Legislation

Wanting to diversify his investments, Ernest “Big Daddy” Bux signed a franchise agreement with GA Fitness last year. Construction by Big Daddy’s contractor Bill Toosuit is scheduled to be completed for in time for an early May grand opening in the new strip center owned and managed by Mawl & Mawl. Last week, in response to the COVID-19 pandemic, the town’s mayor and the state governor prohibited any gathering of more than 10 people and directed that all bars, restaurants and gymnasiums close. Now that gymnasiums are prohibited from opening, Big Daddy’s business is almost certain to fail, and Mawl & Mawl loses a tenant. If Big Daddy stops construction and buys out his current lease obligation, Bill Toosuit loses his construction project and Mawl & Mawl loses a long-term tenant. Can Big Daddy get out of his lease obligations? And his construction contract? Are there other options to get to a win-win? Legally Maybe and probably. If Big Daddy is looking to set aside or suspend his obligations under the lease and construction contracts, he should first examine them for a force majeure clause, which is addressed here. If Big Daddy’s contracts do not contain a force majeure clause or the clause does not cover pandemics like COVID-19, hope is not lost. Impossibility Defense The Texas Supreme Court recognizes an impossibility-of-performance defense – upon an event occurring that the contracting parties assumed would not occur. Unlike force majeure clauses, a successful impossibility defense must also demonstrate reasonable efforts to surmount the obstacle to performance and, only then, performance is excused if it is impracticable in spite of such efforts. Texas courts have applied the impossibility defense narrowly and upheld it in three scenarios: (i) a person necessary for performance dies or becomes incapacitated; (ii) the thing necessary for performance is destroyed or deteriorates; and (iii) the law changes making performance illegal. Consistent with force majeure clauses, the impossibility defense is not satisfied simply because performance is more inconvenient or economically burdensome than anticipated – increased difficulty or expense is judicially regarded as being covered within a fixed-price contract. The COVID-19 pandemic could cause the first and third scenarios—a person who entered into a contract to provide services could become infected or governmental decrees or regulations issued to combat the virus could prevent parties from performing their contractual obligations. For instance, the recent order banning gatherings of more than 50 people in Dallas County would “make performance illegal” of a contract to host a large party or concert. Businesses affected by COVID-19 might also argue for expansion of the impossibility defense beyond these three recognized scenarios. Some authority excuses performance if there is either a risk of injury to persons disproportionate to the purpose of performance or a severe shortage of raw materials or supplies. And courts may be receptive to expanding the defense, given that a pandemic causing a broad economic shutdown is a rare and devastating event. For those sellers and lessors of goods, the Universal Commercial Code (UCC) may offer some COVID-19 relief. In Texas’s version, delays in delivery by sellers, lessors or suppliers of goods is not a breach “if performance as agreed has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made” or by good faith compliance with a governmental order or regulation. Notably, these only protect sellers and lessors of goods from one type of breach—delay in delivering the sold or lease goods. Practically As with invoking a contract’s force majeure clause, stopping performance based on the impossibility defense is risky because, if done improperly, it could itself amount to a breach of the contract – entitling the other party to terminate and sue for damages. Consult with an attorney to assess whether the defense applies to your case. Bottom line: it’s risky and there will be a cost—win or lose. Tilting the Scales in Your Favor If you believe that this COVID-19 pandemic is permanent and terminal, abandon all hope! Big Daddy’s business will fail. Bill Toosuit will lose his construction contract (likely only one among many). Mawl & Mawl will lose a long term tenant. The local citizens will lose the positive economic impact of a new business – and a gym! If, on the other hand, you believe that by working together we can beat this short-term challenge – nearing a panic – consider these: Collaborate. Share the short-term risk. Find common grounds of trust. Then, get creative and flexible. For Big Daddy, almost everyone would agree that the scheduled grand opening of his new business in early May is a bad idea – probably terminal for his business. The closure would significantly impact his landlord Mawl & Mawl, who would probably prefer a multiple-year tenant to a short-term cash settlement, Bill Toosuit would lose the rest of his construction project and cash flow for his workers and subcontractors. This is just one of many legal issues the pandemic is raising. For Gray Reed resources on additional issues, check out our firm’s COVID-19 Resource Center. https://www.jdsupra.com/legalnews/does-covid-19-make-a-contract-69401/

