LETTER TO STATE REPRESENTATIVE/SPEAKER OF THE HOUSE, ARMOND BUDISH

I have sent this letter to Armond Budish as Speaker of the House and my State Representative, Robin Belcher. Please feel free to borrow from this letter to write to your own Representative TODAY, decisions will likely be made this week.

Dear Armond:

As you know from our time together at Hahn Loeser, I am an attorney, but you probably do not know that I focus my practice in the area of construction law, am the President of American Subcontractors Association of Ohio, which has regional groups in Cleveland, Columbus, Cincinnati and Dayton. I am also the general counsel of the Builders Exchange (Cleveland, Toledo, Dayton and Cincinnati) and am a member of the Executive Committee of ASA (National) and Chair of the ASA Subcontractors’ Legal Defense Fund. I am also the author of the treatise, Ohio Mechanic’s and Materialmens’ Liens 3d Ed., published by Thompson/Reuters.

As a tax payer and a person who is very involved with clients who will be injured, I am very concerned about the probable result that passage of the Budget Bill, with the amendment inserted by Senator Shirley Smith, will have on the construction industry in Ohio. The amendment waives the requirement that some contractors, financially challenged minority contractors, post a payment and performance surety bond to assure that they not only complete the project and the public will not have to pay more because of a contractor default, but will also assure that all subcontractors and suppliers are paid for their labor and materials used for the public benefit. The amendment, while well-intended, will negatively impact every level of construction participants. The point of the amendment is to permit minority contractors who can demonstrate that they are not financially responsible to bid along with others who are, on an even footing. This increases the risk, without the ability to control the risk, to all bidding subcontractors and supplier. This will also have a negative impact on the taxpayer and other bidding principal contractors, particularly financially responsible minority contractors.

A bond is generally required in public projects because, unlike private projects, the unpaid subcontractor and supplier can only lien the money that is still due from the public authority to the principal contractor, not the improved real estate itself. If there is no money left to be paid to the contractor, the lien of the subcontractor or supplier is valueless, which is where the payment bond provides the required security to make the construction industry work as it does, with acceptable risk. This leads to the improbably security that, in this amendment, is provided to the subcontractors and suppliers by increasing the amount of Retainage withheld from the unbonded contractor. The problem with this “security/protection” is discussed below.

Of the multiple levels of injury, the first is to the public authority/tax payer, with no performance bond, accepting the lowest bidder means that there will be no protection for the public authority/tax payer if the contractor has underbid the project. Rather than saving money, when a contractor defaults it almost always costs more to hire a replacement contractor to complete the work. This is such a strong proposition that, in the event of a termination for default of the contractor, when the surety becomes responsible for the completion of the project, it is common for the surety to hire the defaulting contractor to complete the work. The surety, of course, makes up the short fall required to complete the project, minimizing the financial exposure for all. Here, there will be no surety to make up the short fall. With the surety bond, in all but the most financially stable companies, the principals of the companies are personally liable to the surety, keeping their bids and performance within reason. Without the surety relationship the corporations or limited liability companies that are awarded public contracts with a waiver of the obligation to post a payment and performance bond, there is no personal liability, permitting the bidding contractor to take more risks in the bidding process, unfairly taking work away from companies that have properly bid because they do have personal risk and are otherwise financially responsible.

Second, other, well financed minority contractors will suffer because there will not be a good way for bidding subcontractors or material/equipment suppliers to know in advance whether their bid will be accepted by a contractor that is or is not posting a payment bond. If the bidder is bidding to be in direct contract with the principal contractor, they could have a better opportunity to determine if the contractor to whom they are bidding will be posting a bond, if that information is properly required, however, at this point, the first time that one would determine whether there is a bond is when they read the Notice of Commencement which divulges the identity of the surety, only after the contract has been awarded. If they are bidding to a subcontractor, rather than a potential principal contractor, they will have little control over who the subcontractor that they are bidding to, is bidding to. As potential first tier subcontractors frequently bid to multiple contractors, it would not be uncommon to bid to both bonded and unbonded, potential contractors. They would be offering their labor and materials ultimately to different contractors which are giving them resulting different levels of risk, risk which they cannot easily control. This could cause subcontractors and suppliers to bid in situations where they could be bidding to minority contractors to bid at higher levels to cover the perceived risk, or not to bid to them at all, unfairly prejudicing the financially responsible contractor that has earned a good reputation to receive the bids that it deserves. Without the proper bids, the experienced, well capitalized, bonded minority contractors may be unjustly denied the work that they deserve to win.

