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Help May Be on the Way to Address Surety Problems

By Shappell, Brian
Proquest LLC

Introduced federal legislative efforts designed to reduce fraud and other abuses tied to surety bonds have a real chance to go on the books as soon as the end of summer. Nothing is guaranteed, of course, especially within the partisan divides of the modern US Congress, but supporters of reform may have found a way to piggyback HR 776, a surety-related bill, on recurring legislation that has passed annually for decades. If the bill, known as the Security in Bonding Act, passes and is written well enough to actually provide relief for subcontractors and materials suppliers, the help could not come soon enough.

The last few years have seen suppliers and subcontractors more hamstrung since any time in nearly a quarter century because of inadequate or even fraudulent surety bond pledges. James Fullerton, Esq., partner at Fullerton & Knowles, PC, said the surety problem is more of a cyclical issue than a new one. "You see the same movie every 10 or 20 years, and were certainly on the downward part of that cycle," he said. "After a similar recession in 1989-1990, federal projects had a problem with shady sureties. I had a number of cases where suppliers and subcontractors got burned. Were back to the same thing again, with the government allowing inadequately funded sureties to bond public work."

Even when surety bonds are adequately funded and those responsible for regulating them aren't asleep at the wheel, there's the potential for disputes. After all, it is basically a form of insurance and sometimes there's a reason that insurance companies are viewed as being in the business of collecting premiums, not paying out claims. "The automatic response of the surety is often to 'take the claim under advisement,' which is shorthand for 'we hope it will go away,"' said Robert Kean, a consultant with 25 years' prior experience as a credit manager with Florida Rock Industries. "It has been many years since I have seen a surety pay a claim within a reasonable period upon presentation."

Joanne Brooks, vice president and counsel for the Surety and Fidelity Association of America, acknowledged the negative sentiment, but noted it likely exists due to a lack of information and unreasonable expectations. "Few people really truly understand bonds, especially in construction situations," she said. "Normally, they aren't in the business of being in a bad situation. What their expectation is might be different from how a surety actually works. It's a process." She added that bonding doesn't work like filing an auto claim after a fender-bender, for example. Things aren't necessarily instantaneous.

Brooks also said it is noteworthy that the government has been looking into more cases of fraudulent bonds, and she views the increase in investigation and potetional justice brought to the few bad actors-those who cast an unfair shadow over the majority licensed and operating under good faith-as good for the industry.

Regarding the bad actors, Fullerton suggested the best way to turn around the negative trends in the surety industry is often to remember that public service employees, like individual contracting officers and even lawmakers, answer to the public to some extent. It underscores the importance of contacting the powers that be individually or, better yet, getting involved in group advocacy like that of the National Association of Credit Management. "The more credit managers complain and bring light to problems, the more it will tend to cause contracting officers to be more careful," he said. "That's what happened in the early 1990s with sureties, and it worked for almost 20 years." Perhaps lawmakers in Washington, DC have been listening.

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HR 776

As noted in the NACM Legislative Introduction and Position Brief of 2014 (see pp. 46-51), the Security in Bonding Act would be a welcome step in reducing the risk of nonpayment stemming from problems with surety bonds: "The Security in Bonding Act does a great deal to alleviate the concern by giving subcontractors and materials suppliers the confidence they need to extend credit."

HR 776 co-sponsor Richard Hanna (R-NY) said the provisions will strengthen the entire bonding process and, thus, make life a lot easier for subcontractors and suppliers from a risk standpoint. "HR 776 requires non-corporate sureties to pledge specific and secure assets as required from others providing collateral to the federal government and requires those assets be held by a government entity to ensure payments can be made in the event they are needed," he said. The bill was passed out of committee to the House floor on April 30.

Though a similar effort previously failed to gain traction in the House, a bit of maneuvering by Hannah and co-sponsor Sam Graves (R-MO) has certainly helped its potential. HR 776 is now one of six proposed bills being considered as an attachment to the FY 2015 National Defense Authorization Act (NDAA). Congress has passed NDAA annually for over 50 years now. One Congressional contact noted "its safe to say it usually gets done" and showed confidence that HR 776 would successfully remain in the defense bill. Before popping the champagne, there could be some obstacles along the way, not the least of which being the absence of a high-powered Democrat co-sponsor helping to drive the effort.

In the Meantime

It is important to remember that bond use should never replace credit standards and due diligence. Overreliance on sureties to save the day is simply not a good, risk-averse practice, even if many act like it is. "Many times, the prime takes the lowest bid and will risk nonperformance in the hope that they will dodge that bullet," Kean said. "Firms that are financially challenged often wind up not paying their vendors, and the result is the vendor has to file a claim."

Karen Hart, Esq., partner with the firm Bell Nunnally & Martin LLP, noted the potential for things to go sideways fast in the construction industry, but that basic market research such as internet searches, contacting professionals in one's network and attending industry trade group meetings can go a long way. "Part of it is knowing the players out there," Hart said. "Talk to people in the marketplace, know what's out there on the street. That's what networking is for, to learn from one another. Besides, what's on paper may not always reflect the realities of a situation."

Christopher Kramer, CCE, a supervisory credit/collections/AR manager with Quote 2 Cash LLC, added that it would be wise for credit managers to obtain a copy of the bond to help evaluate the creditworthiness of a surety. After all, he noted, Enron used to sell performance bonds on energy products. "There are rating services out there to assist in evaluating insurance companies. Depending on dollar amount, you may want to confirm directly with the surety the actual existence and content of the bond. Close attention should be given to conditions of the bond to understand performance requirements of all parties. As with standby letters of credit, and depending on industry and bond use, language can be influenced. I would also confirm the surety is licensed to do business in the state where the bond is issued, your location and where goods are sold or services will be performed," Kramer said.

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Even with potential legislative improvements, a little skepticism won't necessarily be a bad thing. Having documentation in order is as critical as looking into issues like licensing or bond content when a worst-case scenario hits and a bond issuer becomes combative. "I think sureties will continue to seek ways to avoid paying out on claims," said Sean Reimer, credit manager at Harsco Corporation. "Provide documentation and answer all questions then pin them down on a decision before any statute of limitations voids the claim. Documentation can be used to show your willingness to mitigate the situation."

Brooks agreed that documentation is critical, but also added "there are some legitimate reasons to not pay a claim. It could be they didn't submit enough documentation or do it timely. Overall, licensed and regulated sureties pay claims. That's what we do. I don't think you can make a broad-brush statement that sureties don't pay claims. We have data that show we pay a lot."

"You see the same movie every 10 or 20 years, and were certainly on the downward part of that cycle. After a similar recession in 1989-1990, federal projects had a problem with shady sureties. Were back to the same thing again."

"The more credit managers complain and bring light to problems, the more it will tend to cause contracting officers to be more careful. That's what happened in the early 1990s with sureties, and it worked for almost 20 years.''

Read more about sureties in "Public Private Partnerships: Payment Security Concerns" on page 8. Also follow the NACM blog (http://blog.nacm.org) for future developments in construction and credit law.

BRIAN SHAPPELL. CBA. CICP

Brian Shappell, CBA, CICP, NACM staff writer, can be reached at brians@nacm. org.

Copyright:(c) 2014 National Association of Credit Management
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