State lawmakers believe they are making the right policy decisions when they support legislation they think will benefit their constituents. Sometimes these decisions prove harmful to the interests of the individuals the legislation is intended to benefit.
During the 2011 legislative sessions in Virginia and Maryland, state lawmakers introduced measures thinking they were making sound policy decisions. Such measures, however, were not justified by empirical data and ultimately could prove to be counterproductive to their intended goals.
In Virginia, legislation (H.B. 1951) was signed into law that raised the performance and payment bond threshold for non-transportation contracts from $100,000 to $500,000—more than three times higher than the federal threshold. Lawmakers supported the bill because they believed raising the bonding threshold would provide greater opportunities for small, women- and minority-owned businesses attempting to win public construction contracts.
By enacting bonding requirements, the Virginia legislature recognizes the importance of having payment bonds in place to protect the downstream businesses that supply labor and materials on public construction projects. Small businesses often cannot compete as prime contractors on public construction contracts, so they participate at subcontractor and supplier levels. At that level, the only viable remedy in the event of nonpayment by the prime contractor is to claim on the statutorily required payment bond.
If the prime contractor fails to pay subcontractors and suppliers due to bankruptcy or other reasons, subcontractors and suppliers do not have an alternative means to recover their wages, costs and expenses. They cannot sue the governmental entity because they do not have a direct contract with the government, and they cannot place a mechanic’s lien against the public property.
By raising the bonding threshold to $500,000, materialmen and subcontractors performing on contracts below the threshold will be without payment bond protections. Having no recourse in the event of nonpayment may be disastrous for those firms, many of which are struggling to weather the difficult economic environment. Although lawmakers believed they were helping small and emerging business owners, the opposite could prove to be true.
The argument often made is bonding is an impediment for small and emerging contractors, and if statutory restrictions are waived or raised, a greater number of small and emerging contractors could obtain public works contracts as prime contractors. The reality is many small businesses are not capable of assuming the entire risk present in the prime contract because of the scale, experience and equipment required at that level, but they can perform at the subcontractor level. Removing their payment bond protection ensures these businesses will be vulnerable. Also, in today’s market the lack of a bond requirement merely opens up the bid to more competitors.
Last year, the North Carolina legislature raised the bonding threshold to $500,000 with the intent of providing greater opportunities for small and emerging contracts after previously raising its bonding threshold to $300,000. Each increase appeared to be a reaction to political pressure rather than empirical data substantiating that the increase would benefit small business inclusion. The impact of either threshold increase is too early to tell.
The law requires North Carolina state agencies and University of North Carolina systems to report the number of defaults, the cost to complete defaulted projects and the number of projects below the $500,000 threshold to prove a greater number of small contractors are participating on state projects. The Virginia law contains a similar requirement. Once these reports are published, taxpayers will gain a better understanding of whether such legislation benefits small businesses. Such a study, however, does not directly address the impact on small businesses that participate at subcontractor and supplier levels.
Legislation was introduced in the Maryland General Assembly (S.B. 782/H.B. 1071), but did not advance out of committee, to allow unregulated individuals to issue surety bonds on private construction contracts without obtaining a certificate of authority from the Maryland Insurance Administration (MIA). The purported goal of the bill was to provide additional opportunities for small and emerging contractors having difficulties obtaining surety credit in the standard market.
Compared to a 2006 bill approved by the Maryland General Assembly that allowed unregulated individual sureties to write on public contracts—provided the contractor has been denied bonding by a corporate surety and the individual surety attaches an affidavit proving appropriate assets are in place to secure the bond—the proposed legislation would have allowed an unlicensed individual surety to write on private contracts without being subject to any oversight by the MIA because subcontracts on public works projects are private contracts.
Furthermore, an unregulated surety could be free to charge whatever rates it wants for surety bonds, use whatever forms it proposes and impose whatever conditions it chooses. Should problems occur on these bonds, the obligee, the principal and the subcontractors protected by the surety bond would have no other recourse to address situations other than private lawsuits, which require significant resources these businesses likely would not have. The procuring agency could not help them, and they could not turn to the MIA for relief.
Much like the North Carolina and Virginia laws, the 2006 Maryland bill mandated state agencies report to the General Assembly concerning the law’s effectiveness. According to two reports issued by the Board of Public Works to the General Assembly in FY2008 and FY2009, small businesses have not benefitted from the law. The last report, issued Nov. 3, 2009, stated, “Bidders and offerors submitted zero individual surety bonds in FY2008 and FY2009.”
Substantial resources are available to small firms seeking to secure surety bonding credit. Waiving or raising statutory bonding thresholds should never be the political recourse, as such actions actually negatively impact small businesses and taxpayers.
Many surety companies offer small contractor programs designed to provide bonds through a simplified application process. Governmental agencies provide bonding assistance and guarantee programs designed specifically for qualified small contractors. Contractors that do not qualify in the standard market can enter bonding assistance programs or guarantee programs offered by the Maryland Small Business Development Financing Authority or the
U.S. Small Business Administration to gain surety credit. Furthermore, the surety community partnered with the U.S. Department of Transportation and other public agencies to create bonding education programs designed to help small and emerging contractors improve their operations and make it easier for them to be bonded or to increase their bonding capacity.
In some cases, a firm should not obtain surety credit because of a lack of the basic ingredients—character, capacity and capital —needed to perform the contract obligation successfully. A grant of surety credit in such circumstances is not warranted and certainly is not in the interest of taxpayers, potential claimants or even the contractor seeking the bond.
The purposes of bonding are to demonstrate the qualifications of a firm to perform a specific obligation and to stand behind that obligation. Raising a bond threshold steals that protection from taxpayers and subcontractors on public projects.