The Surety & Fidelity Association of America

THE SURETY & FIDELITY ASSOCIATION OF AMERICA

MEMORANDUM

TO: Government Affairs Advisory Committee Contract Bonds Advisory Committee

FROM: Lenore S. Marema

DATE: April 10, 2009

SUBJECT: Overview of the State Legislative Sessions—Contract Surety

The following summarizes key state legislation affecting contract surety that SFAA has been working on most recently with AIA and the NASBP. As it is early in the state sessions, this report contains the key legislation that has been introduced in the states to date.

Status of the State Sessions There are 43 states and the District of Columbia currently in their regular sessions. Some of the states are in recess right now for a brief spring break. New Jersey is in budget hearings, and Louisiana has begun pre-filing bills for the start of a late April session. A few states have adjourned for 2009: Kentucky, New Mexico, South Dakota, Utah, Virginia and Wyoming.

Of General Interest Louisiana HB 54 has been pre-filed and it would provide that a “secondary underwriter” for a surety bond on a public works project would serve as the “primary underwriter” if the primary underwriter did not meet the existing law's requirements for surety qualifications. Existing law requires the surety on a bond to be listed on the U.S. Treasury Department's Circular 570, a Louisiana domiciled insurance company with at least an "A-" rating, or to be an insurance company that is either domiciled in Louisiana or owned by Louisiana residents and is licensed to write surety bonds.

SFAA’s believes that the intent of this bill needs to be understood and clarified. The term “secondary underwriter” is not defined and it is unclear if the secondary underwriter replaces the primary underwriter on a voluntary or involuntary basis. SFAA originally thought that the bill was intended to address the situation when the surety on the bond does not qualify under the Louisiana eligibility requirements, but its reinsurer does. In that case, the question becomes whether the reinsurer becomes primarily liable with its consent or whether the reinsurer is required by law to become primary at that point.

Many thanks to members of the local surety association, who promptly met with the bill sponsor. This bill is intended to open up access to bonding to contractors whose surety does not meet the eligibility requirements, some of which may be small and emerging

1 contractors. The local surety association was able to explain the purpose behind the original law, which was to protect the contractors by assuring that they were being insured by a financially sound surety company. They also were able to educate the bill sponsor on the nature of bonding, and how the surety serves to prequalify contractors for the protection of the public so that financially sound and experienced contractors perform public work. They informed the sponsor of existing bonding guarantee programs in which minority contractors can participate including the Small Business Administration bond guarantee program and the Louisiana Department of Economics bonding program. SFAA will follow up with a letter to the bill sponsor about our Model Contractor Development Program and our work to date to implement it in New Orleans.

Bad Faith The surety bad faith bill has been introduced again in Rhode Island. SB 369 would allow any obligee, principal or claimant that is under any fiduciary, performance or payment bond to file a claim against the surety on the bond for wrongfully, and in bad faith, refusing to pay or settle a claim. The bill would allow the claimant to seek both compensatory and punitive damages, as well as reasonable attorneys' fees and costs of the suit. The bill is identical to legislation that SFAA has defeated for the past three years in Rhode Island. The bill recently was heard in the Senate Judiciary Committee. The SFAA, AIA, PCI, CNA Surety and the Defense Counsel of Rhode Island all testified in opposition to the bill, and there were no witnesses in support of it. The Committee held the bill for further study, but could reconsider it later this session.

S tate Bond Thresholds and Bond Waivers --To Governor. New Hampshire HB 284 would increase the threshold for payment bonds on all contracts for public buildings, public highways, bridges or other public works from $25,000 to $35,000. The bill is on the Governor’s desk for signature.

--Bills on the Move. North Dakota SB 2401 would have increased the threshold at which performance and payment bonds are required on construction contracts for public improvements from $100,000 to $200,000. The bill was converted in the Senate into a study bill that required the legislative council to study the bonding and other procurement issues. The House amended the bill even further. As the bill has been sent back to the Senate, the legislative council “shall consider studying,” during the 2009-10 interim, public improvement and capital construction bid requirements, plans and specifications, and the employment of architects and engineers.

Rhode Island SB 53 would prohibit the Department of Transportation or Department of Administration of any state, city or town agency from waiving the bond requirements for contractors awarded contracts in excess of $50,000. The bill was heard and passed out of Committee.

--Dead for 2009. Connecticut HB 5113, as originally drafted, would have permitted state agencies and municipalities to waive payment bonds. When the bill was heard, the bill sponsor submitted a revised bill that would have raised the state bond threshold from $100,000 to $1 million. AIA and SFAA met with the bill sponsor. The impetus behind

2 the bill is a $150,000 paving job for which it appeared that the bond added needless cost and delay after the city attorney noticed that the contract did not require a payment bond and the contractor was forced to obtain the bonds. The intended purpose of this bill is to let small jobs go forward quickly. The bill did not get out of its committee of origin by the deadline and it is dead for this year.

