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COVER
CONTENTS
I. INTRODUCTION
II. DELIVERY SYSTEMS FOR TRANSIT CONSTRUCTION PROJECTS
	A. Project Delivery Systems Defined
	B. Attributes of Design-Bid-Build
	C. The Move to Design-Build in the Public Sector
	D. Attributes of Design-Build
	E. Design-Build Variations
	F. Construction Management at Risk
	G. Other Delivery Systems
III. PURPOSE, HISTORICAL UNDERPINNINGS, AND LEGISLATIVE FRAMEWORK OF SURETY BONDS
	A. Purpose and Function of Surety Bonds
	B. Operation and History of Surety Bonds
	C. Federal Legislation (Miller Act)
	D. Federal Acquisition Regulations
	E. State Legislation (Little Miller Acts)
	F. State DOTs and Modified Bonding Levels
	G. Federal Transit Administration
	H. Costs to the Transit Owner of Requiring Surety Bonds
IV. ALTERNATIVE FORMS OF PERFORMANCE SECURITY
	A. Letters of Credit Contrasted with Surety Bonds
	B. State Legislation Permitting Letters of Credit as an Alternative to Surety Bonds
	C. Recent Projects Using Letters of Credit
	D. Cost Considerations for Owners--LOCs Versus Surety Bonds
	E. Parent/Corporate Guarantees
	F. Determining the Strength and Sufficiency of a PCG
	G. Recent Examples of PCGs used in Transit Projects
	H. Subcontractor Default Insurance
V. PURSUING REMEDIES AGAINST A SURETY
	A. Typical Default Scenarios Triggering Surety Performance
	B. Responses by Owner to a Contractor Default
	C. Industry Bond Forms
	D. Typical Surety Response to Default
	E. Owner's Evaluation of Whether to Place Contractor in Default
	F. Owner's Cost and Time Considerations in Claiming Under a Bond
	G. Conclusion
VI. COMMERCIAL ISSUES AFFECTING THE SURETY RELATIONSHIP ON LARGE, COMPLEX PROJECTS
	A. Significant Contract Provisions
	B. The 2010 Modifications to AIA's Bond Forms
	C. Nonstandard Bond Forms
	D. Use of Bonds on Concession Contracts
	E. Multinational Teams/International Contractors
	F. Bonding the Big Dollar Project
VII. CURRENT PRACTICES AND PERSPECTIVES OF TRANSIT AGENCIES
	A. Construction Project Delivery Systems
	B. Use of Performance and Payment Bonds on DBB Projects
	C. Use of Performance and Payment Bonds on Alternative Delivery Systems for Construction Projects
	D. Use of Alternative Forms of Project Security and the Effectiveness of Security
	E. Construction Projects Funded by FTA
	F. Use of Performance and Payment Bonds on Large Construction Projects
	G. Bonds for Nonconstruction Contracts
VIII. THE SURETY PERSPECTIVE ON BONDING TRANSPORTATION MEGAPROJECTS
	A. Bonding Requirements Affecting Competition
	B. Underwriting Considerations for Major Projects
	Co-Surety and Reinsurance as a Means to Expand Surety Capacity for Megaprojects
	D. Scope of Bonded Obligations
	E. Use of Insurance to Address Risk Allocation
	F. Surety Capacity/Status of the Surety Market
IX. CASE STUDY: THE USE OF SURETY BONDS ON LARGE AND INNOVATIVELY DELIVERED PROJECTS
	A. Dulles Corridor Metrorail Project (Silver Line)--Northern Virginia
	B. SR-99 Bored Tunnel Alternative Design-Build Project--Seattle, Washington
	C. Houston METRO 4-Lines Project, Houston, Texas
	D. Eagle--Denver, Colorado
	E. InterLink--Warwick, Rhode Island
X. CASE STUDY: MODERN CONTINENTAL--MITIGATING A FAILURE
	A. Introduction
	B. Historical Background
	C. Modern Continental's Role on the "Big Dig"
	D. Modern Continental and Its Sureties
	E. Failure
	F. The Owner's Perspective
	G. The Aftermath
	H. Lessons Learned from Modern Continental
XI. CASE STUDY: THE BRAZILIAN OIL PLATFORM CASE--AN EXAMPLE OF SURETY EXPOSURE WHEN A LARGE PROJECT GOES BAD
	A. Introduction
	B. The Project
	C. The 2002 Opinion
	D. 2004 Opinion
	E. Lessons Learned from the Brazilian Oil Platform Case
XII. A GAME PLAN FOR DEALING WITH SURETY ISSUES ON COMPLICATED PROJECTS
	A. Thoroughly and Objectively Assess Project Delivery and Contract Packaging Options
	B. Reach Out to the Contractor and Surety Market Before Developing a Project Delivery and Contract Packaging Strategy
	C. Understand Legislative Bonding Constraints and Proactively Move to Change Them
	D. Undertake an Objective Analysis of Maximum Probable Loss in Setting Reduced Penal Sums
	E. Do Not Shift Unreasonable Contractual Risks to the Contractor
	F. Analyze the Attributes of Standard Industry Bond Forms and Modify Agency Forms Accordingly
	G. Consider Whether Bid Bonds Are Appropriate for Alternatively Delivered Projects
	H. Consider Whether Bonds Are Needed for Procurement of Nonconstruction Goods and Services
	I. Develop an Action Plan for Ineffective Contractor Performance
	J. Develop a Well Thought-Out Process for Keeping the Surety Involved During the Project
XIII. SUMMARY
REFERENCES
APPENDIX A--50 STATE LEGISLATIVE BONDING REQUIREMENTS
APPENDIX B--LIST OF TRANSIT AGENCIES RESPONDING TO THE SURVEY
APPENDIX C--SURVEY ON SURETY BONDING TO TRANSIT AGENCIES
ACKNOWLEDGMENTS
BACK COVER
                        
