TWENTY THIRD ANNUAL NORTHEAST SURETY AND FIDELITY CLAIMS CONFERENCE SEPTEMBER 20th - 21st, 2012

Transcription

1 TWENTY THIRD ANNUAL NORTHEAST SURETY AND FIDELITY CLAIMS CONFERENCE SEPTEMBER 20th - 21st, 2012 WHAT SURETY CLAIMS PROFESSIONALS SHOULD KNOW ABOUT DISADVANTAGED BUSINESS ENTERPRISE SET ASIDE PROGRAMS PRESENTED BY: MATTHEW M. HOROWITZ, ESQ. Wolf, Horowitz & Etlinger, LLC 99 Pratt Street, Suite 401 Hartford, Connecticut Tel: (860) Fax: (860) JAMES KEATING Star Surety 150 North Radnor Chester Road, Suite F-200 Radnor, PA Tel: (610) Fax: (617)

2 WHAT SURETY CLAIMS PROFESSIONALS SHOULD KNOW ABOUT DISADVANTAGED BUSINESS ENTERPRISE SET ASIDE PROGRAMS I. Introduction Many state and federal public contracting programs require that the contractor let out a designated portion of the contract work to businesses that qualify or have been qualified as disadvantaged business enterprises ( DBE ). There are a number of such programs administered by the United States Department of Transportation. Examples are programs administered by the Federal Transit Administration ( FTA ) and Federal Highway Administration ( FHA ) under which there must be compliance with the DBE requirements set out in 49 CFR Part 26. DBE compliance may be critical to a principal successfully completing a bonded project. DBE compliance may also be a critical consideration for a surety in regard to administering both payment and performance bond claims. This presentation addresses the common problems and pitfalls for the contractor and surety acting in good faith and with a basic understanding of applicable DBE standards and procedures. As a frame of reference, the presentation addresses specific problems that arise under DBE programs administered under FHA and FTA programs with recognition that DBE programs administered by other agencies or DBE programs initiated at the state or local government levels may or may not have different requirements and procedures. This presentation does not address the underwriting issues that arise for sureties in considering whether or not to issue bond to contractors that qualify for DBE status. A. What is a Disadvantaged Business Enterprise? A DBE is defined, in pertinent part, under 49 CFR 26.5 as a: for-profit small business concern: (1) That is at least 51 percent owned by one or more individuals who are both socially and economically disadvantaged, or, in the case of a corporation, 51 percent of the stock of which is owned by one or more such individuals; and (2) Whose management and daily business operations are controlled by one or more of the socially and economically disadvantaged individuals who own it. The Code specifically names certain groups of socially and economically disadvantaged groups: 1. Black Americans, which includes persons having origins in any of the Black racial groups of Africa; 2. Hispanic Americans, which includes persons of Mexican, Puerto Rican, Cuban, Dominican, Central or South American, or other Spanish or Portuguese culture or origin, regardless of race; 1

3 3. Native Americans, which includes persons who are American Indians, Eskimos, Aleuts, or Native Hawaiians; 4. Asian-Pacific Americans, which includes persons whose origins are from Japan, China, Taiwan, Korea, Burma (Myanmar), Vietnam, Laos, Cambodia (Kampuchea), Thailand, Malaysia, Indonesia, the Philippines, Brunei, Samoa, Guam, the U.S. Trust Territories of the Pacific Islands, Macao, Fiji, Tonga, Kirbati, Juvalu, Nauru, Federated States of Micronesia, or Hong Kong; 5. Subcontinent Asian Americans, which includes persons whose origins are from India, Pakistan, Bangladesh, Bhutan, the Maldives Islands, Nepal or Sri Lanka; 6. Women; 7. Any individual groups whose members are designated as socially and economically disadvantaged by the SBA, at such time as the SBA designation becomes effective. 49 CFR B. Why a surety should have some working knowledge of these issues and pitfalls? DBE rules and procedures can be arcane and counter-intuitive. It is readily possible for a competent, knowledgeable contractor to find itself at substantial risk of penalties for noncompliance notwithstanding that the contractor has acted in good faith and has made reasonable efforts to comply. The penalties for non-compliance can be substantial and can include, as an example, back charges equal to every dollar of the DBE goal which the contractor has not achieved and/or debarment. Penalties imposed on a contractor for failure to comply with DBE requirements can impair a contractor s ability to complete the bonded obligation or make it impossible for the contractor to fully pay its subcontractors and vendors. A failure on the part of a principal to comply with its DBE obligations can result in both payment and performance bond claims. DBE rules and procedures may also bear on how a surety investigates and administers actual and potential payment and performance bond claims. The DBE regulations on FHA and FTA projects set out payment rules for subcontractors that may supersede the payment terms of subcontracts and these may affect the timing of payments and the merits of payment bond claims. To the extent that a surety is evaluating the financial condition of a principal and is considering financing or other assistance, the surety should identify and evaluate the financial and completion risks posed by a bonded contractor that is out of compliance with its DBE obligations. Where a surety has taken over a project, or is considering doing so, it should identify DBE compliance issues at the earliest possible time and take the best possible remedial actions at the earliest time. The surety should be aware that DBE rules apply to all third party contracts funded in whole or in part with Federal DOT funds. This does not mean, however, that every procurement or contract that the bonded contractor entered into must be reviewed for DBE 2

