Losing the Surety: Subcontractors, Ownership Status and the Need to Avoid Contracting Fraud

There’s an old Russian saying that goes “Trust, but verify.” Quite simply it means don’t go into a situation in bad faith, assuming the worst, but don’t let yourself get played for a sucker, either. The saying was made famous by Ronald Reagan, when he was negotiating with Russia over arms treaties. It was a way of showing strength, but also potential friendship. It is also a great phrase to keep in mind when working out deals with potential subcontractors.

One of the great risks of any construction project is that your subs may be unreliable, unskilled, and even untrustworthy. This is of especially great concern when you consider that you are legally liable for their mistakes. That’s why it is so important you verify every aspect of your subcontractor’s business before signing anything, especially their ownership status. When liability is at stake, and the potential loss of your surety, you can’t afford to go on trust alone.

A New Era of Responsibility

For contractors, a payment bond doesn’t extend infinitely. Jurisdictions have different rules and contracts may vary, but when signing, it is stipulated how long a contract will last where the contractor is responsible and when they are still in danger of having to pay for normal damages and wear-and-tear. It’s called the clock, colloquially. What many contractors don’t know is that the clock can be stopped for a number of reasons, such as gross negligence and fraud.

What is new is that it can be stopped for fraud committed by a subcontractor, as a recent court ruling in Minnesota declared. This clock-stoppage allows for a longer length of time for payment, but more importantly, it further ties the general and the subs into the same legal regime and creates a higher burden of responsibility. The ruling could eventually be overturned, but the general direction of decisions around the country has made it seem that this is perhaps the way of the future. Contractors should then look out for fraud, particularly when it comes to ownership.

MBEs and Persistent Fraud

For a number of historical reasons, government officials are incentivized to award contracts to groups outside the usual business mainstream. The main ones are:

• Minority-owned businesses (MBEs)
• Woman-owned businesses (WBEs)
• Disabled-owned businesses (DBEs)

While it can be argued that the quota system has outlived its usefulness, few doubt that these incentives have helped open up the world of construction and have allowed fresh talent to thrive. Unfortunately, it has also given way to fraud from businesses that aren’t what they claim.

A recent case in Oregon helps to illustrate this problem. A firm established a contract with Willamette on the basis that its owner was female and Native American. They received a $88,000 contract from the city as part of a larger housing project. The case was made that the business was tied up and the same in all-but-name to the construction business run by her husband, a white man ineligible for WBE or MBE status. The case went back and forth, but they were finally ruled ineligible.

This isn’t a one-time deal or some kind of rarity. Dummy companies can be set up in order to obtain a contract, even though the firm doesn’t actually fit into the protected category. There are stories in the news about it all the time. It’s very lucrative, and very illegal, especially when dealing with government contracts. The bottom line: it’s fraud and it will be prosecuted.

Avoiding Getting Tangled In Someone Else’s Lie

So how does that impact you? The most important thing is to be very familiar with the people with whom you are entering into a contract. Having subs that are WBEs, MBEs, or DBEs can, many times, help you obtain a municipal contract. However, based on recent rulings, you could also be punished if they turn out to be frauds. That could have serious implications for you in the immediate term, as well as your ability to stay bonded down the road.

So trust, but certainly verify. The US Small Business Administration can determine eligibility and ownership. It isn’t enough for a company to be owned by someone who claims they meet specific criteria — they have to help prove their status. On the flip side, just because you assume that someone can’t qualify for an MBE doesn’t mean they are lying, or out. As the USSBA says, “Individuals who are not members of one or more of these groups can be considered for the 8(a) program, but they must provide substantial evidence and documentation that demonstrates that they have been subjected to bias or discrimination and are economically disadvantaged.”

So it comes down to proof. Don’t feel bad about looking into potential subs. Ask the necessary questions, check backgrounds, and obtain proof of their status. After all, it hurts genuine MBEs when fraud is committed, so they should be more than willing to help you stamp it out. The only ones with something to hide are usually the ones committing crimes. It’s your responsibility, in the most absolute legal sense, so protect your surety by ensuring the status of your subs.

Getting the contract requires the backing of a strong Surety company with a reputation you can depend on. Contact Surety1 today for a quick and fair bonding process that’ll get you to work.