Document Text Contents
Page 1

The Problem and Its Solution
The nation’s 6,000 plus transit agencies need to have
access to a program that can provide authoritatively
researched, specific, limited-scope studies of legal is-
sues and problems having national significance and
application to their business. Some transit programs
involve legal problems and issues that are not shared
with other modes; as, for example, compliance with
transit-equipment and operations guidelines, FTA fi-
nancing initiatives, private-sector programs, and labor
or environmental standards relating to transit opera-
tions. Also, much of the information that is needed by
transit attorneys to address legal concerns is scattered
and fragmented. Consequently, it would be helpful to
the transit lawyer to have well-resourced and well-
documented reports on specific legal topics available
to the transit legal community.

The Legal Research Digests (LRDs) are developed
to assist transit attorneys in dealing with the myriad of
initiatives and problems associated with transit start-
up and operations, as well as with day-to-day legal
work. The LRDs address such issues as eminent do-
main, civil rights, constitutional rights, contracting,
environmental concerns, labor, procurement, risk
management, security, tort liability, and zoning. The
transit legal research, when conducted through the
TRB’s legal studies process, either collects primary
data that generally are not available elsewhere or per-
forms analysis of existing literature.

Legal Research DigestLegal Research Digest 40

TRansiT CoopeRaTive ReseaRCh pRogRam
sponsored by the Federal Transit administration

July 2012

TRanspoRTaTion ReseaRCh BoaRD
OF THE NATIONAL ACADEMIES

LEGAL ISSUES INVOLVING SURETY fOR PUbLIc TRANSPORTATION PROjEcTS

This report was prepared under TCRp project J-5, “Legal aspects of Transit and intermodal
Transportation programs,” for which the Transportation Research Board is the agency coordinating
the research. The report was prepared by michael C. Loulakis, esq., Capital project strategies, LLC;
shannon J. Briglia, esq., BrigliamcLaughlin, pLLC; and Lauren p. mcLaughlin, esq., BrigliamcLaughlin,
pLLC. James B. mcDaniel, TRB Counsel for Legal Research projects, was the principal investigator and
content editor.

Responsible Senior Program Officer: Gwen chisholm Smith

Applications
Basically, a surety bond is where one has agreed to be
liable for another’s debt, default, or other obligation.
Various types of surety bonds are used on transit proj-
ects, each of which fulfills a specified purpose. They
typically fall under one of four common categories:
bid bonds, performance bonds, payment bonds, or
warranty or maintenance bonds. Transit owners, like
other owners of capital projects, use these bonds as a
means of mitigating the risk of contractor default.
Most often owners of large capital projects encounter
unique problems when seeking surety bonds.

Federal, state, and local laws require bonding at
varying levels for construction and other types of cap-
ital projects. In situations where bonding is not re-
quired, a transit agency must decide whether, on its
own authority, to require bonding or other surety in
some form. More recently, problems have arisen re-
garding the costs of obtaining surety, whether value is
being received for the surety required, difficulties ob-
taining surety for large or unusual projects, and mak-
ing claims against sureties should problems arise with
performance.