4 participation by the state or local grantee. The rules give grantees flexibility in when and how they establish individual contract goals. Certain types of procurements (e.g., off-the-shelf materials) may not have subcontracting opportunities or be appropriate for DBE goal setting. In other words, the DBE rules that apply to all contracts also include guidance and flexibility throughout Part 26 as to how state and local grantees can comply with this part without subjecting every procurement to an individual review for DBE participation. If, for example, the state agency can meet its overall goal through race-neutral means, then contract goal setting will not be necessary. And where goal setting is necessary, the rules do not require goals for every contract nor that every procurement be reviewed for goal setting purposes. Therefore, there may be a situation where the takeover surety has to reaffirm only a portion of the DBE s subcontracts (those where the grantee has reviewed the contractual relationship and is part of the overall set-aside program) and does not have to continue using other non-dbe subcontractors/suppliers unless it chooses to do so. II. Common Pitfalls in Attempting Compliance A. Failure on the Part of the Contracting Agency to Set Achievable Goals The DBE programs currently administered by FHA and FTA arise out of the Surface Transportation Assistance Act for the 21st Century, as amended (hereafter TEA-21. ). TEA-21 requires each state to set an overall statewide goal for DBE participation in federally funded projects and also set a DBE goal for each funded project. The statewide goal and each project goal are intended to be flexible and be reasonably related to the relevant labor and construction market. TEA-21 has been repeatedly challenged in the courts as incorporating alleged unconstitutional racial preferences. Because TEA-21 draws racial distinctions, the courts evaluate its constitutionality using strict scrutiny; that is, to be constitutional, the program must address compelling state interests and be narrowly tailored to achieving those interests. Adarand Constructors, Inc. v. Pena, 515 U.S. 200, 227 (1995); Richmond v. J.A. Croson Co., 488 U.S. 469, 492 (1989). For the most part, the courts have upheld the constitutionality of TEA-21, noting that its set-aside provisions serve a compelling state interest and are narrowly tailored to achieving its objectives. See, e.g., Western States Paving Co. v. Washington State Dept. of Transp., 407 F.3d 983, 995 (9th Cir. 2005); Sherbrooke Turf, Inc. v. Minnesota Dept. of Transp., 345 F.3d 964, 973 (8th Cir. 2003). The courts have also largely upheld TEA-21 as administered by various state and other funding recipients. See, e.g. Sherbrooke Turf, 345 F.3d at ; Northern Contracting, Inc. v. State of Illinois, No. 00-C-4515, 2005 WL (N.D. Ill. 2005) (aff d by 473 F.3d 715 (7th Cir. 2007)). One key reason why TEA-21 and the funding recipient programs to implement the TEA-21 requirements have been found to be narrowly tailored both on face and in application is that the programs are flexible and the numerical goals have a reasonable relationship to the relevant construction and labor markets. Cone Corp. v. Hillsborough County, 908 F.2d 908, 917 (11th Cir. 1990); Northern Contracting, at *25. The courts look with favor on plans that are reasonably achievable because they set forth participation goals that are based on the actual number of qualified DBE contractors available for specific subcontract line items. See Cone, Northern Contracting. In contrast, plans that impose arbitrary set-aside goals that have no reasonable relationship to the applicable labor market, and thus are practically impossible to achieve, are found to raise constitutional issues because they are not narrowly tailored to address the actual 3

