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Illinois Bankruptcy Court Decision May Complicate Remedies to Collect on Payment Bonds

Aug. 26,2016

A recent decision by the U.S. Bankruptcy Court for the Northern District of Illinois has potentially restricted the remedies that sureties—and, ultimately, the contractors and suppliers to construction jobs secured with payment bonds—may have to collect on payment from the owner.

While still subject to future reversal, the decision in In re Glenbrook Group, Inc., doesn’t change the responsibility of the surety to pay, wrote attorney Paul Schrader, of Fullerton & Knowles, P.C. in Clifton, VA in a recent article. However, “…The practical impact of the surety’s ability to collect can have some significant impact on a number of things including: how quickly you are paid and how much you spend in legal fees to collect,” he wrote. Suppliers will need to strictly follow every technicality required for such bond claims, as “…even a minor mistake can be costly.”

“I think the biggest thing with bond claims is being aware that one size does not always fit all,” Schrader said. “There may be some differences in statute when dealing with Miller Act or Little Miller Act bonds depending on jurisdiction. When dealing with a private bond, you cannot assume that the requirements are consistent with the requirements under the Miller Act or Little Miller Act and really need to see the bond to make sure you are complying with its requirements.”

Prior to the Glenbrook Group, Inc. case, multiple federal cases, including the Supreme Court’s decision in Pearlman v. Reliance Ins. Co., have affirmed that sureties are entitled to funds over bankruptcy trustees to pay claims against a payment bond, Schrader notes.

In Pearlman, a general contractor on a federal project filed for bankruptcy and was terminated by the government, which hired another contractor to complete the project, Schrader said. The surety of the debtor, meanwhile, had to pay $350,000 in claims from subcontractors and suppliers against the payment bond. After the government completed the project, it had about $88,000 remaining funds that it turned over to the bankruptcy trustee, whereupon the lawsuit ensued.

The Supreme Court based its decision to give the funds to the surety instead based on the legal doctrine of ‘equitable subrogation,’ which essentially means that “…someone who pays the debts of another is entitled to step into the shoes of that person…,” Schrader wrote. If the general contractor had completed the project, it would have been allowed to collect the funds from the surety and pay the subcontractors and suppliers, the court reasoned.

However, in Glenbrook Group, the Illinois court decided Pearlman didn’t apply because it was decided prior to the current bankruptcy code, and that Pearlman involved a federal project, which Glenbrook Group didn’t, Schrader said. Glenbrook Group concerned a contractor that filed for bankruptcy while working for a municipal agency, leaving the surety to cover unpaid claims by the subcontractors and suppliers against the payment and performance bonds the contractor supplied for the job.

- Nicholas Stern, editorial associate

Kansas P3 Project Highlights Need For Supplier Security

Aug. 26, 2016

The Kansas Board of Regents could expand its oversight and control over public-private partnership (P3) projects because some legislators in the state have criticized the University of Kansas’s unusual method of getting financing for an on-campus, mixed-use project.

Specifically, the Board of Regents has said it may consider “classifying P3 projects as capital improvement projects and as part of each institution’s capital projects plan,” thus requiring universities in the state to obtain board approval, according to a recent report from the National Council for Public-Private Partnerships (NCPPP).

The Kansas project underscores the fact that subcontractors and suppliers must exercise caution before taking on these types of projects as they do not fall under federal statutes like the Miller Act and may lack a way to secure their receivables through means such as a payment bond, said Connie Baker, CBA, director of operations for NACM’s Secured Transaction Services (STS).

Because the projects typically occur on public land, suppliers or others also may not have access to a mechanic’s lien, said James D. Fullerton, Esq., of Fullerton & Knowles, PC in Clifton, VA. Absent of having bond or lien rights on the project, credit managers still have contract rights with their customers. They have to evaluate the creditworthiness of such customers and weigh the potential risks involved, he said. If the customer is insolvent, the supplier has no relief available. The supplier may as a result require money in advance or another type of security before agreeing to the project.

The University of Kansas P3 project, destined for completion in 2018, is for a central district development that will include student housing, a student union, a dining hall and other facilities, the NCPPP said. Kansas legislators grew rankled with the deal, which includes a 40-year lease at an annual fee of about $21.5 million, when the university decided to circumvent the state’s bonding agency by forming a nonprofit that issued about $320 million in bonds through a Wisconsin-based public financing agency, according to NCPPP. The lawmakers argued that the project lacks legislative oversight.

Legislators introduced HB 2703, a bill that died in committee, to prohibit state universities and agencies from borrowing or entering into other agreements without legislative approval or a hearing. The Kansas legislature, however, did move to limit the amount the university can spend using formerly unrestricted fee funds, NCPPP said.

- Nicholas Stern, editorial associate

Trust but Verify: The Key to Securing Payment Rights on Public Projects

Aug. 25, 2016

Whether one is new to the credit management field or an experienced hand, credit professionals working for suppliers and others can and do make certain assumptions about security instruments designed to ensure payment for their companies’ work. Those assumptions in turn bring added risks that can in some cases become very costly.

One of the larger risks for a credit professional is assuming a job account does or doesn’t have a security instrument —such as a mechanic’s lien for a private project or a payment bond for a public one, said Chris Ring, of NACM’s Secured Transaction Services (STS).

Take for instance a recent case he’s seen of a supplier providing product to a public job, he said. The project involved a school district dealing that needed major repairs to its properties following a flood. The supplier assumed it was a public project with a bond. In fact, state law didn’t require the school district to provide a bond for the project because it was paying for the repairs with insurance proceeds. Eventually, the general contractor on the job ran into financial difficulty and couldn’t pay the supplier, which wound up with no security and couldn’t collect thousands it was owed.

On the other hand, suppliers should be aware that just because someone working at a subcontractor, for example, either says he or she doesn’t know or says there is no bond on a project, doesn’t mean it is actually the case—credit managers always need to confirm with a general contractor or owner whether a bond exists and to see a copy of it, Ring said. In public construction, it is a requirement under the federal Miller Act and the state-level Little Miller Act that the owner and general contractor have to forward bonding information to anyone on the ladder of supply, including suppliers.

“One of the hallmarks of the bond claim process is verification,” he said.

Another key factor credit professionals need to consider is that once the bond information is obtained, it needs to be scrutinized to determine the risk associated with the bond itself, as well as the bonding company, Ring said. If the project is federal, the bond has to meet federal requirements and the bonding company has to be approved by the Treasury Department and have an ‘A’ rating, he said. (Find a list of Treasury’s approved bonding companies here.)

But if the project is a state job, such as is the case in Pennsylvania and elsewhere, all that is required is that a bond be posted; there is not state agency overseeing or rating the bonding company. Typically, good general contractors can get good bonds from good bonding companies, while general contractors with payment or creditor issues get bad bonds from less reputable bonding companies.

If your company typically only handles a couple public jobs a year, STS offers a cost-effective service to provide a credit risk rating for a bonding company, Ring said.

- Nicholas Stern, editorial associate

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