The Intertwined Business Worlds of Construction & Surety: Can the Surety Industry Weather the COVID-19 Storm?

By Kat Shamapande posted 04-07-2020 02:46 PM

  

Published April 2, 2020

By Shannon J. Briglia and Lauren P. McLaughlin of Smith Currie & Hancock LLP

 

Before the COVID-19 pandemic spread, construction in the U.S. was booming. Backlogs were deep and project funding was easily accessible. Back before we knew the term COVID-19, the “crisis” in the construction industry was the labor shortage, an aging generation of skilled tradesmen, or the nation’s infrastructure. No one could have ever envisioned that in just a few weeks’ time, those problems would pale in comparison to something far worse—a zoonotic disease that is wreaking havoc on almost every ongoing construction project in the nation.

As our clients know, the surety and construction worlds are inextricably linked. When the construction sector is booming and economic times are prosperous, surety companies see very few claims. They collect premiums and are largely profitable in their zero-loss ratio approach to bonding, meaning their business model is that they expect to incur no losses. Conversely, when there is a downturn in the economic market, there is a corresponding uptick in performance and payment bond claims.

Fast forward to the unfortunate and unimaginable present. The President of the United States declared a national emergency on March 13, 2020. Most states have declared a state of emergency, and many states and some local governments have issued shelter-in-place (or stay-in-place) orders, restricting businesses and citizens from all but essential functions. Some orders exempt construction from the ban by defining them as “essential,” but many are unclear or only permit certain kinds of work to continue. Regardless, the restrictions are impacting construction jobsites, either because parties are unsure if they can continue or specific leave or “hall passes” for workers are required to proceed.

In addition, for some projects and trades, materials such as masks and gloves required for normal construction operations, are also critically needed by hospitals and health care workers fighting COVID-19. This unanticipated market demand is creating material shortages which threaten the viability of ongoing projects. Restrictions on operations across the world have hindered production, acquisition and transport of other materials, driving up prices or slowing job progress. Finally, the advent of the pandemic has created personal safety issues for workers and jobsites which can result in substantial project slow-downs or even wholesale shuttering of projects.

All of these scenarios yield to the unmistakable conclusion that bond claims will increase exponentially over the next year, given the COVID-19 impacts on construction projects around the country.

Bond Claims Related to Coronavirus Project Delays or Nonpayment

As the impacts are being felt and local and state governments are issuing orders rapidly, sureties and their contractors are racing to read the fine print of their contracts. The following clauses or provisions are likely to govern most of the delays relating to COVID-19: force majeure and/or comparable excusable delays; suspension of work or work stoppage; terminations; change in law; material escalation; safety/health requirements; protection of work; notice requirements; and claims or changes clauses granting equitable relief.

Standard form bonds do not address work stoppage, delays, acts of God, or any of the above clauses. They simply incorporate the contract or subcontract they stand behind and set forth procedural notice requirements to pursue claims. As such, it is imperative for sureties, obligees, principals, and bond claimants to carefully assess legal directives concerning jobsite delays or shutdowns, ensure proper notice is given of delays, productivity losses, jobsite shutdowns, and nonpayment, and keep meticulous, detailed records of all costs incurred as a result of COVID-19 impacts.

For example, some contract provisions include pandemics as a defined force majeure or a cause of excusable delay, but many others do not.  Thus, there is a fair amount of uncertainty whether the bond principal and its surety have a legal excuse for work delays or other impacts from a pandemic such as COVID-19, or the right to additional time or compensation.  Regarding future bond claims, contractors will have a difficult burden proving delays on a bond claim if a contractor is keeping an omnibus cost code for “COVID-19,” without breaking out and segregating the specifics of what labor and material is being charged to that cost code.

On federal jobs, pursuing schedule relief or compensation for delays rests solely in the Contracting Officer’s acknowledgement of, and agreement to, a change or delay. Because only the Contracting Officer (CO) has authority to change contract terms, a writing from the CO agreeing to delay/changes is the best form of proof a principal can furnish. Sureties will likewise require this documentation before paying out on a claim.