5 discrimination in the labor market. See Engineering Contractors Assoc. of Fla. v. Metropolitan Dade County, 943 F. Supp 1546, 1583 (S.D. Fla. 1996), aff d, 122 F.3d 895 (11th Cir. 1997)). Participation goals for individual projects under TEA-21 must be based on the actual number of qualified DBE subcontractors available for the specific trades required under the contract, taking into consideration the value of the work available in trades where there are approved DBE subcontractors, so that the overall participation goal can reasonably be attained. There are circumstances where states have applied the same statewide goal to all funded projects with no per project individualization. There have also been circumstances where states have individualized on a per project basis but have overstated the actual availability of DBE subcontractors for the particular skills required on a given project. This risk is particularly evident where a particular contract calls for work that is atypical for the agency in whole or part, thereby creating a risk that the list of approved DBE contractors may not include those with skills needed for the atypical construction required on the project. To the extent that either a statewide goal or a project goal is not reasonably achievable, that goal may be out of compliance with the TEA-21 regulations and possibly constitutionally infirm. Recommendations to contractors: A contractor should analyze whether the project goal is reasonably achievable during the bidding process and it is critical that this be analyzed at the outset of the buy-out process. The earlier that the public agency is advised regarding these concerns, the more likely that the agency will vary the set-aside goal to reflect the facts regarding the particular contract. The longer the contractor waits to address this issue the more likely that the agency may resist meaningful modifications. Recommendations to Sureties: The completion surety should determine at the earliest time whether or not the principal accounted for the necessary number of DBE credits in its buyout. If this is not the case, the surety should evaluate the project goal to determine whether or not that goal was reasonably achievable. If the project goal was not achievable, the surety should seek redress from the obligee at the earliest possible time. B. Problems may arise in the course of contract buy-out. Many DBE Programs require that the contractor submit initial and periodic reports identifying the DBE subcontractors that will be participating and the amounts of their subcontracts and specifying over time the amounts actually paid to DBE contractors as the work progresses. The roster of DBE subcontractors committed to a job may vary substantially over the life of a project. There are many reasons why initial commitments from DBE subcontractors may not prove permanent. Some examples are: 1. High quality DBE subcontractors in major trades are in high demand and may make initial commitments and then back out prior to executing subcontracts because of more desirable opportunities on other jobs. 4

6 2. Some DBE subcontractors/vendors may misunderstand the contract requirements and may lack the capacity to perform or deliver the required materials. 3. Some DBE subcontractors may demand unreasonable payment terms (i.e. payment in advance or immediately upon completion of a particular task) either before or after they execute subcontracts. 4. DBE subcontractors may go out of business or lose their DBE certifications. 5. Subcontractors may promise to achieve DBE status but may not ultimately be certified. In addition to these problems inherent in the program, it is unclear under TEA-12 funded programs whether or not a contractor can include for DBE credits second tier subcontractors. Some contracting officers allow second tier subcontractors to be included and other contracting officers only allow consideration of subcontractors who contract directly with the contractor. Contractors that report substantial changes in their DBE roster or which do not timely report such changes may be at substantial risk of penalties, particularly if their total DBE dollars fall short of goals. Recommendations to Contractors: Contractors needing to achieve DBE goals should be reluctant to rely for this purpose on commitments from subcontractors who indicate that their DBE applications are pending or will be filed shortly. Where a contractor has disclosed on a periodic report the name of a DBE subcontractor and that subcontractor backs out of its commitment to the project, the contractor should report that occurrence to the awarding authority at the earliest possible time and propose either a substitution or a plan for recovering the DBE credits that have been temporarily lost. Contractors need to carefully assure that where a DBE subcontractor/vendor commits to the Project, the subcontractor has the capacity to perform the particular work called for or provide the particular materials called for under the contract. To the extent that it is challenging for the contractor to find the necessary DBE credits, the contractor should consider advancing the timing of executing subcontracts and purchase orders with DBE s who are prepared to commit for the project. Contractors should know definitively whether or not the funds in second tier DBE subcontracts can be applied against their DBE set aside amounts. Recommendations to Sureties: 5

