Rebuttal to NASBP Position Paper on Reforms
Needed in the Federal Acquisition Regulation (FAR) on Sections
Addressing the Acceptability of Bonds Issued by Individual Sureties
Background:
-Individual sureties have a long history of providing security
and, in fact, pre-date corporate sureties. Although in the last
century or so corporate sureties have dominated the market due
to their ability to raise capital, individual suretyship is
alive and well and serves a valuable role in bonding small,
minority, woman-owned, disabled veteran-owned and other disadvantaged
contractors who, for one reason or another beyond their control,
cannot obtain bonding from corporate sureties.
-The corporate surety industry, while "talking a good
game" about helping small, minority, woman-owned, disabled
veteran-owned and other disadvantaged contractors obtain bonding,
has in the past few years almost completely shunned such contractors
in favor of the more lucrative bonding market of large national
and regional construction companies. It is not too much of a
stretch to say that a bonding crisis exists for all but the
largest construction companies.
-While ignoring this very important segment of the market,
a segment on which a huge portion of the American economy is
based, the corporate surety associations such as the National
Association of Surety Bond Producers (NASBP), the Surety &
Fidelity Association of America (SFAA), and the Surety Information
Office (SIO) - which is supported by the NASBP and SFAA - are
actively working to prevent other bonding sources, such as individual
sureties, from servicing this important market segment. One
method the corporate sureties use in their attempt to block
individual sureties is to purposely misinterpret the Federal
Acquisition Regulation (FAR) and case law construing the FAR,
much as they have done in the attached position paper (click
on this link: NASBP
F.A.R. Position Paper) to which this paper responds.
-FAR Subpart 28.200 "prescribes procedures for the use
of sureties and other security to protect the Government from
financial losses." FAR 28.201 establishes the basic requirement
for adequate security for bonds, and states that "[a]cceptable
forms of security include - (1) Corporate or individual sureties
. . . . [emphasis added]." Thus, per the FAR, corporate
and individual sureties are equal forms of security for Government
bond. This conclusion is supported by the fact that the next
two subsections of the FAR, 28.202 and 28.203, address the acceptability
of corporate sureties and individual sureties, respectively,
without a preference for either so long as the applicable requirements
in the FAR are followed. Indeed, these are not the only two
options for securities in support of bonds; FAR 28.204 addresses
"alternatives in lieu of corporate or individual sureties."
-In its recent point paper, the NASBP argues that "[u]nlike
for corporate sureties, information about the financial strength
of individual sureties is not available to contracting officers
from independent third-party rating sources," and points
out that individual sureties are not certified by the U.S. Treasury
or "rated by private rating organizations, such as AM Best
or Moody's, that assess financial strength." First, this
statement does little more than to perpetuate the myth that
being listed on the U.S. Treasury's list of acceptable corporate
sureties, known as Treasury Circular 570, or being rated with
AM Best or Moody's is a guarantee or even good indication of
financial strength. Many readers will recall the recent financial
failures or near-failures (and bailouts) of several high profile
corporations involved in corporate suretyship, such as American
International Group, Inc. (AIG). For an Insurance Journal article
on the Federal Government's bailout of AIG to the tune of $85
Billion to remove "the imminent threat of bankruptcy"
click on the following link: Insurance
Journal Article Readers will note that A.M. Best had given
AIG A+ "Superior" ratings just prior to the bailout.
These recent corporate surety financial crises bust the myth
of corporate invincibility. Second, a CO need not assess the
financial strength of the individual surety because s/he is
pledging valuable assets backing the bond dollar-for-dollar;
thus, the CO need only assess the acceptability and value of
the asset pledged, information which is already required by
the FAR and provided by the individual surety.
-Indeed, the case can be made that individual surety bonds
are safer than corporate surety bonds. Because the individual
surety pledges assets dollar-for-dollar, the Government can
be assured that it is protected in the event of a default. Corporate
sureties, in contrast, leverage the assets on their balance
sheets by as much as 10-to-1 such that, when they fail (and
they do fail - see above), the Government is not assured of
protection.
-The fact that individual sureties are not listed on the Treasury
Circular 570 is irrelevant. There is no such list for individual
sureties, and the FAR does not require one. Instead, the FAR
provides COs with guidance on how to evaluate the assets pledged,
their value, and the bond forms submitted. See FAR 28.203-1
to 28.203-6.
