September 2019

In a report presented to the joint Post Audit Committee, legislative auditors contend that the state Division of Environmental Protection has been skirting a law designed to make sure that coal mine reclamation bonds are on solid financial ground. Coal companies have to get the bonds to guarantee the land will be repaired once the mining is over. But, the audit report says the DEP ignored a stipulation that said insuring agencies have to be approved by the U.S. Treasury with a T-Listing. That certifies the insurers have suitable assets and financial practices. First Surety Corporation got into the business in 2006 and insures hundreds of bonds worth about 48 million dollars. However, the agency does not have the financial credentials that auditors say the law requires. “The legislature is very committed to requiring a T-Listing for these bills, surety bonds and so forth, that protect the land in West Virginia as its being mined for coal,” West Virginia Senate President Mitch Carmichael, (R) Jackson, said. The DEP’s general counsel says the agency interprets the law as having two paths to insure the reclamation bonds. One is for a company to have a T-Listing, the other is by the permission of the West Virginia Insurance Commissioner. Carmichael questioned the lawyer about the DEP’s stance. “Mr. President, my testimony is that the agency thought that there were two avenues pursuant to that rule by which a company would be allowed to submit surety bonds to the state,” Jason Wandling, General Counsel for the W.Va. DEP said. “And one of those avenues would be, would not include T-Listing?” Carmichael asked. Wandling replied, “That’s correct Mr. President.” “I’m at a loss as to how you obtain that understanding of it,” Carmichael said. “I accept that you have to say that.” The legislative auditor says insuring reclamation surety bonds without a T-Listing has a four-year time limit and that First Surety Corporation’s four-year grace period expired in 2010. “Our view is that that stopped in 2010,” Aaron Allred, W. Va. Legislative Auditor said. “And that DEP has allowed this company to continue to issue mine reclamation laws in violation of state law now for nine years.” https://wchstv.com/news/local/audit-alleges-wva-deprotection-ignores-state-law-for-nearly-a-decade