Third, first tier subcontractors will, without substantial due diligence, be unsure the level of risk that they are taking by bidding to a minority contractor. The result is that bids to minority contractors will likely be higher than to other contractors who are required to have payment bonds, either by forcing the bidding subcontractor to submit two bids, one if there is a bond, a higher one if there is no bond.

Fourth, lower tier subcontractors and suppliers will, unless they qualify their bids to exclude the use of their bid to bid to an unbonded contractor will have absolutely no control over the risk to which they will be exposed. Because such a qualified bid is unlikely, except by only the most sophisticated subcontractors, the only rational way to control this will be to increase the price of their bids to offer a better return to offset the perceived risk.

In these tight economic times when prime bids are coming in at or substantially below the architect’s estimate, no one can afford to take the additional risk. The lower the tier participant, the lower the ability they have to properly perform any reasonable due diligence and still make a profit. One possible result is that suppliers may stop supplying in Ohio, or raising their prices so high to cover their risk that construction becomes even more unaffordable for the taxpayer. When speaking of the taxpayer, if it is the will of the people to afford the financially insecure minority contractor a monetary advantage which includes increased risk of subcontractors and suppliers, the only possibility that is fair to all contractors, subcontractors and suppliers is to have the public authority guaranty the payment of all subcontractors and suppliers in lieu of the payment bond. Of course, this just increases the cost to the taxpayer.

The other, related problem arises as a result of what is seen as additional “protection” for the subcontractors and suppliers, that being that rather than the current 8% of labor only on the first 50% of the project and 0% thereafter for an effective rate of 4% Retainage on LABOR ONLY over the life of the project held by the public authority from the principal contractor, to increase Retainage for projects with contracts over $50,000 a 15% Retainage on the contract and for contracts of $50,000 or less a 12% Retainage. Retainage is an amount of money to be withheld from the contractor for payment otherwise due for properly performed work until the completion of the job, just to keep the contractor interested in completing the project. The point, when the concept of Retainage was first instituted, in England in the mid-1800s, in railroad construction projects, was to withhold the contractor’s profit only. At the time, it was widely accepted that contractors worked on a 10% profit margin. Retainage was set at 10%, affording the contractor sufficient cash flow to permit the contractor to pay all of its bills. If more than the profit margin is withheld, the contractor has to withhold money from others (subcontractors, suppliers, withholding tax which should have been paid to the IRS or fringe benefit payments which should have been paid to labor unions). The last option is to borrow the money from a lender. Because the target contractors are, by definition, financially challenged, this will not be an option. When money is withheld from a subcontractor or supplier that is otherwise due its payment, it cannot pay its bills, bills for its materials, labor, bills to the IRS, or bills for union fringes. As you can see, over-withholding payments due to the principal contractor has a cascading effect that will injure the entire payment stream to all involved. To protect themselves, the subcontractors and suppliers will need to file mechanic’s liens earlier and law suits faster to protect their own payment and their businesses. The problem with the lien and the lawsuit is that neither are guaranties that they will either be paid or be paid in full. Making the situation even worse, if the contractor does not have sufficient cash flow and elects to withhold payments from the IRS or any other taxing authority or from payments due to unions, the contractor will suffer prohibitive penalties which will even further hurt the financially challenged company and its owners.

The two issues with the existence of a bond is first and foremost that there is security for the payment that is due and second, that the surety has performed all of the due diligence to assure that the contractor is bondable, financially responsible. This amendment provides the right of the contractor who is not financially responsible or bondable to have the same rights without any risk, all the risk being placed on the shoulders of the subcontractors and suppliers.

This amendment unfairly shifts the risk of financial ruin to subcontractors and suppliers who cannot control the risk, in our already struggling construction industry, with only an illusory benefit to the contractor itself, as the Retainage it will suffer in exchange for the waiver of the bond will cause it to fail or constantly defend itself against liens and in law suits. It is neither the time nor the manner to provide the intended benefit. If this additional assistance to the financially challenged minority contractor were a good idea, it deserves to be in its own legislation where it can be properly debated and vetted to provide the intended benefit, while still protecting others, not placed in a “must approve” unrelated budget fill. Please, revise the Budged Bill, removing the Smith amendment, and return it to the Senate for proper approval.

Please contact me if you have any questions that might help you make a decision on this important issue.

Thank you,

R. Russell O’Rourke
O’Rourke & Associates Co., LPA
RORourke@ORourke-Law.com