7 In the context of a default and termination, the surety claims handler must read the bonded contract and understand if there is a need for DBE compliance. Find out what percentage the DBE bond principal represents for the entire project. One strategy that has had some limited success is to try to negotiate the DBE requirements out of the takeover agreement with the obligee. It may be the case that the setaside program has met its requirements to FHA or FTA on a statewide basis and then some, and therefore has room for flexibility. The state agency may have good relations with the federal administrators and may be able to secure approval for a deviation from the compliance goals in default/termination context without risking a reduction in federal funding. The only reasonable way to make this determination is to work cooperatively with the obligee. There is much to be gained by garnering the assistance of the procuring agency if encountering problems finding a competent replacement DBE contractor. To the extent that a completing surety remains obligated for DBE compliance, the surety needs to determine at the outset whether or not the principal is or is not in compliance with the project goals. If not, the surety needs to ascertain whether or not these goals are achievable in the relevant construction market and petition the obligee to modify the project goal to the extent warranted. The surety needs to account for DBE obligations in the course of the ratification process. It may be necessary to try to recruit additional DBE subcontractors. To the extent that there are performance issues in regard to certain of the principal s subcontractors, the surety needs to consider whether or not a subcontractor is DBE certified and, if so, the surety needs to develop a strategy for dealing with a loss of DBE credits to the extent that a DBE subcontract is not ratified. C. There may be special rules for payment of DBE subcontractors either expressly or as matter of practice 49 CFR Part requires that all subcontracts on FTA/FHA projects have payment clauses requiring that subcontractors be paid within thirty days after payment is received by the contractor for the specific work and further requiring that subcontractors be paid retainage within thirty days after the subcontractor s work is satisfactorily completed, regardless of whether or not the public agency has released retainage to the contractor and regardless of whether or not the subcontractor s work has been accepted. State agencies enforcing DBE compliance may also have unwritten practices regarding whether or not a prime contractor will be permitted to assess back charges against a DBE subcontractor for any reason (defective work, delay, etc.). Withholding payment to a DBE subcontractor may result in a contractor failing short of the project wide goal and may result in the state agency falling short of its statewide goal. The contractor may receive explicit signals from the obligee that there will be untoward consequences for back charging a DBE subcontractor regardless of whether or not a back charge is warranted under the contract documents. Recommendations to Contractors: Contractors should understand the differing payment terms on certain public projects as a result of DBE requirements and which of these terms are read into their subcontract forms as a matter of law. The contractor should impress upon the owner that there is a mutual interest in 6

8 expediting final approval of a DBE s work at the earliest possible time so that, even if the contractor must issue payment before it is paid by the owner, payment will not issue for noncompliant work and the subcontractor s incentive to correct noncompliant work will not be dissipated. To the extent that backcharging a DBE subcontractor is warranted, the contractor should consider discussing this matter with the public agency well in advance of the decision to back charge and should further consider at the earliest time means of recovering DBE credits to the extent that a back charge is required. Recommendations to Sureties: For purposes of evaluating payment bond claims, the surety claims handler must obtain subcontracts/purchase orders from the bond principal to understand the agreed-upon payment terms. However, the claims professional must also understand that on FHA and FTA Projects, contractual payment terms may be superseded by the payment terms mandated by regulations. Without an understanding of what the current obligations are it would be difficult to properly manage claims of non-payment from subcontractors and/or suppliers. The surety claims handler would also do well to use care when taking a bonded principal s back charges or set-offs to defend against a DBE payment bond claimant. A useful tactic could be to immediately pay the undisputed amounts due the DBE claimant, reserving all rights to raise defenses to the balance allegedly owed. This would serve two purposes; to possibly appease the claimant and thereby provide additional time to investigate the disputed portion of the claim and to show the grantee good faith efforts to keep the DBEs paid according to the CFR guidelines. A completing surety must assure itself that a completion contractor fully understands the required payment terms on FHA and FTA funded projects and also understands the obligee s possible reluctance to permit back charges against DBA subcontractors. D. Providing Assistance to Struggling DBE Bonded Contractor There may be special rules or practices regarding a contractor providing assistance of any sort to a struggling DBE subcontractor or terminating a DBE subcontractor. Many public owners are concerned about efforts by contractors to evade DBE procedures by using fictitious DBE s or entering into fictitious subcontracts with DBE s in whole or part. Good faith efforts by contractors to assist a struggling DBE (i.e., purchasing materials under the DBE s scope, helping to complete some of the work, or helping the DBE to complete paperwork) may be construed by the public agency as evidence of fraud and collusion. Public owners are equally concerned with a contractor terminating a struggling DBE. Recommendations to Contractors: A contractor should advise the public owner of problems with a DBE subcontractor at an early time and should vet a response with the public owner in lieu of unilateral actions. 7

