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L.A. Schools May End Small-Firm Payment Bonds

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Photo courtesy of LAUSD
Cahuenga Elementary School in Los Angeles
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California state legislators, lobbyists, and sureties are butting heads over state senate bill 616, which proposes an entirely new approach to contract surety.  If it passes, small businesses and microbusinesses will have an alternative to the traditional payment bond for certain projects within the Los Angeles Unified School District.

The proposed legislation would allow the district to waive the payment bond requirement for public works contracts with small businesses or microbusinesses, as defined by the California government code, for projects less than $1 million in value. In its place, contractors would be required to enroll in a proposed self-insurance program run by the district, which would incorporate the district’s current mandatory pre-qualification analysis, participation in the district’s existing Small Business Bootcamp, and adherence to the district’s current project stabilization agreement.

Eric Bakke, legislative advocate for LAUSD, says the bill would allow the district to save contract funds while maintaining a low level of risk. In the ten years since the district began a $20-billion construction bond program, the district issued around 3,100 contracts valued at less than $1 million, for an accumulated value greater than $1 billion. According to analysis included in the proposal, $31 million in payment bond premiums were passed along to the district for those contracts. Bakke says that the district has called on the bond for less than one-half of a percent of contracts, at less than $1 million in aggregated value.

“We’re just looking at it from an economic standpoint in terms of what kind of benefit we are truly getting. The payment bonds were intended to provide a level of security and risk protection, but based on our history we’re not getting that benefit because there haven’t been the defaults that the bonds were to provide for,” says Bakke.

During the last ten years, the district built 130 new schools. The next ten-year construction bond program, at $7 billion, will focus on smaller renovation and maintenance projects. Bakke says that the proportion of contracts valued at less than $1 million will increase with the shift in focus.

Representatives of corporate surety and the California Surety Federation have strongly criticized the bill, and Bakke has received letters of opposition from the American Subcontractors Association and the National Association of Surety Bond Producers. Most often, critics site the untested nature of the program, the risk to the district’s finances, and the district’s presumed lack of experience in evaluating contractors for reliability.

“The idea of a school district, even the largest school district in the country, putting in place a self-funding self-insurance program seems not in the spirit of what a school district typically would do when there is a perfectly viable alternative that’s been in place for decades longer,” says John Hopkins, owner of InterWest Insurance Services Inc. and CSF board member. “Why re-invent the wheel?”

Bakke responds to such criticism by pointing out that the LAUSD prequalifies all contractors annually based on financial statements, school project experience, and safety record. The criticism, he says, “is coming from someone who knows nothing about our school district. We are running the nation’s largest public works project right now.”

The self-insurance program, says Bakke, would utilize escrow accounts with enrollment fees from contractors for each project. If the contractor defaults, the funds raised through those deposits would be used to pay subcontractors and suppliers. If the project is completed successfully, Bakke says the funds would be reinvested into the district’s construction bond program.

The novel proposal comes after similar payment bond legislation passed in Virginia: as of 2011, the commonwealth permits state entities to waive the payment bond requirement for state and municipal public works contracts valued below $500,000 and transportation public works projects below $350,000 as long as contractors are prequalified for any such projects above a certain value.

Details of the LAUSD proposal—such as authorities responsible for oversight, cost of enrollment, or how subcontractors and suppliers would make claims with the district for payment—have yet to be decided. The bill, which was introduced into the legislature in February, is currently on hold while the LAUSD and bill sponsor Senator Roderick Wright discuss the program’s specifics with the state’s Department of Industrial Relations. Bakke says the bill may be reintroduced into state senate as soon as December of this year.

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