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By Douglas G Fox, CCE: Guest Column
Reprinted by permission from Trade Vendor Quarterly Blakeley & Blakeley LLP

Problems and solutions when construction project are awarded to the lowest bidder

Construction projects are often awarded to the lowest bidder. However, that can increase the risk of default because the successful bidder is often the one with the lowest overhead -- and usually few if any unencumbered assets.

The Miller Act of 1935 [ 40 U.S.C. 270 (a) - (f)] requires performance and payment bonds for federal public works projects:

(a) the performance bond insures the government for the successful completion of the project.

(b) the payment bond insures subcon tractors ("SC") that they will be paid by the general contractor ("GC").

(c) sometimes the process starts at the bidding stage with a bid bond. This demonstrates that the contractor is bondable, and provides some protection to the government by providing a third party guaranty that the contractor will start the project.

A typical bid bond might be 20% - 40% of the contractor's bid -- which is forfeited in the event that the contractor fails to start work; or fails to provide the required per- formance and payment bonds within the prescribed time limit.

The states have enacted similar statutes often referred to as "The Little Miller Acts."

In the event that a job is bonded and the GC defaults, the surety essentially has four options:

(1) put out the uncompleted work for bid by other contractors

(2) finance the original GC to complete the job

(3) the surety could do the work itself (an impractical option)

(4) pay the bond penalty (often 100% of the order to the GC) and walk away.

The bankruptcy filing of a GC may not always result in an event of default. Sometimes, the surety with the consent of the court is granted a "super priority lien" in exchange for providing new Debtor in Possession ("DIP") financing.

Many creditors make the mistake of thinking that they are automatically protected whenever there is a payment bond. However, for federal public works projects (such as U.S. Army Corps of Engineers projects) where the amount of the contract exceeds $ 5 million, the statutory minimum for the bond is $ 2.5 million.

The $ 2.5 million is the amount for all claims combined. Thus, in extremely large contracts, the amounts owed or potentially owed to SC can grossly exceed the protection afforded by the payment bond.

In practice, how the surety divides the $ 2.5 million seems to be "less than fixed in granite." Underwriters say that in some cases the surety has paid "first come, first served," and those who came late got nothing. However, that appears to be the exception rather than the rule. To be safe, creditors should notify the surety as soon as serious problems appear.

Often large jobs are bid by several GC's acting as a "joint venture" ("J/V"). What happens in the event of a default of one of the J/V? Each member of the J/V is responsible with 100% of its assets for the financial obligations of the project. In the event that one partner cannot complete its obligations, the other(s) must do so -- as supported by their own surety bond(s).

In other projects, it is common for the bonds to be 100% of the contract values. Obviously those bonds provide greater protection for SC.

With more than one project running simultaneously, the surety often has multiple obligations to a GC. However, bonds for each project are considered unique. Obligations on one project will not "spill over" to any other. From a bonding perspective, any deficit on one project cannot apply against a surplus on another - and vice verse.

How (and when) should creditors determine whether the project is bonded? In order to avoid problems "down the road," it is extremely important to request this information from your customer prior to order placement.

However, failing this, you may still be " in the ball game." Many statutes (including The Miller Act) require the GC to furnish a copy of the bond upon request. However, be forewarned that there are strict " time windows" in which to make claims, and even a day's delay may render your claim null and void.

The Surety Association of American ("SAA" - the trade group of the surety industry) has established on behalf of participating members, a voluntary Bond Authenticity Program. The author has used this program and his inquiries have always been met with a timely response from the individual surety.

To find out about the program, simply log onto the SAA home page at www. , then (in the middle side bar) click on the word "Surety."

On extremely large or complicated jobs, it may be in your best interests to assess the financial condition of the surety. The leading rating company is A M Best Company.

Ratings on individual sureties may be obtained by (a) automated telephone/fax reply, or (b) on-line via the A M Best Company's home page at , then go to the upper left of your screen and click on the top choice, "Ratings & Analysis." Next, in the right hand column, enter the name of the surety in the search field. Finally, the site requires registration which can be accomplished somewhat simultaneously (and, as of press time, was free).

Also, may states have enacted legislation establishing a trust fund whereby the construction funds are deemed to be held in trust by the GC, and not considered property of the GC's estate. However, that is a topic for another time.

Reprinted by permission from Trade Vendor Quarterly Blakeley & Blakeley LLP
Summer 03

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