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April 01, 2018

A Forged Notary Stamp and the Fake Bonding Company Just Skipped Town…Now What?

Christopher D. Strang and Brendan Carter

Massachusetts Joins other Jurisdictions Holding Contracting Agency is Responsible in Tort for Verifying the Authenticity of Payment Bonds

A fundamental piece of public construction projects is the requirement of contractors to provide payment and performance bonds to government contracting entities.  This requirement has its roots in the Miller Act, a Federal statute enacted in 1935 to protect subcontractors from general contractor non-payment and default during the Great Depression.  The function of the Miller Act was to act as de facto common law mechanic's lien on government projects, which would be immune from lien protections through the doctrine of sovereign immunity.  This concept of requiring payment and performance bonds spread across the country with numerous states enacting their own "Little Miller Acts" which individually tailored legislation to address each state's specific concerns related to bond requirements.  The Commonwealth of Massachusetts enacted such a public bidding requirement through its own "Little Miller Act" in M. G. L. c. 149, §29 (Massachusetts Bond Statute).

The Massachusetts Bond Statute requires that, "officers or agents contracting in behalf of the commonwealth" will be responsible for "[obtaining] security by bond" for payment and performance of contractors engaged in public projects. The Massachusetts Bond Statute also provides criteria for sureties that issue payment and performance bonds for construction projects.  It requires that sureties be organized either under Massachusetts insurance regulations or, as a foreign surety company, be licensed to transact business in the state with the Massachusetts Division of Insurance, and then finally be approved by the U.S. Department of Treasury to provide bonds on federal projects.  Much like the Miller Act, the Massachusetts Bond Statute is silent on the duties and protocol for government employees to authenticate sureties or the veracity of project-provided bonds, but a recent decision does provide some guidance.

The Federal Government's duty, or lack thereof, in the Miller Act was established in United States v. Smith. In Smith, Plaintiff was a subcontractor on an Air Force project where the general contractor failed to pay Smith for labor and materials.  The government had not secured a payment bond.  Smith sued the government for negligence based upon the Federal Tort Claims Act (FTCA). The Fifth Circuit found that the FTCA was not applicable to the Miller Act because the FTCA requires an analogous private duty to exist in order for a claim of negligence to be successful and there is no private action for failure to secure a payment bond.  In Hardaway Company v. United States Army Corp of Engineers,<\/u> the Eleventh Circuit further found that the government has no duty to investigate the financial status of a surety.  Not all State courts follow the Federal Court's Miller Act decisions though.  Many states do establish a duty for state and local government entities as it relates to performance bonds and a Massachusetts Superior Court judge recently ruled that Massachusetts awarding authorities on public construction projects do in fact have a duty to confirm that the payment bonds submitted by general contractors are valid.

In Kapiloff's Glass, Inc. v. University of Massachusetts (UMASS), four subcontractors who provided labor and materials on scopes of work for metal windows, interior glass, roofing materials, and custom laser curtains on a University of Massachusetts (UMass) construction project brought suit against the general contractor and payment bond surety named in the bond. Collectively, they each obtained favorable judgments in the amount of $500,000 and the general contractor promptly filed bankruptcy. Additionally, the payment bond proved to be fake with the notary stamp on it even being forged. The surety named in conjunction with bond was not an organization registered to do business with the Massachusetts Division of Insurance and an investigation revealed that an entity going by that surety name had been issuing fake bonds on construction projects across the country for years, with many uncollectable judgments entered against it.

The subcontractors brought suit against UMass under the Massachusetts Tort Claims act, alleging that UMass was negligent in not at least verifying that the bond was issued by a surety registered to do business with the Massachusetts Division of Insurance. UMass first argued, in a motion to dismiss, that it was not an officer or agent of the Commonwealth within the meaning of the statute. The court ruled that this defense was "neither logical nor in accord with common sense."

The court decision explained in great detail the remedial nature of the statute, and how its express purpose is to protect subcontractors, and not the Commonwealth. It cited many prior court decisions opining that the statute should be construed liberally to accomplish its intended purpose of getting subcontractors and material suppliers paid for their work. The statutory language plainly states that the payment bond a general contractor provides must be from a surety registered to do business with the Commonwealth's Division of Insurance. Without the Commonwealth having the modest duty of checking to verify such registration, the statutory language is meaningless. No subcontractor would have access to the general contractor's payment bond prior to bid, as the general contractor is yet to be selected at that point. The Superior Court's decision was not appealed.

