Impact of Washington State Ruling on Performance Bond Could Trickle Down to Suppliers

A Washington State Supreme Court decision could significantly alter the landscape for performing public contracts, potentially making performance bonds more difficult to obtain for contractors and bond premiums on public projects difficult to afford.

The decision in King County v. Vinci Construction Grands Projets seems to have gutted the requirement that a public agency must make an offer of settlement as required under public works statute, according to a recent article by Marti McCaleb, Esq., associate attorney with Schwabe, Williamson & Wyatt PC. “Instead, the Court held that the attorney fee provision of the statute is not the exclusive fee remedy, and that parties to a public works contract may pursue fees based on contract, statute or other equitable principles without having to make a settlement offer,” she wrote.

In the case, the joint venture contracted with King County to expand the county’s wastewater treatment system. After the contractors failed to meet the contract deadline caused “by unforeseen site conditions,” the county terminated the contractors and brought a claim against the performance bond. The contractors claimed the county was at fault for the delays and was in breach of contract by terminating them. The sureties sided with the contractors and refused to cover the county’s claim against the performance bond. The trial court ruled in favor of the county and awarded it $130 million in damages for the contractor’s breach, as well as nearly $15 million for its attorneys’ fees “because the contractors defaulted under the contract and the sureties had wrongfully denied coverage on the performance bond,” McCaleb said. The state’s Court of Appeals affirmed the decision, as did Washington’s Supreme Court.

“This Supreme Court decision is not going to directly affect suppliers’ ability to conduct their business, but the trickle-down effect could impact with whom they must do business,” said Connie Baker, CBA, director of operations for NACM’s Secured Transaction Services (STS). “Sureties could ultimately increase premium cost and for whom they will approve a bond. Credit professionals should continue their due diligence in obtaining job information and payment bond copies so they are protected when contractors are removed from a public works job.”

Also, the majority of Supreme Court justices reviewing RCW 39.04 et al. suggested the statutory fee provision excludes all other means of recovering attorney fees, thereby allowing the prevailing party in a public works dispute to pursue such fees based on contract, statute or other equitable principles, McCaleb wrote. This essentially overturns the prior principle that a prevailing party must make a settlement offer that, if not accepted, then, at trial, the party making the offer has to do as well or better than the offer it made to settle the dispute, she said. The statute had been intended to encourage parties to public contracts to resolve their disputes before following through with costly, lengthy trials. “It may deter parties from making offers to settle disputes that arise under a public works contract—causing parties to engage in costly litigation at the tax payers’ expense instead of reaching a resolution,” she said.

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June 10-13, 2018

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Possible Catalonia Independence to Affect Corporates, Others

The fight for independence in Spain’s Catalonia region may impact bond issuers, banks and corporates among other entities in the area and abroad. While many Catalans want to celebrate the political separation from the central government in Madrid, there are many factors that could come into play should the break occur.

“The No. 1 reason to oppose this fragmentation is economic,” said NACM Economist Chris Kuehl, Ph.D. “The small states that are created by these movements are often not viable economically. They lack the domestic economic strength to compete and many find themselves dependent on a very narrow economic base. The fact is that a larger and more diverse economy is stronger and will be preferred by the investment community.”

Catalonia is roughly a fifth of Spain’s economy, so losing this percentage of its gross domestic product would be equivalent to the U.S. missing out on Illinois, Pennsylvania, Ohio, New Jersey, Georgia and North Carolina as part of its GDP. These states are ranked fifth through 10th by the Bureau of Economic Analysis in GDP by state.

The move toward autonomy has forced Fitch Ratings to place Catalonia on Ratings Watch Negative. The decision by Fitch is due to “further deterioration in institutional cooperation between Catalonia and the central government.” If the situation remains constant, Fitch said, “political uncertainty does not significantly compromise economic growth prospects.” An increase in unrest could, however, create risks for banks.

Political risks increased following the referendum earlier this month, but the liquidity positions of Spanish banks remains sound, said Fitch. “This provides a cushion against the risk of deposit outflows, although we view this risk as currently contained.” The diversification of many rated Spanish companies is among the reasons why some risks would be limited should Catalonia separate from Spain. These companies could see some disruption, but Fitch believes there will be no ratings threat unless the situation worsens.

