As the economy begins its slow recovery, contractors are looking for work to keep their businesses going, their workers employed and their equipment fully utilized. In particular, contractors have their eye on the public projects being funded through the $787 billion economic stimulus that Congress passed earlier this year. In some cases, these contractors previously worked in the residential construction market and are seeking public work for the first time.
Legislators at the state and federal level have tried to pass laws to help small and emerging contractors win public jobs in the current economy by waiving the bonding and other requirements for public procurement.
This year, the U.S. Senate discussed a provision to waive surety bonds for any public project funded by the economic stimulus package. Shortly thereafter, the Oregon Department of Administrative Services adopted temporary emergency procurement rules that permitted state procurement officers to waive performance bond or payment bond requirements for projects funded under the 2009 “Go Oregon!” economic stimulus package. The temporary rules expired in August, and legislation that would have extended the emergency rules until January 2012 was defeated later in the session.
In New York, legislation was introduced late in the session that would have created a small business mentoring program under which the Metropolitan Transportation Authority (MTA) would have been able to waive many state procurement requirements. Small businesses would have partnered with MTA-selected construction manager mentors for four years, during which time the team could have been awarded MTA public works projects costing $1 million or less. The MTA would have been permitted to waive requirements for bid, performance and payment bonds; competitive bidding; awards to the lowest responsible bidder; and the anti-directed insurance and surety provisions for small businesses participating in this mentoring program. In the first year, the aggregate amount of contracts let under this program could not be less than $10 million or more than $100 million. The legislation was defeated in the New York Senate.
However, Ohio successfully enacted a bond waiver program as part of its state budget that allows contractors to perform four state projects without bonding. The first contract for a project done without bonding may be $25,000 or less, after which a contractor can obtain a contract of up to $50,000 without providing the bonds required by law. The third contract without bonding is for a project up to $100,000, and the fourth is for a project up to $300,000. The bond amounts for unbonded work for contracts with local governmental entities are $25,000, $50,000, $100,000 and $200,000. Contractors must participate in a contractor assistance program for the first two unbonded projects and must have successfully completed such a program to obtain the last two unbonded projects. A contractor must successfully complete one unbonded job to be awarded another one.
The Problem: Taxpayers Pay the Price
Although well-intended, these legislative efforts could hurt more than help contractors and taxpayers. Because mechanics liens cannot be asserted against public property, laborers, subcontractors and suppliers on public projects must rely on the general contractor’s payment bond for protection.
If this bond is waived, these parties have no way to collect for their services and supplies if the contractor is unable or unwilling to pay them. Small and emerging contractors are more likely to start as subcontractors. If no bonds are in place, subcontractors and suppliers either have to risk losses from nonpayment that they cannot afford, or not work on the public jobs for which they are qualified.
In the current economy, contractors must have payment protection.
The performance bond ensures the project is completed with the state and local taxpayers paying only the contract price. If a performance bond is not provided, the taxpayers take on the risk that the contractor will default. If no bonds are in place and a default occurs, the state and local contracting entities bear the burden of re-letting work and paying any excess completion costs. Those costs ultimately are borne by taxpayers. Most state and local budgets currently have little or no leeway to absorb the extra completion costs from a contractor default.
Because waiving bond requirements permits contractors to bid on public projects without being required to provide payment and performance bonds, the result could be that financially unstable contractors—which otherwise cannot obtain bonding and are not prequalified by sureties—would be bidding and obtaining public construction projects. This increases the risk of nonpayment for subcontractors and the risk of default to the state and its taxpayers.
Bid Protests Likely
In Oregon, state procurement officers have not used their temporary powers to waive bonds. But in Ohio, state and local procurement agencies face the difficult task of implementing their new law. Will state and local agencies have to let contracts for which some of the bidders have to provide bid security and others do not? How many jobs can a small or emerging contractor bid on in order to get that first unbonded job? Who will keep track of how many times a small or emerging contractor bids to obtain a contract, and who will know if the contractor is on its first, second, third or 20th contract without bonds?
Contractors will be bidding without bonds to various state and local entities. What mechanism exists to detect and prevent a contractor from performing four unbonded jobs and then starting all over under a different company name or a change in ownership? If contactors are bidding on a job without bonds against other bonded contractors, which party will review the unbonded contractors to see if they can complete the job, and when in the process will this qualification be done?
