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Discretionary Protection - State Bonding Requirements in P3 Projects




by:
Vianney Lopez
Smith, Currie & Hancock LLP - Atlanta Office

 
August 25, 2014

Previously published on August 19, 2014

Public-private partnerships (“P3s”) have become an increasingly popular procurement method for public projects.  P3s refer to the partnership between a public government agency—which can be federal, state, or local—and a private entity.  The private entity’s role in the P3 agreement may involve the finance, design, construction, operation, ownership, or maintenance of facilities, infrastructure, or services for public use.  Not only does a partnership with a private entity increase the amount of funding available for public projects, but it also often allows for faster completion at a lower cost. 

Not surprisingly, many states have embraced the P3 method and have enacted legislation promoting and authorizing the formation of P3s.  P3s are creatures of statute and states have taken different approaches to their use. While some states have enacted legislation allowing for broad use of P3s, other states permit only limited use, perhaps allowing a P3 for one particular fund-depleted project.  The result is that state and local entities choose which government agencies and what types of P3 projects to authorize by statute.  This level of specificity extends to bonding requirements. 

Bonding requirements in P3 projects address a common concern in construction projects—contractor default.  State and local governments condition the award of a public contract on the private entity’s ability to issue a bond to guarantee its payment and performance.  The bond requirement provides payment protection for subcontractors and suppliers working on P3 projects and provides performance protection by guaranteeing project completion in case the contractor defaults.  But, as with the use of P3 projects in general, the extent of this protection varies significantly by state.

Maintaining Public Control

In an effort to encourage participation in P3 projects by private investors and contractors, state and local governments often minimize bureaucratic red tape, and thereby relinquish some control over the project to the private sector.  At least in the case of bonding requirements, however, bond statutes allow the government entity to maintain some control over the project and to hold private investors and contractors accountable to the bond beneficiaries.  Bonding requirements not only allow public owners to prequalify contractors but, in many states, the government entity has authority to determine the form and amount of the bond or security that would be satisfactory or “acceptable” under the statute. 

Some states provide even more discretion to the government entity.  One Texas P3 statute, for example, grants the agency authority to require a performance and payment bond “or an alternative form of security” in lieu of or in addition to a performance and payment bond so long as the amount is “sufficient to ensure proper performance of the agreement, and protect the authority and payment bond beneficiaries.”  Tex. Transp. Code § 366.404.  Another example, Arizona, which allows P3 agreements by the Department of Transportation, requires performance and payment bonds “or other acceptable forms of security or a combination of any of these, the penal sum or amount of which may be less than one hundred per cent of the value of the contract involved based on the department’s determination, made on a facility-by-facility basis, of what is required to adequately protect this state.”  Ariz. Rev. Stat. § 28-7705 (emphasis added).  These statutes provide government agencies with broad discretion to determine what is in the best interest of the state and the individual project and, thus, allow the agencies to maintain a certain level of control over the project when making these determinations.

Potential for Inconsistency and Incomplete Protection

Granting expansive government authority may allow the public entity to maintain some control over P3 projects, but it also creates an uncertain landscape for other parties affected by the P3 agreement.  To say that bonding requirements vary from state to state would be an understatement as the requirements vary even within states, depending on the type of project.  In fact, because of the discretion granted to many government entities, it is possible, in some cases, that the same government agency may require a different type and/or amount of security on the same type of project if the agency finds it is in the best interest of the public to enforce bonding requirements differently.  Accordingly, contractors doing business in more than one state should be mindful that they likely will encounter different bonding requirements depending on the state, and even depending on the type of project as some requirements may vary on a facility-by-facility basis.

Moreover, while the current statutory framework in many states certainly provides payment protection for subcontractors and suppliers, the extent of this protection can be inconsistent and incomplete.  Bonding requirements vary not only with respect to the type of project that requires bonding, but also with respect to the type of security and the amount.  In some states, the form and amount of security is set by the statute.  For example, in North Carolina, one statute authorizes a government entity to enter into P3 agreements for construction contracts and requires a payment bond for 100% of the construction value for the project.  N.C. Gen. Stat. § 143-128.1C.  This North Carolina statute essentially provides the same payment protection in P3 projects (100%) as it does for all public projects under the North Carolina Little Miller Act, N.C. Gen. Stat. § 44A-26.  Colorado, on the other hand, sets a much lower threshold, requiring a bond of not less than 25% of the contract value for P3 projects.  Colo. Rev. Stat. § 43-2-202.  Colorado provides twice the protection to all other public works projects under the Colorado Little Miller Act, requiring a bond or other security “issued in a penal sum not less than one-half of the maximum amount payable under the terms of the contract.”  Colo. Rev. Stat. § 38-26-106.  The result is that, in instances in which state governments require bonds for less than the amount of the contract price, subcontractors and suppliers may be left with insufficient payment protection in case of contractor default, which is precisely what the payment bond is supposed to protect against in the first place.

Finally, inconsistent bonding requirements affect sureties, who, upon contractor default, will incur liability for payment and responsibility for project completion.  Because the government agency has discretion in determining the type and amount of the security, and the government’s goal is to ensure project completion and immediate payment bond protection, it is possible the government entity will require a bond security that provides for immediate and broad surety liability upon contractor default.  Accordingly, sureties must be mindful of the bonding requirements of a given state and the requirements for a specific project.  Additionally, to the extent possible, the sureties should involve themselves in bond negotiations in order to protect their interests.   

Conclusion

While it may appear that state and local governments are relinquishing control to the private sector when participating in P3 projects, state bonding requirements suggest that government entities still have ways of maintaining control as they can exercise significant authority and discretion, at least with respect to enforcing bond requirements.  Much of the legislation requiring payment and performance bonds is fairly recent.   Time will tell how government entities choose to exercise this discretion.  Will public agencies follow strict enforcement guidelines or will they choose a more individual “facility-by-facility basis” approach?  Will agencies exercise their discretion to provide greater payment protection for subcontractors and suppliers?  Will agencies protect the interests of the sureties?  Further legislation and case development will help us evaluate the answers to these questions.



 

The views expressed in this document are solely the views of the author and not Martindale-Hubbell. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.
 

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