SFAA testified when the bill was heard and compared the Connecticut law to other state and federal requirements. Connecticut requires only a payment bond and has one of the highest state bond thresholds at $100,000. There were several other opponents from the local contractors associations, and no supporters. SFAA will follow up with the bill sponsor and send him information about SFAA’s Model Contractor Development Program (MCDP). Although this was not overtly a small and emerging contractor issue, that may have been seen as an issue with the contractor and SFAA wants to offer an alternative solution that works instead of bond waivers and increases to the bond threshold.

Two bills in Iowa, SSB 1291 and SSB 1239, would have provided that performance and payment bonds would not be required for contracts for the emergency repair of a public improvement, highway, bridge, or culvert. This is part of a Rebuild Iowa disaster recovery plan. SSB 1239 has now been formally introduced in Iowa as SF 457, and the provisions regarding bond waiver have been eliminated. This is the bill that likely will go forward in the legislature this year. SSSB 1291 should not move, but we will continue to monitor it because if it is introduced, it still contains the bond waiver provisions.

The AIA was successful in removing provisions from the final New York budget legislation, AB 157/SB 57, which would have increased the threshold at which performance and payment bonds are required for state university construction projects from $50,000 to $250,000. There still is standalone legislation pending to increase the thresholds. AB 2020 would set the threshold for performance and payment bonds on contracts to the State University of New York at Buffalo (SUNY Buffalo) at $250,000. The current bond threshold for all state university contracts is $50,000.

--Recent Introductions. California AB 958 would authorize metropolitan water districts to use design-build firms for the design, construction, fabrication, and installation of a solar energy system in excess of $1 million. The bill would include the existing requirements for design build firms. Such firms would be required to demonstrate the ability to obtain "sufficient performance and payment bonding" for the non-design portions of the contract as part of the State's pre-qualification process. The firms also would have to submit information on any work that a surety has completed. The design-build firms would have to possess or obtain sufficient bonding to cover the contract amount for non-design services. Further, if performance and payment bonds are required, retainage would be capped at 5%. The firm also would be permitted to withhold additional retainage in excess of the limit from its subcontractors if they are unable or refuse to furnish any required bonds.

Payment and Performance Bond Issues

3 --Dead for 2009. Another attempt failed in New Mexico to eliminate or limit the requirement for subcontractor bonds. SB 363 would have exempted subcontractors from the performance and payment bond requirements on design and build projects, on contracts where the prime contractor is a construction manager at risk under the Educational Facility Construction Manager At Risk Act, or on contracts where the prime contractor was selected using competitive qualifications-based proposals. Current law requires all subcontractors to furnish a performance and payment bond on all public works contracts in excess of $125,000.

Retainage --Dead for 2009. Oklahoma SB 573 would have created a new retainage bond to permit a general contractor, subcontractor or sub-subcontractor to post a bond before the start of a project in lieu of any retainage being withheld. The new retainage bond would have been for 10% of the contract or subcontract price. SFAA was concerned about this new “release of retainage” bond, which would have been required to contain provisions substantially similar to the guarantees made in the payment and performance bonds, which would already be in place.

SFAA worked with the Oklahoma local surety association, who put us in touch with the local ASA, the proponent of this legislation. We suggested some alternative provisions to the ASA, which were based on the existing law in Washington, which permits retainage bonds, and the local ASA agreed to our changes. Recently, however, the bill was pulled from consideration for this year. The local ASA agreed to wait until next year as other industry groups thought that more work was needed to assure that the bill achieves its intended purpose, which is a bond in lieu of withholding retainage. ASA is going to form a task force locally to work on a bill for introduction in the 2010 session. They will want surety representation on that task force, and we will work with the local surety association to provide input.

PPPs and Mega Construction Projects With most of the state budgets in deficit positions and with many states needing infrastructure projects, once again a number of public-private partnerships (PPPs) have surfaced. In all the bills we’ve seen this year, the PPP could be required to provide less than 100% bonding.

--Bills on the Move. Colorado SB 248 is a late session introduction that appeared to be an innocuous bill to permit a letter of credit (LOC) to be posted in lieu of a surety bond on public construction projects. Although we believe surety bonds provide better protection for the public entity and are better for the contractor, Colorado law already allowed alternative security, such that SFAA offered only some technical amendments.

