC 20005-2004

202.220.1200

FAX 202.220.1665

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1313 Market Street

P.O. Box 1709

Wilmington, DE 19899-1709

302.777.6500

FAX 302.421.8390

For more information, visit www.pepperlaw.com.

Pepper Hamilton, LLP The New York Times Building 620 Eighth Avenue-37th Floor

New York, NY 10018-1405

Ira M. Schulman 212.808.2718 [email protected]

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