The decision in Kapiloff aligns itself with court rulings in other jurisdictions that assigns the responsibility of verifying payment bonds to the governmental contracting agency. In Kammer Asphalt Paving Co. V. East Chia Twp., the plaintiff was a paving subcontractor on a school project with payment and performance bonds per Michigan statute.  During construction, multiple subcontractors expressed concerns over late payments and the Township pointed to the payment bond to assuage any concerns.  The Township later discovered that the bonds were fraudulent and terminated the general contractor for failure to furnish the required bonds. The plaintiff filed suit against the Township and summary judgement was granted on the negligence claim with the trial court finding no legal duty to ensure the validity of the bonds. The Supreme Court of Michigan found that the statute required a government entity to verify the validity of a bond when a subcontractor requested a certified copy, and the Township had not done so.

The California Fourth District Court of Appeals also found that the city had a mandatory duty under California code to investigate the validity of a bond after its initial rejection. In Walt Rankin & Associates, Inc. v. City of Murrieta, the plaintiff was subcontracted to furnish and install playground equipment for the city of Murrieta.  Per California civil code, the general contractor furnished payment and performance bonds to the city.  After an initial rejection of the bond, the city approved the bonds without any further investigation into their validity. The plaintiffs completed their contract work and the general contractor failed to make payment.  The subsequent claim on the bond found that the surety was a Turks and Caicos based corporation with no assets and not authorized to do business in California. As a result of its lack of investigation, the city was negligent under the California Tort Claims Act.

In Atlanta Mechanical, Inc. v. Dekalb County, the Georgia Court of Appeals found an investigatory duty similar to Walt Rankin. Defendant contracted to construct a records facility and the general contractor submitted payment and performance bonds per Georgia law.  The surety was not licensed to do business in Georgia and the statute required an affidavit stating that it held real estate in equal value to the bond.  The statute imposes liability to the county for any losses realized by subcontractors for the county's acceptance of a "bond not taken in the manner and form as required [.]" The county then prepared and accepted the affidavit from the surety with no further investigation.  Subsequently it was found that the affidavit was false and the surety did not own the purported real estate. The Georgia Court of Appeals found that the county breached a duty to the plaintiff on account of the legally deficient real estate listed in the surety's affidavit and the county's failure to investigate it.

Finally, in Sloan Construction Company Inc. v. Southco Grassing, Inc. <\/u>the South Carolina Supreme Court rejected the characterization of its statute as a "Little Miller Act," but did find a duty for the state. Sloan entered into a subcontract to provide asphalt paving on a Department of Transportation project.  The general contractor secured a payment bond but its surety became insolvent and the bond was canceled.  A replacement bond was never received and Sloan did not receive full payment.  Sloan brought a negligence action against SCDOT under the South Carolina Tort Claims Act for not securing the statutorily required payment bond. The Court found that the state's bond claim differed from the Miller Act because only a payment bond was required, not a performance bond and therefore was not a "Little Miller Act".  The court further found that South Carolina's law required that a right of action was implied with the creation of a statute created for a specific benefit to a private party, i.e. the subcontractor, rather than the public at large, i.e. the protection the state through the bond.  Furthermore, the Court found that an agency's failure to secure a statutory bond does give rise to a third-party beneficiary breach of contract claim by a subcontractor.

The Miller Act and its progeny of "Little Miller Acts" have been an effective means to protect both the government contracting agencies and contractors from bad actors in the industry or companies that found themselves contracted with an insolvent entity. Payment and performance bonds provide confidence to contractors that there is a mechanism in place which will allow for payment in the event of contractor default.  This system benefits the government by keeping prices down by allocating risk it cannot assume to a third party surety.  Some states have decided that such a system only works if a contractor has the certainty that a bond it may rely upon for payment is sound and verified to exist, and the contracting agency has a duty to verify such bonds because they are in the best administrative position to do so.

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Christopher D. Strang

Strang, Scott, Giroux & Young, LLP, Boston, MA

Brendan Carter

Associated General Contractors of Mass, Wellesley, MA