Meanwhile, Moody’s Investors Services said it expects Catalonia to remain part of Spain. “However, if over the longer term Catalunya were to become independent, this would have broad credit implications for a wide range of debt issuers,” said Moody’s Managing Director Colin Ellis in an announcement. In the near term, Spain “would likely remain an investment-grade credit following Catalan independence,” said Moody’s. The credit ratings agency expects the region to have trouble accessing financial markets initially, but that could dissipate once the preliminary uncertainty dissolves.

Among the first hurdles for Catalonia would be the relationship it has with Spain and the rest of the European Union. “Most of their ‘exports’ are aimed at other parts of Spain. It is not clear these markets would still be available if they elected to break away,” said Kuehl.

“It is assumed that should the Catalans declare independence, they will try to make common cause with China as an alternative to the EU, but the Chinese are thus far uninterested as they gain far more by staying connected to the EU. The Catalan economy would take a major step back according to most analysts,” concluded Kuehl.

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P3s Found at High Risk of Default in Opening Years of Project

As part of its annual study of default and recovery rates for unrated project finance bank loans, Moody’s Investors Service has recently found that public-private partnerships (PPPs or P3s) have a much higher default risk in the first years after financial close than those funded by availability payments.

“PPPs and other infrastructure projects that are exposed to demand risk show a higher marginal annual default rate than average—especially during the initial life of the project,” said Kathrin Heitmann, vice president at Moody’s. “This suggests that these projects need to establish a longer operational track record before default risk subsides materially.”

According to the report, the average 10-year cumulative default rate for P3 projects that are not availability-based puts them in line with Ba-rated corporates. That rate is 13.7%. For other projects not based on availability, the rate is 10.9%. P3s that are based on availability lie at the low end of the risk spectrum, with a 10-year cumulative default rate of 2.1%, similar to corporates rated single-A.

The marginal default rates for infrastructure-related projects decline as construction is completed and a track record is established. P3s and other infrastructure-related project financings record a marginal default rate similar to that of Baa3-rated corporates starting five years after financial close.

Nine infrastructure-related projects defaulted in 2015, almost all of which were transportation P3 projects in Western Europe. Earlier this year, the Indiana Finance Authority took over an Interstate 69 highway project that operated under a P3, alleging that the development partners had fallen behind schedule, were late on payments to subcontractors and had only $72 million remaining to complete $236 million of work, reported the website Construction Dive.

The termination of a P3 contract is more complicated than that of a traditional construction contract. It will involve multiple parties and complex financial analysis, even if the construction contractor is not performing or in default, according to the article “P3 Contracting and Risk” from law firm Faegre Baker Daniels. Often, the public sector is obligated to make payments to the private partner even in the case of a developer default.

P3s are increasingly in the news as President Donald Trump's $1 trillion infrastructure proposal will likely include P3s. Late last month, the president appeared to reverse course on the P3 element of the infrastructure proposal, telling lawmakers in a closed meeting that public-private partnerships are not the solution for building and repairing the nation’s highways and bridges, that such projects don’t work, Bloomberg reported.

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California Amends Condo Lien Law

Mechanic’s lien laws on private projects vary from state to state. Every so often state statutes are rewritten or changed to update and clarify the laws that govern these payment securities in construction. In a unanimous vote, the California Assembly and Senate each passed AB-534 to amend sections of the Civil Code relating to mechanic’s liens and common interest developments (CIDs). Gov. Jerry Brown signed the bill into law July 10. The Davis-Stirling Common Interest Development Act and the Commercial and Industrial Common Interest Development Act define CIDs as a condominium project, planned development and stock cooperative.

The new law “benefits suppliers” in California with a decreased cost to lien against CIDs, said Connie Baker, CBA, director of operations with NACM’s Secured Transaction Services (STS). Now, lien claimants will only have to notify the association and not every owner—one of the changes to the law. Other changes include allowing the association to represent all of the owners of the CID and allowing individual owners to remove themselves from a lien.