This digest includes a review of applicable federal
law, examples of state and local laws, and industry
practices. The digest also examines surety issues and
industry practices in various types of construction and
other public transportation projects. The types of surety
available, including performance, payment, and war-
ranty bonds; letters of credit; and other instruments, are
discussed.

Page 2

ConTenTs (cont’d)

I. Introduction, 3

II. Delivery Systems for Transit Construction Projects, 4

III. Purpose, Historical Underpinnings, and Legislative Framework of Surety Bonds, 12

IV. Alternative Forms of Performance Security, 20

V. Pursuing Remedies Against a Surety, 30

VI. Commercial Issues Affecting the Surety Relationship
on Large, Complex Projects, 35

VII. Current Practices and Perspectives of Transit
Agencies, 42

VIII. The Surety Perspective on Bonding Transportation Megaprojects, 49

IX. Case Study: The Use of Surety Bonds on Large and Innovatively Delivered Projects, 55

X. Case Study: Modern Continental—Mitigating a Failure, 63

XI. Case Study: The Brazilian Oil Platform Case—
An Example of Surety Exposure When a Large
Project Goes Bad, 67

XII. A Game Plan for Dealing with Surety Issues on Complicated Projects, 73

XIII. Summary, 76

References, 78

Appendix A: Fifty State Legislative Bonding Requirements, 83

Appendix B: List of Transit Agencies Responding to the Survey, 95

Appendix C: Survey on Surety Bonding to Transit Agencies, 96

CONTENTS

Page 54

54

duration beyond which their liability ends. The concept
of extended exposure during a period of O&M is simply
foreign and, therefore, difficult if not impossible to
evaluate and underwrite.

6. Bonding Gap Financing
On some projects, there may be a substantial gap be-

tween the time the construction costs are being in-
curred by the JV contractor and when the owner begins
paying for the project or revenue is generated from pro-
ject operations to reimburse the contractor. Sureties are
averse to bonding a principal under such a financing
structure. For example, Florida DOT (FDOT), which
was a pioneer in using this “gap financing” approach,
has several major contracts underway where the con-
tractor finances a multiyear project, and FDOT begins
reimbursing the contractor starting sometime after con-
struction commences.

For sureties, a key concern with gap financing is the
security of their collateral—the contract balance—in
the event of default and their priority to the contract
balance against competing claims by others. Generally
speaking, following a contractor default, a surety has
priority to the contract balance over any claimant other
than the Internal Revenue Service.179 With gap financ-
ing, where the contractor is doing the work now in ex-
pectation of being paid later through tolls or other fu-
ture funds, the surety could be forced into a situation
where it has the obligation to fund completion and may
have a fight as to priority over the right to be paid the
future contract balance. In that event, the surety will
have to negotiate an acceptable arrangement with the
concessionaire, the lender, and the ultimate owner/end
user as part of the up-front agreements to ensure that
the surety has priority to the funds or revenue to be
paid in the future. These negotiations are highly com-
plex and will require the owner’s or end user’s involve-
ment and consent and may command a higher premium
due to the significant expansion of the surety’s expo-
sure. The level of underwriting and efforts to negotiate
acceptable arrangements make the bonding of gap fi-
nanced projects not a very cost-effective or sustainable
form of construction.

Less frequently, owners or obligees will seek to bond
the concessionaire, including the concessionaire’s obli-
gation to obtain financing for the construction. From
the surety’s perspective, seeking this type of bonding is
understandable but not very practical. Where the owner
is not funding the work, but faces the possibility that it
could be left with an unfinished project if the conces-
sionaire defaults, the owner is looking for a source of
funds to complete the work. While the agency may pre-
fer a conventional surety performance bond, obtaining
such a bond is problematic. Sureties find it difficult to
underwrite a concessionaire because it is usually a shell


179 Edward G. Gallagher, Entitlement to Contract Proceeds,

in THE LAW OF PERFORMANCE BONDS, ch. 4, at 65–75,
(Lawrence R. Moelmann & John T. Harris eds., ABA 1999);
BRUNER & O’CONNOR, JR., supra note 39 § 12:102.

company, set up for the purpose of a specific project.
Thus, it has no track record, no relationship with a
surety, and it does not have the type of financial re-
sources that will support the size bond that would be
required. Some sureties simply refuse to consider bond-
ing the obligation to finance a project, and instead
spend time educating the owner as to what a perform-
ance bond does and why bonding the finance obligation
is not obtainable.