-The drafters of the FAR, understanding that they could not
envision every future asset that might be pledged in support
of a bond, smartly established a system under which they provide
general standards for the acceptability of assets (see FAR 28.203-2)
and then list non-exclusive examples of acceptable (FAR 28.203-2(b))
and unacceptable (FAR 28.203-2(c)) assets to guide COs. There
is simply no good reason to amend the FAR "to make clear
that the list of 'acceptable assets' constitutes an exclusive
list" as argued by the NASBP, as this will unnecessarily
restrict the types of assets that can be pledged in support
of a bond, which is exactly what the language of the FAR seeks
to avoid. It simply makes no business sense, and does not afford
the Government any more protections, to amend the FAR to restrict
the types of acceptable assets. What restricting the types of
assets that an individual surety can pledge will do is make
it harder for individual sureties to write bonds, thereby protecting
the corporate sureties from competition.
-If anything, the FAR should be amended to reinforce the point
that additional, non-listed assets such as gold bullion and
other commodities are acceptable. One individual surety has
submitted a FAR change proposal that, among other things, includes
this proposed change. For a copy of this FAR change proposal,
currently under review by the FAR Council, click on the following
link: Individual
Surety F.A.R. Change Proposal
-The NASBP cites to the U.S. Court of Federal Claims ("COFC")
case of Tip Top Construction v. United States, 2008 WL 3153607,
as somehow supporting the need to amend the FAR to restrict
the list of acceptable assets. The exact opposite is the case.
Tip Top shows that the FAR should be amended to clarify, among
other things, that gold and other commodities meet the requirements
of the FAR and can be accepted by a contracting officer ("CO")
in his/her exercise of discretion and business judgment. Indeed,
that is what the COFC decision found - i.e., that the CO's decision
was not arbitrary, capricious, irrational or contrary to law
or regulation. The natural implication of that Tip Top ruling
is that any other CO could just as easily exercise her/his discretion
to accept the same bond and asset, and the COFC suggested that
the FAR was confusing and needed to be clarified. Indeed, in
writing the decision, Judge Lynn J. Bush specifically noted
that she herself may have reached a different conclusion and
accepted the bond at issue but that it was not the Court's place
to substitute its judgment for that of the CO. For a more detailed
analysis of the COFC decision which debunks the NASBP's interpretation,
click on the following link: COFC
Tip Top Decision Summary.
In short, this case, which began as a fairly routine bid protest
before the Government Accountability Office ("GAO")
took a turn for the worse as the GAO and, later, the COFC and
the U.S. Court of Appeals for the Federal Circuit ("CAFC"),
shifted their focus from the pertinent issue * the reasonableness
of the CO's discretionary decision not to accept the proffered
bond and underlying asset based on information before the CO
at the time she made her decision (i.e., the standard of review
under the Administrative Procedures Act applicable in bid protest
cases) * to an unwarranted attack on coal and other commodities.
The three judge panel of the CAFC went very far afield in making
many unfounded pronouncements regarding coal, including but
not limited to stating that:
--Mined coal is clearly less liquid than cash, stocks, CDs,
etc., and the fact that there is a ready market for coal does
not mean it is "readily marketable", a statement which
on its face does not make sense;
--Coal is like "frozen pork bellies, lean hogs, or oats"
and that the CO would be justified in rejecting those assets
even though those commodities (like coal) are routinely traded
on commodities markets, a statement which begs the question
of "why should a CO not be able to accept such assets which
clearly have value and are readily marketable?";
--"Mined coal is a speculative asset because its value
is difficult to ascertain and is highly dependent on variables
such as the type, quality, and provenance of the coal proffered,"
a statement that could just as easily be made about stocks and
other assets routinely accepted under the FAR; and
--"At a minimum, mined coal is unacceptable personal property;
coal is clearly less like cash, stocks, or bonds, and more akin
to jewelry, furs and antiques. Thus, the [CO] correctly concluded
that the coal asset pledged in this case was not acceptable
to support Tip Top's bond", a statement that simply does
not pass the common sense test.
Clearly, these statements are wrong as a matter of fact and
law. The CAFC panel went much farther than was prudent or required
to affirm the COFC's decision and the underlying CO decision,
resulting in a broad, sweeping indictment of coal as an asset.
The panel obviously was not thinking of the potentially far
reaching impacts its dicta might have on the coal mining industry
and coal producing states, as well as contractors who benefit
from bonds for which commodities are pledged.