Additionally, contractors should seek a contractual modification incorporating new department/agency guidance. Contract modifications should be used to document any deviations from the contracting regulations that contain certain types of relief for contractors impacted by COVID-19. While authoritative, the regulatory language can be general and may not be precisely tailored to the contractor’s situation. As such, sureties may assert defenses to the extent the obligations of the contractor are not clearly spelled out.

Surety defense to performance or payment bond claims 

One surety defense that will be especially lethal with COVID-19 payment and performance bond claims is failure to give proper notice. Claimants will face unique difficulties in ascertaining deadlines for notice requirements, given that “project completion” or “date work last performed” may be in flux as noted above with lack of clarity with governmental orders, and jobsites shutting down multiple times due to infected jobsite workers.

Some projects have been halted, but may not commence in earnest again. With the economic downturn, project funding may be pulled and for projects that do not start back up, potential claimants will unknowingly miss their 90-day bond notice requirements, unaware that the clock began to run when a project was initially shut down. Likewise, most jurisdictions have not tolled the statute of limitations on filing lawsuits, but some have. Contractors must be astutely aware of payment bond claim deadlines, as sureties will not be bound to pay any claims that are not filed timely, or when the surety is not provided adequate notice as required.

COVID-19 Federal Legislation Potentially Beneficial to Sureties

The COVID-19 economic impact will most assuredly result in the surety world incurring losses this year in the following categories: (1) financing principals and/or projects to prevent defaults and reduce exposure on bond obligations; (2) bond losses (payment on valid bond claims and monies expended to complete projects); and (3) litigation fees incurred in defending claims and pursuing indemnitors.

However, the surety market may be poised to benefit from federal legislation recently passed. The recently passed CARES legislation entitles certain businesses to seek relief from the federal government to assist with payroll. It remains to be seen whether a bonded contractor may seek this federal assistance without first knocking on the door of its own surety. To the extent there is no such requirement, surety losses may be reduced somewhat. Secondly, at least one federal agency has indicated that price adjustments may be available due to COVID-19 related delays. To the extent the federal government is willing to compensate parties for delays, this will potentially reduce surety exposure to bond claims for COVID-19 events.

Best Practices for Sureties, Contractors, and Claimants

As all parties in the privity chain navigate the new COVID-19 world, claimants and sureties alike will be tasked especially with reviewing the risk-shifting provisions in contracts granting schedule or monetary relief and termination rights. Sureties must proactively communicate with principals to ensure that projects with COVID-19 related delays are handled with requisite contractual notices both upstream and downstream. Contractors and their sureties should ensure the principal is keeping detailed and segregated records of all delays and issues relating to COVID-19 to both mitigate damages and prepare documentation for any future delay claims or bond claims to have merit. Contractors and their sureties should and must review backlog of any jobs that may be at risk for shut downs and mitigate any damages that may occur with the principal, the owner, and subcontractors and suppliers.

 

Shannon J. BrigliaShannon J. Briglia is a partner in the Tysons, Virginia office of Smith Currie & Hancock LLP. She focuses her practice on advising construction industry participants in risk management and disputes, provides neutral services and serves on project dispute resolution boards. Shannon has litigated construction contract disputes and surety cases in federal, state and bankruptcy courts in Maryland, Virginia, the District of Columbia, Michigan, Florida, Connecticut and Texas, and has presented arbitrations and mediations before panels and solo neutrals in many other states. She can be reached at sjbriglia@smithcurrie.com or 703.506.1990.

 

Lauren P. McLaughlinLauren P. McLaughlin is a partner in the Tysons, Virginia office of Smith Currie & Hancock LLP. She has represented owners, developers, contractors, subcontractors, sureties and design professionals in all aspects of public and private construction projects. With that perspective, she counsels clients on project risk management and litigation avoidance. Lauren has successfully tried dozens of complex cases in state and federal courts throughout Maryland, Virginia, Pennsylvania, New York, and the District of Columbia, as well as before arbitral panels, administrative boards and boards of contract appeals. She can be reached at lpmclaughlin@smithcurrie.com or 703.506.1990.

 

0 comments
10 views

Permalink