E. Use of Insurance to Address Risk Allocation
To the extent that transit projects pose unknown

risks with respect to soil conditions, tunneling, un-
known foundations, or highly complex, never-before-
tested designs, the surety at times will require its prin-
cipal to obtain and furnish insurance policies to cover
the design component of the bonded obligations. As
noted above, sureties prefer to avoid bonding the design
component of any project, including those that are built
through DB. The reality of megaprojects, however, is
that design is normally part of the package; it is the
rare project where the surety can avoid bonding that
part of the scope.

To partially address the risk inherent in guarantee-
ing completion of design, sureties will require the JV, or
at least the design entity that is part of the JV, to ob-
tain errors and omissions (E&O) insurance coverage,
naming the surety as an additional insured. Higher
levels of insurance or project-specific insurance may
also be required, but sophisticated contractors and de-
sign entities almost always already have this level of
insurance in place before approaching the surety.

Even though they may demand higher coverage lim-
its, most sureties understand the illusory protection
insurance offers the surety in the event of default. Ac-
cording to one surety underwriter, the “E&O coverage
available pales in comparison with the exposure” ex-
pected by the surety for design. E&O coverage typically
is available at $1 million, $2 million, or $10 million lev-
els, which is de minimus compared to the design com-
ponent of a megaproject with a total contract value of
$500 million or more. In evaluating requests to bond
design, sureties look at the same factors they do for
other aspects of the work: does the contractor have the
requisite experience, infrastructure, resources, and
track record to support the project? Particular under-
writing efforts to confirm the type and amount of insur-
ance available for the project are also critical.

F. Surety Capacity/Status of the Surety Market
Given the recent examples of the Oakland Bay

Bridge and Missouri Safe and Sound Bridge projects,
where the contractors were unable to obtain bonds at
100 percent of the contract value, many industry par-
ticipants question surety capacity for megaprojects in
excess of $500 million. Through the surety interview
process, however, sureties uniformly refute that there is

Page 55

55

any such capacity issue.180 Importantly, and without
exception, each of the sureties interviewed identified
strong support for bonding megaprojects, and stated
that they had sufficient market capacity, through the
use of co-suretyship arrangements, to provide surety
bonds for these large infrastructure projects.181

With respect to bonding capacity, the sureties who
service large national accounts generally, not surpris-
ingly, hold the view that the surety market has ade-
quate capacity to issue billion dollar bonds. In other
words, in their view, sureties will find a product that
meets the needs of the obligee. This is particularly true
where most megaprojects involve the use of JVs, co-
sureties, and reinsurance to “spread” the potential for
surety losses.

Some sureties say that they are asked to, and do, in
fact, bond megaprojects upwards of $750 million at 100
percent of the contract value. The FMI Annual Surety
report supports this contention, finding current ample
capacity in the surety industry for megaproject bonds.182
As a result of an extended period of above-average prof-
its for the surety industry as a whole, starting in 2004,
and including reinsurers, as well as the availability of
co-surety arrangements and a “return to underwriting
basics,” surety industry analysis predicts that the
surety industry is poised to provide bonds at whatever
level is required for megaprojects.183 This may change
as we move into a projected loss cycle, expected to peak
in 2012 before subsiding.184

With this backdrop, then, why do some owners and
contractors feel that bonds are not currently available
for megaprojects? Some interviewees attributed this
disconnect to the facts that megaprojects are each in-
credibly unique, and that individual experiences on a
project where a bond was not obtained (for reasons un-
related to capacity of the market) and the sensationalis-
tic publicizing of certain projects where bonds were not
obtained has skewed the overall perception.

Another contributing factor may be that the recent
market cycles and sureties’ reaction to them has caused
this misconception. One surety executive explained that
over the last 10 years the lack of new capacity in the
surety industry may have created the perception that
the industry could not accommodate megaproject bonds.
This is especially true where, in the post-Enron era,


180 Marc Ramsey, 2010 Surety Market Report, available at

http://www.constructionexec.com/Issues/November_2010/
Special_Section8.aspx.

181 Co-suretyship involves two sureties being jointly and
severally liable for the bonded obligation.

182 Surety Firms Weigh in on Construction Markets and
Contractors: FMI Surety Providers Survey, at 2,
https://www.asaonline.com/eweb/upload/SuretySurvey_2010Ap
ril.pdf.