The local surety association, the local AGC and the AIA state counsel met with the Senate bill sponsor, and learned that the bill addressed an upcoming Regional Transportation District (RTD) project in which the construction costs could be $2 billion. The RTD was concerned that bonding would not be available. SFAA and AIA worked with the RTD and we suggested an amendment that in contracts in excess of five hundred

4 million dollars, the amount of the bond shall not be less than one-half of the total amount payable under the contract, except that if the public contracting entity finds that a bond in that amount is not reasonably available, it shall set the amount of the bond at the largest amount reasonably available, but not less than two hundred fifty million dollars. The RTD preferred its approach, which was to base the amount of the bond or the LOC on the largest amount the contractor would be paid in any one year of the contract. The RTD staff refused to believe that a surety bases its premium on the total contract price, rather than the amount of the bond. In the end, the RTD approach was included in the bill, which has now passed the Senate.

For example, if the $2 billion contract is completed in equal parts in two years, the bond required on the whole project will be one-half of $1 billion, or $500 million. If it is performed over four years in varying amounts, with the highest total work performed in any one year being $600 million, then the bond on the whole project is $300 million. The project carried out in 10 years in equal parts of $200 million/ year would result in a $100 million bond on the whole project.

In Washington, SB 5499 has passed the House and was heard in the House Transportation Committee. The bill would permit less than 100% bonding on Department of Transportation construction contracts that are in excess of $250 million. The DOT would determine the amount required in this case on a contract-by-contract basis, and the amount would have to "adequately protect [100%] of the state's exposure to loss." The bill would require the DOT to develop guidelines for assessing such loss risks for the State. The Office of Financial Management would have to approve the guidelines. Of note, in no case could the bond be in an amount less than $250 million. The Secretary of Transportation would have to approve each performance bond and payment bond authorized to be less than the full contract price of a project. For these projects, a separate performance bond and payment bond would be mandatory. Also, the payment bond could not be in an amount less than the amount fixed for the performance bond. This is a significant improvement over legislation SFAA, AIA, PCI and others worked to defeat last year in which the minimum bond would have been $80 million. SFAA worked with the DOT over the summer on this year’s bill.

--Recent Introductions. Florida HB 1291/SB 2060 would authorize the Department of Management Services (Department) and all governmental entities to enter into public-private partnerships for infrastructure projects, excluding transportation facility projects. The bill provides that the private entity would have to provide security for performance on the project and the payment of subcontractors. Security could be in the form of surety bonds, letters of credit, parent company guarantees, and lender and equity partner guarantees. With respect to the form and amount of such security the bill provides that the Department and the participating governmental unit must "balance the structure of the security requirements with the cost of the security in order to ensure the most efficient pricing." SFAA is concerned that this provision is so vague that it doesn’t really require any security, but rather just a promise to perform. Among the examples of acceptable requirements are parent company guarantees and equity partner guarantees, which are not really security at all. If the contractor goes broke it is usually because the

5 parent company is broke too. If the equity partner is broke, and therefore the contractor can’t perform, what good is a guarantee from the equity partner? The point of a surety bond is a guaranty by an independent, regulated financial institution. SFAA suggested bonding provisions that we had included previously in the Florida law for transportation projects in excess of $250 million under which the bond cannot be below $250 million.

Florida HB 1355 would establish a privatization pilot program for the State's land management program for preserving "environmentally significant" lands. The bill would create a public-private partnership to assist the State in coordinating its tasks and to provide funding for these conservation projects. The bill provides that a performance bond would be required as a part of the management agreement for the pilot program. The amount of the bond would be capped at $1 million.

Illinois SB 305 would authorize the State and its political subdivisions to enter into public-private partnerships (PPPs) for the construction of transportation facilities. The bill provides that the PPP agreement would have to provide for performance and payment bonds for the development and/or operation of the facility in an appropriate amount. The bill is being held in the Senate Executive Committee and the deadline for its passage is being extended. Otherwise, the bill would be dead by now for having failed to pass out of its committee of origin. Should the bill move this year, SFAA has provided AIA with amendments that would assure that the payment and performance bonds cover the construction phase of the PPP only and to remove any appearance of discretion as to 100% bonding.

Massachusetts SB 2023 would authorize the proposed Massachusetts Surface Transportation Authority (Authority) to enter into public-private partnerships under design-build-finance-operate-maintain or design-build-operate-maintain contracts for transportation facilities. The public-private agreement for the project would have to provide for "any plans to obtain a labor and materials payment bond that covers all construction, reconstruction, or maintenance, including capital maintenance.” The agreement also would have to require the payment of prevailing wages for labor performed on the project to comply with existing labor laws.