9 Recommendations to Sureties: Does the surety or its completion contractor take on additional risk by assisting a struggling DBE subcontractors? The surety claims handler must understand that exerting any type of influence over the day-to-day operations of a DBE or assisting a DBE could be perceived by the authority as an impermissible affiliation which could take the DBE outside of the program. An example of this could be a surety arranging for funds control solely as to funds earned by a struggling DBE subcontractor. Any such remedial actions should be fully vetted with the obligee in advance of implementation. III. Conclusions It is critically important that a contractor take time to understand the intricacies of an applicable program DBE. This includes consultations with DBE administrators since many of the practices may not be evident from published rules and guidelines. It is important that the Contractor identify the potential DBE implications of possible decisions before those decisions are made. While contractors may not generally involve the owner in subcontractor issues, contractors on DBE projects may be well-served by involving the public agency in problems with DBE s and solutions to these problems promptly after issues arise. A surety must fully understand any DBE requirements in the bonded contract in a default and termination situation and the obligee s practices in administering these requirements. A surety must also have a handle on the unique payment issues regarding subcontractors on FTA and FHA funded projects in the event of receipt of payment bond claims

10 Matthew M. Horowitz Wolf, Horowitz, & Etlinger, L.L.C. 99 Pratt Street, Suite 401 Hartford, Connecticut Phone: (860) Facsimile: (860) Matt Horowitz is a partner in the Hartford, Connecticut Law Firm of Wolf, Horowitz, & Etlinger, LLC. Mr. Horowitz graduated from Tufts University in 1973 and New York University School of Law in He is a member of the Connecticut, Massachusetts, District of Columbia and Texas Bars. Over the last 35 years, he has engaged in a varied litigation practice. For approximately 23 years, his practice has focused primarily on fidelity and surety claims and litigation in Connecticut and Massachusetts. He has co-chaired the surety presentation at the ABA Fidelity and Surety Mid-Year Meeting and presented papers at the ABA Fidelity and Surety Mid-Year Meeting, the Northeast Surety and Fidelity Conference, the National Bond Claims Association Conference, and the Surety Claims Institute. He is a coeditor of the TIPS Law of Performance Bonds Manual and the TIPS CGL/Builder s Risk Monograph and he is a contributor to numerous TIPS publications, including the Miscellaneous Bond Monograph, the Law of Commercial Surety & Miscellaneous Bonds, and The Law of Payment Bond Manual

11 James A. Keating Mr. Keating is an in-house insurance attorney with extensive surety, construction, and litigation experience. At Star Surety, Mr. Keating is involved in all aspects of the surety claim process from initial receipt of surety claims, investigations, mediations, trials, and appeals. Mr. Keating is also in charge of the administration and handling surety claims for another surety as TPA. In addition to handling surety claims, Mr. Keating also handles general liability litigation matters for Star Surety s sister company, Century Insurance. He has testified as corporate representative and corporate records custodian at numerous depositions and trials for several surety companies. Prior to joining Star Surety, Mr. Keating worked for a surety in the Philadelphia area. In private practice he was associated with a Philadelphia law firm where he represented injured clients in several multi-million dollar construction-related cases. He has experience in state and federal courts as well as before arbitration panels. Having served a four-year carpenter s apprenticeship and nine years in residential and commercial construction prior to attending law school Mr. Keating worked as construction foreman on many projects. He has intimate knowledge of the construction process from initial surveying and layout of the foundation to rough framing construction to completion of interior trim woodwork. Furthermore Mr. Keating s expertise includes the ability to read and understand construction drawings, construction project financing documents and coordination of schedules of the various trades on a project. A member of the Phila. Surety Claims Assoc., National Bond Claims Assoc., and PA Bar Assoc., Mr. Keating is a 2002 graduate of the Widener Univ. School of Law, where he was a graduate of the Intensive Trial Advocacy Program and appeared in Who s Who Among American Law Students in 2001 and He earned his undergraduate degree from St. Joseph s Univ. in 1999, and has also earned numerous construction-related and OSHA certifications.