183 Id. at 4.
184 WILLIAM J. MCCONNELL, P.E., 2010 STATE OF THE

CONSTRUCTION & SURETY INDUSTRY REPORT 26–32,
http://www.phillysuretyclaims.org/wp-content/uploads/2010/
11/2010-State-of-the-Construction-Surety-Industry-Report.pdf.

some reinsurers exited from the market entirely and
some sureties unilaterally reduced their capacity. It is
reported that one surety even wrote letters saying the
maximum bond it would issue was $250 million.

As the loss results have improved since 2004, how-
ever, sureties’ appetite for risk has increased and the
ability to obtain larger and larger bonds has improved.
With the right JV partners and the right surety, surety
executives predict it is probable that a $1 billion bond
could be obtained. As we move into the forecasted loss
cycle, however, the surety market may tighten up, with
the consequence that bonds for megaprojects may once
again become harder to obtain.185

IX. CASE STUDY: THE USE OF SURETY BONDS ON
LARGE AND INNOVATIVELY DELIVERED
PROJECTS

As discussed in previous chapters, using 100 percent
performance and payment bonds can create challenges
for public agencies on certain types of construction pro-
jects. At the top of the list is the megaproject, where the
contract price is so high that either 1) the surety mar-
ket does not have the capacity to readily provide 100
percent bond coverage, or, if there is sufficient market
capacity, 2) competition will be reduced if the agency
requires 100 percent bond coverage. If the agency de-
cides to use performance and payment bonds with penal
sums less than the contract price, then it faces the chal-
lenging prospect of balancing market concerns (i.e.,
surety capacity and competition) with the need to pro-
tect its interests in the event of a contractor default.

In addition to handling the challenges that big-dollar
projects can create, agencies also struggle to deal with
using surety bonds on certain types of delivery sys-
tems—most notably CMAR and PPP projects. Agencies
that use these delivery systems face commercial issues
over which contracting party (if any) will provide per-
formance and payment bonds, who is the beneficiary of
the bond, and whether other forms of performance se-
curity are more practical and effective.

Many projects provide interesting examples of how
agencies have dealt with these challenges. The five case
studies discussed below involve recent, and, in some
cases ongoing, projects, and show the spectrum of con-
siderations that can arise under different delivery ap-
proaches:


• A Virginia heavy rail project using a negotiated DB

process.
• A Washington State highway tunnel project using

a competitive DB approach.
• A Texas light rail project using a negotiated facil-

ity provider delivery approach, with the facility pro-
vider having responsibility for designing, building, op-
erating, and maintaining a new light rail system, as
well as purchasing rolling stock.


185 Id. at 26–32.

http://www.constructionexec.com/Issues/November_2010/Special_Section8.aspx
https://www.asaonline.com/eweb/upload/SuretySurvey_2010April.pdf
http://www.phillysuretyclaims.org/wp-content/uploads/2010/11/2010-State-of-the-Construction-Surety-Industry-Report.pdf

Page 108

108

ACKNOWLEDGMENTS
This study was performed under the overall guidance of TCRP Project Committee J-5. The Committee
is chaired by Robin M. Reitzes, San Francisco City Attorney’s Office, San Francisco, California.
Members are Rolf G. Asphaug, Denver Regional Transportation District, Denver, Colorado; Sheryl
King Benford, Greater Cleveland Regional Transit Authority, Cleveland, Ohio; Darrell Brown,
Darrell Brown & Associates, New Orleans, Louisiana; Dennis C. Gardner, Ogletree, Deakins, Nash,
Smoak & Stewart, Houston, Texas; Elizabeth M. O’Neill, Metropolitan Atlanta Rapid Transit
Authority, Atlanta, Georgia; and James S. Thiel, Wisconsin Department of Transportation, Madison,
Wisconsin. Rita M. Maristch provides liaison with the Federal Transit Administration, James P.
LaRusch serves as liaison with the American Public Transportation Association, and Gwen
Chisholm Smith represents the TCRP staff.

Page 109

These digests are issued in order to increase awareness of research results emanating from projects in the Cooperative Research Programs (CRP).
Persons wanting to pursue the project subject matter in greater depth should contact the CRP Staff, Transportation Research Board of the National
Academies, 500 Fifth Street, NW, Washington, DC 20001.

Subscriber Categories: Administration and Management • Law • Public Transportation

ISBN 978-0-309-25832-6

Transportation Research Board
500 Fifth Street, NW
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http://www.national-academies.org

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