The association is the agent of the owners of each interest in the CID relating to work in a common area. “Labor performed or services or materials furnished for the common area, if duly authorized by the association, shall be deemed to be performed or furnished with the express consent of each separate interest owner,” according to the new law. To be removed from the lien, owners can either pay the lien claimant their portion of the total or record a lien release bond “in an amount equal to 125% of the sum secured by the lien that is attributable to the owner’s separate interest.”

This new law doesn’t get owners involved at the time of the notice, said Baker. If the association is served with a lien, it has 60 days to give notice to the members. It may change suppliers’ minds when dealing with nonpayment at a CID project since the entire owner community will not have to be notified, ultimately saving time and money. Liens that may not have been filed before due to the cost/reward ratio may now be served, added Baker. Costs can add up when notifying each owner if working with an attorney. Now that is being alleviated by just notifying the association.

Despite differences across the nation, some states have similar laws. In Texas, the preliminary notice can go to the association, but when it comes time to file the lien, it must go to each owner of the CID. In Illinois, only the association needs to be notified if common areas are owned by the association. If not, the lien must be served to each owner.

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Insider Threats Deepen as Criminals Move to the Cloud

As companies move toward shared services using cloud technology, cyber criminals are right behind them, gaining access to infrastructure, tools and the ability to monetize their exploits. Financial messaging service SWIFT has released three papers whose aim is to establish better cyber defenses for the financial industry, as a result of issuing three grants to study cybersecurity. As threats continue to grow, it behooves the finance services industry to understand such criminals, identify their patterns of behavior and facilitate better communication in order to prevent criminal activity.

One paper, Sharing Insider Threat Indicators: Examining the Potential Use of SWIFT’s Messaging Platform to Combat Cyber Fraud, examines the patterns of behavior typical of criminals who use insiders to cash out on fraudulent activity and explores how an existing telecommunications platform, such as SWIFT itself, can be used to communicate fraud threat information.

Services that enable the cyber criminal to monetize illicit activity are defined as cashout services. “Cashout activity occurs when the insider is assisting cyber criminals with laundering their ill-gotten gains,” the report said. “Examples of cashout activity include an employee offering to aid placement of illicit funds on the dark web in exchange for payment; access to dormant accounts followed by sudden activity in the dormant accounts; and regularly changing customer account attributes.”

Institutions must share information with one another on cyber fraud activity to build a body of reporting to identify when cashout activity is occurring. Individuals who engage in fraudulent activity will display certain behaviors outside of the norm, the report said. Occupational fraudsters usually exhibit such traits as living beyond their means, financial difficulties, unusually close association with customers, irritability, refusal to take vacation and social isolation while committing their crimes. Insider threats can be exposed by identifying suspicious behavior.

“An insider can be in a supervisory or nonsupervisory role but will have a position in the organization that allows the employee to create, alter and terminate customer accounts,” according to the report. “An insider will have financial and/or nonfinancial motivations to engage in fraud and may be recruited by an outsider or by someone they know personally.”

The report’s authors created an Insider Threat Report (ITR) for financial institutions to use to communicate insider threat activity that could presage cyber fraud. It includes information on the type of threat, the action conducted and the severity of the threat. If the proposal to use SWIFT as a platform for communicating insider threat activity were implemented, the MT 998 report format would be the most appropriate format for communicating information in the ITR, the report stated. The MT 998 is a structured message that can be sent via the SWIFT network to SWIFT member banks.

SWIFT itself has not been immune to cybercrime. In an $81 million heist from the central bank of Bangladesh in February 2016, attackers compelled the Federal Reserve Bank of New York to transfer money to accounts in the Philippines using the SWIFT network, The New York Times reported. Additional hacking attacks on SWIFT member banks surfaced in the summer of that year, news agencies said.

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Credit Professionals Rely on NACM's Lien Navigator

NACM’s Lien Navigator is a trusted guide for credit professionals that determines when and how action needs to be taken to protect lien rights across the 50 states, Washington, DC and Canada. The real-time Navigator ensures that you’ll always have current information. Specific questions are also answered for subscribers through the Navigator Answer Line. The Navigator is a web-based service, accessed through our website and available from any computer.

The STS management team comes from construction credit so we know how important every job and customer is to your company!

For more information, call Chris Ring at 410-302-0767 or visit www.nacmsts.com.