1July 26, 2011

Presented with

The Pearlman Association

Managing the Complex Performance Bond Claim – Medic or Mortician

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PRESENTER BIOGRAPHIES

Rick Levesque, a Director with Hartford Bond, has worked in the surety claim industry since 1987, principally in the area of construction performance and payment bonds. He began his surety career after law school, enjoying positions with Reliance Surety, St. Paul Fire and Marine and Hartford Bond. He is licensed in Washington and Pennsylvania and holds CPCU, AFSB and AIC designations. Mr. Levesque is a frequent speaker at industry gatherings, a former director of the National Bond Claims Association and the founder and current chairman of the Pearlman Association, a 501(c)(3) surety training organization.

Edward Rubacha is a partner with the Phoenix, Arizona law firm of Jennings, Haug & Cunningham, LLP, practicing in the firm’s Construction and Surety Section. Although well-known for his work with contractors and sureties dealing with tribes and tribal entities, Mr. Rubacha also has represented general surety and construction clients for over twenty years. He is a frequent speaker at various professional organization meetings, including the American Bar Association Forum on Construction, The Pearlman Association, is the author of numerous papers on contracting with tribes and tribal entities, and is a contributing author to the Arizona chapter of “Fifty State Construction Lien and Bond Law” and the “State by State Analysis of Legal Issues Affecting Architects, Engineers, Contractors And Owners,” Aspen Publications.

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Surety v. InsuranceKey Distinctions

Insurance• Two-Party Agreement• Addresses fortuitous, non-controllable events• Premiums based on risk pooling/law of large numbers• Loss is expected

Surety• Three-Party Agreement (right to be indemnified)• Control risk through managerial, technical and financial

reviews• Not actuarially based – resembles an extension of credit• No expectation of loss

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Surety v. InsuranceAbility to Influence/Manage

LossInsurance Claims are presented at or after(Mortician) insured peril – tornado, earthquake,

flood

Surety Claims arise at many stages of the(Medic) project/backlog

Significant future loss contributors can be managedPatient can be “saved”, damage reducedSpeed, sense of urgency

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…or this area…or this area

IND

EMN

ITY

AG

REE

MEN

T

Surety

Contractor Owner

PERFORM

AN

CE

BON

D

CONSTRUCTION CONTRACT

TripartiteRelationship

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General Indemnity Agreement

Contract which memorializes/strengthens common law rights against Principal and Indemnitors– Exoneration– Reimbursement– Subrogation– Joint and several– Extends to individual/other indemnitors

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General Indemnity Agreement

Common Provisions• Right to demand collateral• Rights of assignment• Right to settle claims• Power of Attorney• Can be filed as a financing statement• Right to books and records• Right to takeover projects• Establishes trust nature of contract funds

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Contractor Failure Causes/Signs

Growth -- Change in type of work-- Significant change in size of projects or backlog-- Work outside of historical geographic area

Personnel -- Loss of key management-- Ownership change – retirement, death, purchase-- Insufficient personnel-- Lack of trained personnel-- Lack of or inadequate ownership transition plan

Financial -- Inadequate cost and financial management systems-- Poor estimating-- Poor receivable/payable management-- Credit restriction/non-renewal of bank line

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Complex ClaimsIn the beginning…

• Slow buildup of payment bond claims – single job/backlog

• Resolution of disputes with payment plans• Bankruptcy filing – voluntary/involuntary• Threatened or actual termination for default• Request for financing/bonds• Request for payroll – usually on Friday

afternoon

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Surety’s Independent Investigation

Sources of Information• Company Claim Files• Company Underwriting Files• Agency - Producer Files• Principal/Indemnitor Records• Claimant Records• Internet

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Investigation ObjectivesDiffer by Type of Claim

Single Project TFD -- Principal’s position-- Propriety of the default-- Performance obligations/options

Request for Financing -- Financial condition of principal/indemnitors-- Status of construction backlog-- Equipment and bank debt/competing creditors-- Accounts payable/accounts receivable-- Competence and trustworthiness of principal

Bankruptcy Filing -- Similar to above being mindful of the automatic stay

Abandonment of -- Status of projects Bonded Backlog -- Status of receivables/payables

-- Reconstruction of principal’s position through whatever means available

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The Surety’s Team

• Claim Administration• Accounting• Engineering• Legal• Underwriting• Specialist/Expert

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Protect and PreserveThe Eight “C’s”

• Cash• Contract Backlog• Completion Costs/Options• Claims

– Subcontractors/Suppliers– Obligees– Indemnitors

• Change Orders• Collateral• Creativity• Common Sense

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The Claim Hemorrhage to Morphage

• General Builder – School Contractor• $50 million bonded backlog (CTC) down from $100 million two years

earlier• Contractor was typically a broker who occasionally performed some

landscaping/irrigation but in the last year has begun to self perform a significant amount of framing, plumbing and electrical work to save money.