The faults in the CAFC's logic were highlighted in a recent
article by renowned U.S. Government Contract authority Ralph
C. Nash, Professor Emeritus of Law at The George Washington
University and one of two legal scholars credited with developing
government contract law as a distinct legal specialty. Although
he appears to purposely avoid taking aim at the Court, his article
points out the ludicrous results reached if one applies the
CAFC's interpretation of the FAR which, Professor Nash notes,
would allow General Motors stock (now severely depressed in
value) and a surety's personal residence regardless of location
to be pledged but not coal. He concludes: "Well, I'd take
the coal. All that Tip Top proves is that the FAR was written
before we got our recent lesson in modern economics. Those good
assets turned out to be bad assets and that coal still has quite
a lot of value without regard to the FAR. Maybe someone should
try to pledge a retirement account." It is even more obvious
that Tip Top does not provide any support for restricting individual
sureties' ability to write bonds, especially in these difficult
times for contractors (and, especially, small, disadvantaged,
veteran-owned and woman-owned contractors).
USISA's Message:
-COs undeniably shoulder substantial administrative burdens,
as the NASBP points out, but the acceptance of individual sureties
and their assets is not beyond their or their agencies ability
and, in fact, benefits the Government. It certainly promotes
the socioeconomic principles embodied in, and programs governed
by, FAR Part 19, Small Business Programs - e.g., small business
set-asides, the small business subcontracting program, Small
Business Administration 8(a) program, HUBZone Program, and Service-Disabled
Veteran-Owned Small Business Procurement Program. It also allows
construction projects to be built that otherwise would not be
built. This is why the FAR specifically allows individual sureties
and has for decades.
-Under the FAR, individual sureties are already required to
provide detailed information by which a CO may assess the existence,
authenticity and sufficiency of the asset. The process is very
transparent. Additionally, individual sureties are already required
to provide a sworn affidavit. There is simply no need for and,
it should be noted, no evidence is advanced in support of the
additional information that the NASBP would have the Government
require of individual sureties, other than to discourage and
restrict other persons from serving as individual sureties,
which class of sureties the NASBP and SFAA see as competitors
despite their refusal to service the needs of the market segment
serviced by individual sureties.
-Thus, the NASBP's argument is nothing more than a transparent
ploy by which the corporate sureties are attempting to protect
the near monopoly that they enjoy. The corporate surety industry
knows that, if it can limit the acceptable assets to cash, CDs,
U.S. Government securities and the like, it will severely restrict
others' ability to serve as sureties. The NASBP nonsensically
argues that "stocks, corporate bonds, and real estate should
not be acceptable due to the likelihood of their misrepresentation,
the volatility of their value, and the difficulty and timeliness
of liquidating those assets to pay bond claims." Let's
break that down. It is nearly impossible to "misrepresent"
stocks or corporate bonds these days, especially under the safeguards
already provided in the FAR. There is also no evidence that
this is occurring. The "volatility" of stocks was
considered by the drafters of the FAR and for decades the FAR
has contained procedures to mitigate that risk; nothing has
changed in the meantime. Of course, almost everyone knows that
stocks and bonds are very easy to liquidate, so this NASBP argument
makes no sense at all. As for real estate (as with stocks and
bonds), there is no greater (and actually less) risk of this
asset being misrepresented than the forging of a corporate surety
bond form and/or the attached affidavit of the corporate representative
issuing the bond - something which is known to have happened.
For most of the country's history, real estate has been less
volatile than many other assets, and the process for liquidating
the same was not considered sufficiently problematic as the
FAR contains an entire subsection specifically allowing the
acceptance of real property (see FAR 28.203-3).
-The NASBP represents itself as the voice of its members; however,
individual NASBP members/producers enthusiastically do business
with Individual Sureties because they offer solutions for members'
clients when the corporate sureties refuse to do so. NASBP members
should also be asking themselves why, if NASBP claims to be
the association for bond producers, it is working so hard to
remove a potentially lucrative market for its members. Perhaps
the true voice of the NASBP is the corporate surety membership
rather than the individual bond producers who choose to do business
with individual sureties.
-USISA agrees with the NASBP on one point - the FAR could stand
some clarification. However, as shown in the FAR change submitted
by one Individual Surety (a link to which is provided above),
the changes should be expand the types of assets that can be
pledged, including valuable commodities such as oil, coal and
precious metals. Any changes to the FAR should be for the purpose
of bringing it into the 21st Century and expanding bonding opportunities
for small, minority, woman-owned, disabled veteran-owned and
other disadvantaged contractors. This goal is entirely consistent
with the American Recovery and Reinvestment Act of 2009 (i.e.,
the Federal Government's stimulus package) and attempts to get
the economy moving again by investing in construction and infrastructure.
