Monday, March 19, 2012

Ohio Court Permits Subcontratcor "Default Insurance" Instead of a Surety Bond

In State ex rel. American Subcontractors Ass'n, Inc. v. Ohio State University, 940 N.E. 2d 984 (Ohio 2011), the Ohio Supreme Court heard arguments on a pilot program - instituted pursuant to House Bill 318 - to test whether alternate methods of procuring public construction projects would increase efficiency and lower costs.

In the case before the court, The Ohio State University contracted with a construction manager "at risk" for the expansion of its medical center. Ohio's bidding laws usually require public entities, like Ohio State, to bid the project to multiple prime contractors. But as everyone who gets involved in public works knows, the multi-prime scenarios often lead to scheduling conflicts and project delays.  While contractual provisions can soften the financial blow to the public institution, it still means a delayed project.

Ohio House bill 318 permitted awarding a contract to a "construction manager at risk", using a best value bidding system which based the selection of the construction manager (CM) on qualifications rather than the lowest responsible bidder. This system was to be used on three test projects.

In the bidding documents, the university decided against requiring a performance bond issued by a surety (which would have been required under Ohio's public bidding laws), but instead required that the construction manager furnish a $20 million irrevocable standby letter of credit. The university also required that the CM provide subcontractor default insurance to protect against a default by one of its subcontractors.

When the bidding documents were released, petitions to the Ohio Supreme Court for a writ of mandamus were filed by several subcontractor associations, as well as a national trade association of companies licensed to write surety bond in Ohio. The petition requested that the court require the university to compel the CM to obtain performance bonds for the project as was required by the regular bidding laws.

The university argued that House Bill 318 provided it with flexibility as to what guarantees it could require from the subcontractors. By removing the bonding requirements and replacing them with the letter of credit and insurance, the university would be able to save nearly $12 million.

In rejecting the petitions, the Court held that the subcontractor associations did not have standing to bring the suit because they could show no plausible damage to any particular subcontractor. To the contrary, the Court found that the construction manager at risk agreement contained multiple safeguards to ensure the subcontractors were timely paid for work. Additionally, the Court found that if the CM was required to obtain a bond, the subcontractors would also have been required to obtain bonds, inhibiting minority subcontractors such as MBEs (minority business enterprises) and WBEs (women business enterprises) from submitting bids, in direct contravention to the main purpose of the legislation.

As for the surety association, the Court found that it did have standing, but nevertheless ruled against the association on the merits. Though the surety association argued that the language of the bill stated that the university was not exempt from laws concerning bonding, the Court held that the bond requirements were only applicable to situations where the project was being awarded to the lowest responsible bidder. Since the project was bid and awarded under a qualifications and best value basis, bonding requirements did not apply to the university.

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