• Two payment bond claims of approximately $50,000 are being investigated where principal’s position appears weak or unfounded and/or principal has been largely non-responsive.

• AIA 312 meeting has just concluded where owner has alleged– Project is late– Workmanship is poor– Staffing/manpower is deficient– Subcontractors and suppliers not being paid

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Driving Back From the Meeting

(In the new F-350)Contractor advises

• Dad turned the business over to me too soon and didn’t tell me the extent of the company’s financial problems.

• The bank line is tapped out and the contractor is in “workout” mode.• Payroll is $200,000 a week and he has only been able to make net payroll

for the past year.• He will not be able to make payroll this week.• Current problems are only “cash flow” issues and with a temporary loan to

get over the hump, all will be good.• Confirms the payment bond claims are not legitimately defended but he

simply has no funds.• Has a box full of held checks – not sure what to do with them.

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Confirm, Clarify, Create a Record

• Memorialize the material aspects of the conversation, particularly the statements pertaining to admissions of liability, solvency and other GIA “default” triggers.

• Have the contractor confirm its expectations of or requests to the surety.– Is contractor confirming liability on the payment bond claims,

confirming its inability to pay and expecting the surety to pay?– Is contractor confirming it has failed to pay tax, trust fund and union

obligations on the bonded work?– Is contractor confirming it is and has been unable to meet its

obligations as they become due?– Is contractor requesting that the surety finance some or all of its

bonded obligations, along with other debt?

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Financing Request

• Confirm no obligation/extreme reluctance to finance.• Obtain a written request from indemnitors

clarifying/confirming– They are requesting some level of financial assistance from the surety

to address their bonded obligations.– They are unable to obtain financing from any other source, including

personal assets.– They executed and continue to be obligated to surety for all terms and

conditions of the GIA.• Explain that certain “default documents” will be required of

indemnitors as a condition of surety considering the request for financing.

• Explain no quid pro quo regarding the indemnitors providing “default documents” and surety agreeing to provide financing.

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Default Documents

• Invitation to conduct books and records review• Irrevocable assignment (by project)• Irrevocable directives re payment to surety (by

project)• Voluntary letters of default to surety (by project)• Voluntary letters of default to owner (by project);

these are held by surety until needed• Indemnitor acknowledgement of default• Certified copy of board resolutions (authorizing all

above actions)

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Payroll Considerations

• Develop a payroll calendar• Is it all bonded payroll?• Home office v. field payroll

– Sr. management, friends, family, etc.• Gross or net payments• Fund through

– Contractors account– Special trust account– Direct payment by Hartford

• Are their bonded receivables in the pipeline or in the contractor’s bank account?

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Performance/Completion Options

• Takeover and Completion• Tender• Finance• Completion by Obligee

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Takeover and Completion

• Documents– Takeover Agreement– Completion Agreement– Ratification Agreements

• Advantages– Surety maintains control of completion costs– Usually promotes good will and a positive working relationship

with owner– Minimizes disputes over cost reimbursement from indemnitors

• Disadvantages– Surety will be involved with the project directly through

completion– Cost of consultants and administration

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Tender• Documents

– Takeover Agreement – two-party/three-party– Ratification Agreements– Contract Documents (incorporated into Tender Agreement)

• Advantages– Amount of surety loss established early– Surety administration and consulting expense reduced– Claim staff resources become available– No exposure for unforeseen events post tender

• Disadvantages– Process of rebid is time consuming– Bond forms create owner reluctance– Obligee does not want to “let go”/release original surety– Cost of tendering all but the newest projects can have high bidder

contingencies• Comment

– Best utilized when projects have just begun or are in their early stages

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Financing• Considerations

– Is cash or collateral available (all in)?– Is the contractor capable of performing efficiently?– Is contractor honest and committed?– Can the bonds’ penal sums be preserved?

• Types of Financing– Loans from surety (“look-see” or long term)– Guarantee a bank loan– Indirect “back door” financing by paying subcontractor and

supplier claims– New surety credit/bonds

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Financing (Continued)

• Advantages– Avoids learning curve with new contractors– Job progress not interrupted– No contingencies or markups as with new bids– Claims are preserved– No subcontractor “negotiations”– Obtaining of collateral

• Disadvantages– Loss is not ascertained– Bond penalty is at risk– Certain non-bonded obligations are paid– Consulting/administration costs are high– Financed principals slow to finish – no “life after”

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Effective Claim Management

• Protect and Preserve– Cash– Contract backlog– Claims

• Manage what is manageable on a prioritized basis

• Maintain a sense of urgency, creativity and common sense

• Consider the promise – preserve the product

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Managing the Complex Performance Bond Claim -- Medic or Mortician

YOUR QUESTIONS?If you do not have the opportunity to have your question addressed during the Seminar, you may contact the presenter directly:

Rick Levesque Ed RubachaHartford Jennings Haug &

CunninghamRick.Levesque@thehartford.com er@jhc-law.comPhone: (253) 853-2203 Phone: (602) 234-7846