Letting a job in Ohio in which the bids of small and emerging contractors do not have to include bid and final bonds, but the bids of other contractors must include bonding, could increase bid protests in the state. Under the Ohio procurement laws, the state must accept the “lowest responsible and responsive bidder.” For the state’s political subdivisions, it’s the “lowest and best” bidder. What if an unbonded small contractor is the low bidder? Do the public contracting entities in Ohio have enough authority under the statutory standards of “responsible and responsive” bidders and “best” bidders to award the contract to a bonded contractor? The new law may turn Ohio’s procurement process into a contentious and litigious mess.
There is good public policy for the universal requirement of surety bonds on public works projects. These bonds guarantee the project will be completed and that subcontractors, suppliers and laborers get paid. If a surety backs a contractor that defaults on the project, the full amount of the surety bond is available to complete the work and to pay the companies that performed work on the job.
It makes little sense in a weak economy to waive the protections of the performance and payment bonds required by state and federal law.
Small and emerging contractors historically have had difficulty obtain-ing bonding on public projects, but this challenge is being met through contractors’ increased awareness of bond readiness requirements. New products and markets for bonds are tailored to this contractor group, and federal, state and local governmental entities support enlightened programs in partnership with the surety industry. This combination has proved to be a powerful and effective way to make bonding available to the broad spectrum of contractors that need it.
A troublesome fallout of the economic downturn is the increasing undercapitalization of small contractors that, in turn, contributes to their bonding difficulties. Applications for lines of credit, the lifeblood of contractors, are being rejected at a record rate, and banks are lowering these lines for their existing customers, too.
In the absence of some form of expanded capital access, small businesses are having difficulty taking advantage of contracting opportunities in the economic stimulus package. And with reduced credit, some contractors are not able to obtain bonds in the amounts that they have in the past. This often is seen as a problem with the surety tightening its underwriting standards, but it actually is a problem of access to capital.
Model Contractor Development
During the past several years, The Surety & Fidelity Association of America’s (SFAA) Model Contractor Development Program (MCDP) has been implemented successfully around the country, and current programs are under way in New York, Mississippi, Maryland, Texas, Illinois, Ohio and Washington, D.C.
The MCDP is a collaboration between the surety industry and local partners (usually state or local governmental entities) that consists of educational workshops that provide information on improving a construction company’s operations. Bond readiness activities include one-on-one interactions with surety bond producers, underwriters and other professionals who work with the contractors on a case-by-case basis to assemble the materials necessary to complete a bond application and address any omissions or deficiencies that might deter the successful underwriting of a bond.
In its first year, the New York State Bonding Initiative resulted in more than $30 million of direct bond placement, and the Mississippi program graduated more than 300 contractors in five locations throughout the state.
MCDP initiatives also include capital access components that address the working capital and collateral needs of contractors seeking bonding. Both the New York and Mississippi MCDPs employ capital access to support contractors participating in these programs. In New York, the capital access program provides working capital loans for contractors to support their cash flow needs once a contract has been awarded. Collateral lending also enhances their bondability.
In Mississippi, the capital access loan program increases the availability of financing for borrowers that might have difficulty obtaining conventional loans. Although these funds are not directly tied to bonding, access to such funds enhances a company’s ability to obtain bonding by providing an incentive to the participating banks to provide a loan or line of credit to the contractor.
Pilot Programs
Drawing on these experiences, SFAA entered into a memorandum of agreement with the U.S. Department of Transportation (DOT) that includes a “pilot” capital access effort in which the DOT would fund the collateral often needed to meet bonding requirements. If successful, this regional pilot program will be implemented through state DOTs around the country.
SFAA also has a memorandum of understanding with Associated Builders and Contractors (ABC), and is exploring ways to incentivize small and emerging contractors to become ABC members by offering targeted access to the resources of SFAA’s MCDP.
As small and emerging contractors struggle through what is likely to be a slow economic recovery, more will utilize these types of programs for collateral and their first bond, as well as to obtain working capital and bond increases. As a matter of policy, legislators at the state and federal levels should avoid the dubious fix of bond waivers and increased bonding thresholds, and instead fund and implement workable programs that address both access to capital and access to bonding for this critical sector of the contractor community.