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

Following up on our previous bulletin, Performance Bonds: What Project Finance Lenders Should Know, in this bulletin, we compare the widely used Canadian Construction Documents Committee’s Performance Bond Form 221-20021 (“CCDC Form”) with the new Form 32 – Performance Bond that is mandated for certain projects by the Ontario Construction Act2 (“Form 32”). Background Pursuant to section 85.1 of the Construction Act and section 12 of the accompanying General regulation, all “public contracts” with a contract price of $500,000 or more require the contractor to furnish both a performance bond and a labour and materials bond that, in each case, must be in the prescribed forms and have coverage limits of at least 50% per cent of the contract price.3 The Act defines a “public contract” as a contract where the owner is the Crown, a municipality or a broader public sector organization, but excludes contracts where the contractor is an architect or engineer from the application of that section.4 Thus, the provision is meant to capture all government-procured construction contracts with a contract price of $500,000 or more. In the context of public-private partnership (“P3”) and alternative financing and procurement (“AFP”) projects, section 1.1(4) of the Act clarifies that the “public contract” for the purposes of section 85.1 is not the typical project agreement between a special purpose vehicle and the government entity, but rather the “dropdown” construction contract or design-build contract between that special purpose vehicle and the contractor.5 Section 3 of the General regulation further stipulates that the minimum coverage limits for the bonds are capped at $50 million for P3 or AFP projects – i.e., the 50% requirement does not apply to projects with a contract price greater than $100 million.6 As with the other new provisions of the Act, the requirements of section 85.1 do not apply to contracts where the procurement process was commenced before July 1, 2018.7 Under section 1(4) of the Act, a procurement process begins whenever a request for qualifications, request for quotation, request for proposals, or a call for tenders is first made.8 In the context of projects procured by Infrastructure Ontario, for example, this would be the date that the request for qualifications is issued for a typical procurement. Notably, a market sounding or a Request for Expression of Interest issued by Infrastructure Ontario does not on its own constitute the commencement of a procurement process.9 Form 32 Form 32 to the Construction Act was developed by the Ministry of the Attorney General of Ontario in close consultation with the Surety Association of Canada and other industry stakeholders. It is intended to be a complete, detailed code of conduct governing the relationship between the surety, the owner, and the contractor, and is designed to address some of the deficiencies of the very short and potentially ambiguous CCDC Form. Form 32 is significantly longer and more detailed as compared to the CCDC Form. Unlike the CCDC Form, which is a 1 page document, Form 32 (in blank form, together with Schedules and Appendices) is 12 pages long. It sets out a detailed claims regime addressing, among other things: specific parameters for written notice (including various prescribed forms), a mandatory pre-notice meeting and post-notice conference, specific timelines for the surety’s investigation and response, a regime for necessary interim work and mitigation work, specifics regarding the owner’s direct expenses to be paid by the surety, and a detailed checklist of documents that must be delivered to the surety when a claim is made. Mandated Timelines A key new feature of Form 32 is that it introduces mandatory timelines for notice, investigation, and response following an alleged default. The CCDC Form does not mandate such timelines, instead relying on the reasonableness of the parties. Under the new Form 32, after receipt of a demand under the bond from the owner in the form of Schedule A to Form 32, the Surety must, within four business days, deliver to the owner an acknowledgement in the form set out at Schedule B. Furthermore, within twenty business days, the Surety must deliver a complete written response to the demand, based on its investigations and review, in the form of Schedule C. The surety must also propose a “Post-Notice Conference” within five business days or such longer period as may be agreed. Other Differences between the CCDC Form and Form 32 An apparently minor but consequential difference between Form 32 and the CCDC Form is the definition of “Contract” in the preamble. Form 32 incorporates not only the underlying contract but also “amendments made in accordance with its terms”. This language is not effectual on its own but where the underlying contract includes terms allowing minor variances and amendments, this more incorporative language may offer better protection against a surety who claims to having been discharged due to a variation in the contract without their consent. As noted above, article 1 of Form 32 imposes an express notice requirement and details the necessary procedure for declaring a principal in default. While notice to the surety was always a functional requirement due to the need to declare the principal in default, this new term makes this requirement express and adds procedural clarity. Section 1.2 also establishes a procedure for notice in cases with multiple sureties. Article 2, which requires a “Pre-Notice Meeting”, and article 5, which requires a “Post-Notice Conference”, provide the parties with a mandatory regime for meetings and communications both before and after the declaration of default. This appears to codify, and reinforce, the common recommendation that the bond parties communicate openly and often in respect of the bonded work and any potential issues. Article 3 imposes an express obligation on the surety to investigate a declared default and sets a timeline for their response to the obligee’s notice. This codifies the surety’s common law right to investigate defaults prior to responding to a claim but notably circumscribes that right by imposing a time limit on any investigations and establishing requirements for the response. Article

New Jersey recently introduced legislation that regulates mortgage servicing in the state. Under the new law, which takes effect July 28, servicers must be licensed and obtain a $100,000 New Jersey mortgage servicer bond in order to operate legally. The law also specifies the obligations and responsibilities of licensed servicers, such as filing annual reports, keeping records, and more By July 28, mortgage servicers in New Jersey will need to obtain a license in order to operate legally in the state. This requirement was recently introduced with the passing of bill A4997, also known as the Mortgage Servicers Licensing Act. Moreover, persons exempt from licensure that service five or fewer residential mortgage loans per year are also exempt from the provisions of this bill. Read More … https://mortgageorb.com/new-jersey-passes-licensing-law-for-nonbank-mortgage-servicers