Within the Authority, the bill would create the Division of Roads and Bridges (Division). For work done in the right of way of a state highway, a permit from the Division would be required. The bill would authorize the Division to require a surety bond in connection with the permit to guarantee the work and the repair of the highway should any damages occur in the course of the work. The bond would have to be in the amount that the Division determined, but it could not exceed the estimated cost of the work and "possible damage.” The bond could not be in an amount less than $300,000.

South Carolina SB 521 would authorize the South Carolina DOT to enter into public-private partnerships (PPPs) for transportation facilities. Such facilities would include highways, roads, bridges, tunnels, toll roads, overpasses, ferries, mass transit facilities, vehicle parking facilities, rail facilities, and intermodal facilities. The bill provides that the comprehensive development agreement between the private entity and

6 the DOT could provide for a surety bond, a letter of credit or a corporate or parent company guarantee for the private partner's operations and maintenance obligations under the agreement. In our view, a public transportation project is a public works project and has to be bonded according to the State’s Little Miller Act. How it is funded does not change the fact that it is public construction.

The bill is moving in the Senate Transportation Committee. It requires 100% security and limits it to the construction phase of the PPP so that the bond amount does not have to cover the design phase or the warranties and operation and maintenance—the latter of which could be decades in duration. SFAA provided the AIA with amendments that eliminate the option of “or otherwise secured in a manner satisfactory to the department.” That could bring in alternatives to bonding from Dollar One. It could be misread, for example, to permit a parent company guarantee in lieu of the bonds. We also suggested that if the bond amount does not include the cost of design, warranties, operation, maintenance, and finance, then the bond form cannot condition performance on those items either.

Prevailing Wages --Recent Introductions. New York AB 6696 would require all subcontractors on public works projects to submit a surety bond for the underpayment of the prevailing wage and supplements. The bond would have to be in an amount equal to 5% of the subcontractor's total payroll for the project. The state or municipal fiscal officer for the project would have to retain the bond for a period not to exceed two years from the date the project is completed. The bill also provides for the accumulation of interest on the surety bond. Such interest would accrue at a 5% annual rate. The bond would be used to pay wages or supplements owed to workers under the existing labor law.

New York SB 6886/SB 33980 would make contractors ineligible to bid for a public work contract if the prevailing rate wages and supplements due from all prior public work contracts remain unpaid.

Surety Eligibility Requirements Texas HB 3487 would amend the existing requirements for bid, payment and performance bonds on public works contracts with a county. The bill would authorize the commissioners’ court to establish financial criteria for accepting surety companies that provide bid, payment, or performance bonds. Existing law requires these bonds on county public works contracts in excess of $100,000.

Small and Emerging Contractors --Enacted Laws. Arkansas HB 1418 appropriates $2 million for the Arkansas Department of Workforce Education for its Small Minority Contractors Surety Bonding and Mentor Protégé Training Pilot program.

--Recent Introductions. Tennessee HB 518 would require the Department of Economic and Community Development to create a state bond guarantee program for small and emerging contractors, with an emphasis on small and minority-owned businesses. The

7 bill would create a fund for the guarantee of bid, payment and performance bonds on contracts up to $1 million. Texas HB 4646/SB 2188 would require the Texas Facilities Commission to implement and administer a collateral guarantee program to guarantee a working capital loan or surety bond to help enable a small contractor to participate in a public works project. The program would be included in the Commission's existing Small Contractor Participation Assistance Program which already provides for technical assistance for contractors to prepare bond application packages for public works projects in a format that will be acceptable to bond underwriters and to obtain the bonds that are required to participate in public works projects.

--Dead for 2009. Maine HB 263 would have required the Director of the Bureau of General Services within the Department of Administrative and Financial Services to adopt rules establishing a preference percentage of up to 15% for small businesses bidding for state contracts.

Bid Preferences --Bills on the Move. Oregon SB 479 would authorize state contracting agencies to give preferences to disabled veterans when awarding contracts. The bill has passed the Senate and has been sent to the House.

Electronic Bidding --Enactments. Montana HB 120 allows the Montana Transportation Commission to accept electronic bid bonds from contractors bidding on its projects. The bond would have to be signed electronically or the bidder and the surety would have to provide some other form of verification.

Other Legislation of Interest --Enactments. Virginia HB 2029 would reduce the subdivision bond required from developers under existing law from 25% to 10% of the construction costs. The bond is required to guarantee the completion of the streets, sewers and utility installations in a subdivision. Surety bonds or other security may be posted.

--Bills on the Move. New York AB 2369 would prohibit any agreement for the construction, alteration, repair or maintenance of a building from requiring subcontractors and materialmen to exhaust all other remedies prior to filing a claim and/or commencing an action on a payment bond. The bill has passed the Assembly and is now in committee in the Senate.