June 18, 2014

Walking the High Wire Without a Safety Net: The Unbonded Federal Project


Thousands of federal construction projects are let each year. A certain percentage of them, however, are much riskier than one might expect. When a project goes awry efforts are made to resolve it. But once it becomes clear that litigation is the next step, the first question for the unpaid supplier or subcontractor is— "who is the surety that provided the bond on the project?" — especially if the contractor is broke or out of business.

Under the federal Miller Act, a prime contractor is required to provide a surety bond as security for payment to its subcontractors and certain material suppliers. But there are instances, which are not readily apparent, in which the Miller Act bonding requirements are loosely applied. Even though a federal project has construction components to it, the Contracting Officer may decide that the contract is not necessarily a construction contract. This is more likely to occur when the contract is classified as a supply or services type contract.

A federal supply or services contract is not subject to the Miller Act bonding requirements and the contracting agency need not require a bond unless it is a "construction" contract. The Contracting Officer is given discretion on classification of the project, and if the Contracting Officer determines that the project is not a construction project subject to the Miller Act, the Contracting Officer has the latitude to not require a bond from the prime contractor. The Contracting Officer may also make a mistake and not require a bond even though the Miller Act applies. In some supply and services contracts, the scope of work agreed to by the subcontractor consists of the vast majority of the prime contract, and may be virtually all construction-related. It may look and smell like a construction contract to the subcontractor or supplier, but if the Contracting Officer determines that it is not "construction" a Miller Act bond may not be required of the prime contractor — even though the Miller Act requires such a bond — and unpaid subcontractors or suppliers may be left without an effective remedy if the prime contractor is unable or unwilling to pay.

Once a dispute over payment with the prime contractor has begun, what security does the subcontractor or supplier have that it will be paid for its work on the project? The two typical sources of security are bonds and construction liens. Although a construction lien can be filed on federal (or state) property, it is essentially worthless and cannot be foreclosed. Consequently, the improvement does not provide security for payment to a subcontractor or material supplier. For this reason, the Miller Act, (and Oregon's "little Miller Act"), require a bond for construction projects. But the Miller Act does not provide relief if the federal agency misclassifies a project as a contract not requiring a Miller Act bond, or otherwise fails to ensure that the prime contractor provides a bond for the project (unlike Oregon law which provides a remedy against the agency and the "officers authorizing the contract" if a bond is not secured when it should have been). If this is the case, an unpaid supplier or subcontractor may not have any security for payment for the materials supplied to, or work performed on, the project.

Until fairly recently, equitable liens were being asserted against the federal contracting agency that made such mistakes. An equitable lien is a claim against the agency that has control over the project funds. The party claiming an equitable lien requests an order from the court that payments be made directly to it out of the project funds. Some states have provisions under "stop notice" and "retainage lien" statutory schemes that yield a similar result.

Until a few years ago, federal courts were allowing material suppliers and subcontractors to assert equitable liens against the federal agency that issued the contract. However, in 1999 the United States Supreme Court overruled the lower federal courts and disallowed equitable liens in the so-called Blue Fox case. The Court determined that an equitable lien was a claim for damages, and because of the protections provided to the federal government under principles of sovereign immunity (the same protections that prevent government property lien foreclosures), equitable liens against the federal government are prohibited. Accordingly, the Supreme Court put an end to equitable liens against the federal government.

So how do you protect yourself when you are providing materials and/or subcontracting to a prime contractor on a federal project? If you are providing a quote before the project bids, and you have an opportunity to inspect the bid package, carefully review it to see if a bond is required. If you don't have access to the entire bid package, call the Contracting Officer and ask him or her if a Miller Act bond is required on the project. If you are providing a quote after bid, you can make the same inquiries, or you can request a copy of the bond from the agency before providing a bid, or signing a contract. What you should not do is assume that a bond is in place — it may not be. Don't walk the high wire on a federal project without a safety net. It is a long fall.

For more information on this topic, please contact marketing@jordanramis.com or call (888) 598-7070.

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