On August 6, 2014, plaintiff-relator Andrew Scollick filed a complaint in the United States District Court for the District of Columbia against eighteen defendants for multiple violations of the False Claims Act (“FCA”) in connection with an alleged scheme to submit bids and obtain millions of dollars in government construction contracts by fraudulently claiming or obtaining service-disabled veteran-owned small business (“SDVOSB”) status, HUBZone status, or Section 8(a) status, when the bidders did not qualify for the statuses claimed. United States ex. rel. Scollick v. Narula, et al., No. 14-cv-1339 (D.D.C.). Unique in this case were not the claims against the contractors, who were alleged to have falsely certified their status or ownership. Rather, what set this case apart was that Scollick also named as defendants the insurance broker who helped secure the bonding that the contractor defendants needed to bid and obtain the contracts, and the surety that issued bid and performance bonds to the contractor defendants. Scollick alleged that the bonding companies “knew or should have known” that the construction companies were shells acting as fronts for larger, non-veteran-owned entities violating the government’s contracting requirements—and thus the bonding companies should be held equally liable with the contractors for “indirect presentment” and “reverse false claims” under the FCA. This suit appropriately seized the attention of the surety industry, which had never before faced similar claims or the threat of trebled damages liabilities under the FCA. Pursuant to the Miller Act (40 U.S.C. §3131), contractors who bid on government construction contracts are required to post bid bonds (to ensure a contractor will undertake the contract if the bid is accepted), performance bonds (guarantees that the contractor will complete the project per contract specifications), and payment bonds (to ensure that those who furnish labor and materials for the project will be paid). A construction contract cannot be awarded and cannot commence unless the required bonding is in place. Surety bonding is subject to underwriting, which provides government contracting officers with reasonable assurances that the contractor’s organization and financial ability can satisfy the obligations of the construction contract. The claims alleged in this suit have the potential to fundamentally rewrite the “rules of the road” for the underwriting and due diligence requirements for the entire industry. The surety defendants were initially dismissed. United States ex. rel. Scollick v. Narula, et al., 215 F. Supp. 3d 26, 30-31 (D.D.C. 2016). But Scollick amended his complaint to add factual allegations that the bonding defendants necessarily engaged in underwriting and due diligence efforts that should reasonably have revealed that the contractors lacked the skill, resources, and experience to carry out the scope of work, and should have reasonably revealed that these contractors did not qualify for SDVOSB or HUBZone set-asides. Scollick specifically alleged in the Amended Complaint that the bonding defendants “knowingly facilitated the fraud scheme and knowingly caused false claims to be submitted to the government” by providing surety bonds when they “knew, or should have known, that the Defendants were concealing material information from the government” regarding their eligibility for these set-aside contracts. Scollick further claimed that “[h]ad the government known . . . it would not have entered the contracts at issue . . . [and] premiums and fees knowingly derived from the fraud scheme, and thereby indirectly charged to the government, were paid [to the insurer].” In a stunning reversal, the court issued a second opinion in July 2017 reinstating the claims against the broker and the surety on the grounds that the plaintiff-relator had adequately alleged that the bonding defendants had knowledge of the scheme and were sufficiently complicit in the alleged misconduct to allow these claims to proceed against them. Scollick, 2017 WL 3268857 (D.D.C. July 31 2017). Specifically, the court pointed to allegations that the insurance defendants knew or should have known that the contractors were violating federal contracting requirements because the insurance defendants conducted on-site inspections of the contractors’ offices, which would have revealed that there were “shell compan[ies] dependent on the resources and capabilities of [other defendants],” who dominated and controlled the entity held out to qualify for SDVOSB set-asides. Even though neither the broker nor the insurer directly presented false claims or made false statements to the government, the court permitted the plaintiff-relator’s theory of “indirect presentment” to proceed. Notably, the court pointed to specific statements in the bond forms—e.g., Standard Form 25, which states, among other things, that the performance guarantee extends to “all the understanding, covenants, terms, conditions, and agreements of the contract.” In United States v. Sci. Applications Int’l Corp., 626 F.3d 1257 (D.C. Cir. 2010), the D.C. Circuit held that where a defendant fraudulently sought payment for participating in a program designed to benefit third parties rather than the government itself, “the government can easily establish that it received nothing of value from the defendant and that all payments made are therefore recoverable as damages.” Thus, under a Standard Form 25 performance guarantee, a Miller Act surety may incur reverse False Claims Act liability for a bonded contractor’s violation of that guarantee. For more than five years, the surety industry has been watching this case and waiting to see if the Sword of Damocles would actually fall on sureties and brokers involved in issuing Miller Act bonds on government projects. The issues raised by this suit, especially whether insurance companies and brokers might be subject to FCA liability and treble damages if they offer underwriting and Miller Act sureties to contractors who submit fraudulent claims or certifications to the government, have already elevated the stakes and raised a significant flag of caution to brokers and sureties involved in issuing Miller Act bonds on government construction projects. On August 28, 2019, the parties jointly requested a sixty-day stay of proceedings to pursue mediation, which request was granted on September 13, 2019. If the case is not settled at mediation, the parties must submit by November 12 a joint proposal for further proceedings. An adverse outcome against the surety defendants in this case

An arbitration provision in a contract typically applies only to the contracting parties. Where, however, the contract is incorporated by reference into a second agreement, if it is broad enough, the party to the second agreement–although a non-signatory to the original agreement–may find that the arbitration provision applies to them as well. This was the result in a case before the Second Circuit involving a surety on a performance bond. In Federal Insurance Co. v. Metropolitan Transportation Authority, No. 18-3664 (2d Cir. Aug. 30, 2019) (Summary Order), a surety on a performance bond brought suit against the public transportation authorities that contracted with the contractor principal. The public authorities moved to dismiss the claim based on the arbitration clause in the underlying contract. The underlying contract had a broad arbitration clause, which provided that the “parties to this Contract hereby authorize and agree to the resolution of all disputes arising out of, under, or in connection with, the Contract” through arbitration. The underlying contract and all of its terms were expressly incorporated by reference into the performance bond. The district court concluded that the surety was bound by the arbitration On appeal, the Second Circuit affirmed. The court made two significant findings. First, the court agreed that the district court had properly concluded that the dispute was subject to determination under the arbitration provision in the underlying contract. Because the broad arbitration clause was not restricted to the immediate parties, the court held that it was effectively incorporated by reference into the performance bond. The court found the language of the arbitration provision sufficiently broad to bind the surety even though it was a non-signatory to the underlying contract. Second, the court held that the question of arbitrability was for the arbitrator to decide. This was because the contract used “any and all” language when describing the disputes to be resolved, which was “clearly and unmistakably” broad enough to require the issue of arbitrability to be decided by the arbitrator and not the court. https://www.natlawreview.com/article/non-signatory-surety-bound-arbitration-clause-incorporated-contract