Fraudulent Bonds: U.S. Court of Federal Claims Case Provides an Object Lesson on Why It’s Important for a Contractor to Verify Its Bonds Before Submission to the Government Court of Federal Claims Case

U.S. Court of Federal Claims Case

On March 27, 2014, the U.S. Court of Federal Claims upheld the U.S. Navy’s default termination of a general contractor that had submitted fraudulent MiIler Act performance and payment bonds on a project at Marine Corps Base at Camp Pendleton, California. In its complaint, plaintiff Allen Engineering Contractor, Inc. (Contractor) alleged that the government (Navy), under several theories of liability, improperly terminated the contract between the parties. The court granted the government’s motion to dismiss the complaint in its entirety, finding that the Contractor failed to state any claim on which relief could be granted. The court’s Order in Allen Engineering Contractor, Inc. v. The United States, Case No. 1:13-cv-00684-JFM, provides a lucid analysis of the purpose of Miller Act bonds on federal projects and provides an object lesson on why it is so critical that contractors verify that their bonds are issued by authorized sureties and that the surety actually authorized the issuance of the bonds. To access the Order, click here.

The facts of this case are interesting and illuminating. After the Contractor and the Navy executed the construction contract, the Contractor provided the required bonds from Liberty Mutual Insurance Company (Liberty). After initially rejecting the bonds, the Navy ultimately accepted them. Thereafter, the Contractor submitted a second set of bonds, from Pacific Indemnity Company (PIC), and asked that, if the PIC bonds were approved by the Navy, they be substituted for the Liberty bonds. The Contractor received the PIC bonds from Individual Surety Group (ISG), a company that represented itself as a broker for PIC, a subsidiary of Chubb Group (Chubb).

The Navy approved the PIC bonds, substituted the PIC bonds for the Liberty bonds, and returned the Liberty bonds to Liberty. Afterwards, a Chubb representative informed the Contractor and the Navy that the PIC bonds were not in fact issued by PIC and were, therefore, invalid. The Navy suspended performance of the contract and requested that the Contractor provide valid replacement bonds. The Contractor had trouble obtaining replacement bonds and proposed several alternatives, including providing an escrow agreement, to allow the project to move forward. The Navy rejected the contractor’s alternative proposals, stating that they did not meet the FAR bonding requirements. Ultimately, with the Contractor failing to provide valid replacement bonds, the Navy issued a notice of termination for default.

The Contractor responded by filing suit in the Court of Federal Claims and attached to the complaint a copy of a lawsuit filed by Chubb against Eric Campbell (a purported representative of ISG), ISG, and others, relating to fraudulent bonds. The court firmly rejected the Contractor’s claim that the Navy violated its own regulations by accepting fraudulent bonds. The Contractor’s arguments, simplified, centered on the general theory that the Navy had violated some affirmative duty to ensure that the bonds, submitted by the Contractor, were not fraudulent.

The Contractor alleged that the Navy violated several Federal Acquisition Regulation (FAR) provisions and Navy regulations by not properly ensuring the validity of the bonds. The court made short work of these arguments, as it found that these regulations dealing with authentication or approval of bonds were designed for the benefit of government employees, not private contractors. Because the regulations were not promulgated for the benefit of contractors, the court found that the Contractor had no claim as a matter of law. The court stated the following regarding the cited Navy regulations and the purpose of Miller Act bonds:

Among other creative arguments, the Contractor claimed that compliance with the bond requirements after discovery of the fraud was unnecessary since the Contractor had complied at the time the contract was executed by supplying the valid Liberty bonds. The court soundly rejected this argument, citing various statutory and regulatory provisions that require a contractor to maintain the bonds throughout the contract term. For instance, 48 C.F.R. 52-228-2(a) requires a contractor to furnish additional bond security in specified circumstances, including when the “surety upon any bond . . . furnished with the contract becomes unacceptable to the Government.” The court observed that this is “effectively a mechanism for ensuring adequate security is maintained throughout the contract term.” The court found that the Contractor’s offer to provide an escrow agreement does not comply with this provision. Its failure to provide additional security under this provision is one reason the contract was terminated.

Lesson Learned

The Allen Engineering court was not swayed by any of the Contractor’s inventive arguments that it was improperly terminated by the Navy. The important lesson learned from this case is that it is generally the responsibility of the contractor seeking surety bonds to protect itself from bond fraud. This can be accomplished through a simple two-step process: (1) checking the authority of the surety to issue the bonds; and (2) verifying that the surety actually authorized the issuance of the bonds. In this case, the purported surety, PIC, did indeed have the authority to issue the bonds. But, and this crucial, PIC did not actually authorize issuance of the bonds that the Contractor submitted to the Navy; and the Contractor became a victim of bond fraud.

This case is one of many in which unscrupulous individuals or entities assume the name of an established, reputable surety company or adopt a very similar name to a well-known, reputable surety company. As illustrated by Allen Engineering, the fact the surety company is genuine and solvent is not sufficient if the bond was not authorized by that company. It is always good practice for a contractor to contact the surety directly and ask for confirmation that the bond was authorized.

NASBP’s “Always Verify Your Bond!”

To help combat bond fraud, NASBP issued in January 2014 a one-page resource to educate contractors and subcontractors on how to verify the authenticity of bonds before acceptance. NASBP’s “Always Verify Your Bond!” can be accessed by clicking here.

This document explains how contractors, subcontractors, and suppliers can verify bonds through a two-step process, which confirms that the surety is licensed in the jurisdiction of the project and that the bond has been authorized by that surety. A brief restatement of this two-step process follows:

By undertaking this two-step process, contractors can avoid the harm caused by bonds that are unauthorized, such as occurred in Allen Engineering and other cases. No prudent and responsible contractor wants to “bet the business” on submitting a potentially fraudulent bond to the government.

NASBP is grateful to member Don Appleby, Vice President at Surety Willis of Colorado, Inc. in Denver, Colorado, for bringing this Order to our attention.

The author of this article is Martha Perkins, General Counsel at NASBP. Martha Perkins can be reached at mperkins@nasbp.org or (202) 686-3700.

This article is provided to NASBP members, affiliates, and associates solely for educational and informational purposes. It is not to be considered the rendering of legal advice in specific cases or to create a lawyer-client relationship. Readers are responsible for obtaining legal advice from their own counsels, and should not act upon any information contained in this article without such advice.