Q & A – The Complexity of Performance Bond Claims in Green Building
May 7, 2024
In this Surety Today: The Blog post we will discuss the Complexity of Performance Bond Claims in Green Building. The format of this post will be in a Q & A form taken from an interview with Mr. Connor Chow, MRAIC, Assoc. AIA, P.GSC, AScT, PMP, LEED AP BD+C, Senior Consultant, Surety Division, The Vertex Companies. We will start off discussing some basic background information on green building in general. Then, we will discuss how green building requirements can impact the surety on a performance bond claim.
Mr. Chow is a construction professional who has been working in the industry for over a decade in the areas of building design, project management, construction management, and surety claims. He has been a part of architectural design teams for hospitals, schools, conference centers, fire halls, restaurants and he has handled performance bond claims in each of those types of projects as well. Connor has been both an in-house claims manager, as well as, an external consultant for surety matters in both the U.S. and Canada. Mr. Chow is an award-winning member of the Canadian construction industry, having been named a top 40 under 40 in that country for his construction related work. In addition, he was named to the top 50 Rising Stars by Insurance Business Magazine. He holds an Associate Degree in Architectural Technology as well as a Bachelor’s Degree in Construction Management, both from Saskatchewan Polytechnic. He has a Master’s Degree in Architecture from the University of Calgary. He holds certificates in Project Management and Construction Law. He has designations as a Professional Applied Science Technologist, a Project Management Professional and is a LEED Accredited Professional in Building Design and Construction. He is a member of both the Canadian and American architectural regulatory bodies and is one of only 10 Professional Gold Seal Certified Owner Construction Managers in North America. So, we are very fortunate indeed to have Connor with us to talk about green building, so let’s get started:
Q: What are green building certifications?
A: So, green building certifications are a way for building owners to measure the impact of sustainable technology, green construction methods, or building improvements against how efficient a typical building may be. The goal is typically to reduce what is known as lifecycle impacts or the amount of emissions that a building may produce over its lifespan and the energy use and impact that building has over its life. There are dozens of different organizations that certify buildings in their own ways or construction projects. There’s LEED, Energy Star, Green Globes, and many others. The most popular in North America is LEED, which stands for Leadership in Energy and Environmental Design, LEED is currently on its fourth generation. The fourth generation has been iterated on a number of times, but the fifth generation is coming soon in the future. LEED to date has certified 197,000 projects since it began.
It is in 186 different countries and it has certified 29 billion square feet of projects. Realistically, the LEED program, has been tried and tested, it’s seen fairly positively by many different organizations and even the private industry. And really what it focuses on is environmental impact, the carbon reduction emissions measurements, air quality, safe materials, and the way that they do that is there actually are different areas you can be certified in. So, building design and construction is one of the main ones that focuses primarily on new construction or larger renovations. There’s interior design where you’re renovating a couple of floors of an office building, for example, operations and maintenance, neighborhoods, homes, and even entire cities. These certifications have been around for a long time. Generally, they have operated in the background to the general public. You may see a certification plaque or a window sticker as you walk into your favorite mall or your office tower that you work in, but that is really about it. Most of the initiatives that these certifications are intended to provide for, they’re intended to be passive, so you’re supposed to not really notice them, and they’re not supposed to intervene in your day to day activities.
Q: So why do building owners use these types of certifications?
A: First I’ll go through which buildings really use these certifications. So, universities and colleges are really common, office towers and renovations to office towers are also extremely common. You will find them in malls, convention centers, hospitals, sports arenas, warehouses, really most of them are focused on commercial buildings. So for example, the Willis Tower in Chicago is a certified as LEED Gold. The Empire State Building is LEED Gold and most of the tech companies that are across really anywhere in the world are all either gold or platinum under LEED. For many organizations the certifications are used to measure against their larger corporate or a mandated sustainability plan. It can be difficult to measure the impacts of a small change like putting motion sensors on your light switches against the larger sustainability plans that they have in place.
So it can sometimes make sense for ownership groups to put forward LEED as a goal for these buildings so they’re easier to measure the impacts or the proposed changes against these sustainability plans. These goals, they could be from emissions reductions, energy savings, water use goals. There’s really an endless list and there’s technology as well. They could be using geothermal or heat capture and they’re a means and method to a larger approach. There’s typically the consultation process with the architect and the engineer or the owner’s rep and they’ll decide what certification they’ll use. But in summary, if you have a building and you want to get it certified in a green system, there’s probably something that already exists or probably a certification group that probably already exists.
Q: How do these certifications tie into the actual construction of the building or the project?
A: It begins at the initial design or the inception phase of the project. So, the architect, the engineer, the owner’s rep, whoever is on that project and the owner will sit down and select a certification type or system and what target that might be. So, for example, under LEED there is certified, silver, gold, and platinum. Typically, what will happen is once that is selected, the project designer will go back and do some very simple design and suggest what credits might be important to the building or achievable. So, for example, if you want to achieve LEED’s top status as platinum, you have to accumulate 80 credits, and those credits are in addition to mandatory compliance items. I will get more into that, but a credit can consist of a different number of points. So, each credit isn’t weighted the same, some are worth one point and others can be worth six or more.
And while the number of points to achieve the certification level will always stay the same, it will always be 80 to achieve platinum. The building type and what LEED area you’re registering under will have different credit requirements and as well different mandatory requirements. So, you’ll have a different credit plan for say a renovation to an existing warehouse building, then you will for an office building. There’s a significant amount of planning that goes into that to achieve the certification. The majority of that is done in the design phases by the design team and it’s planned for long in advance of any actual construction taking place. You might have to in some cases build on what’s also known as a brownfield site. So, for those that aren’t aware, virgin land is not considered a brownfield site, a brownfield site is one that has been built on in the past. The site can’t be used for agriculture or a more suitable use, and it’s typically land that might have human intervention on it. So it might’ve had a chemical spill from a gas station or might be along a decommissioned train line.
All of these are considerations that will play into the larger credit planning for that specific type of building or project. This is obviously second to the building intent itself, and I want to reiterate, the use of green certifications shouldn’t be the first priority. The building occupants, the way that that building is intended to operate, and other factors all play equal roles and should be weighted appropriately. Once the design is in progress and the credit plans are in place, everything gets logged into an online interface. We live in a technological society now, so everything goes on the internet and goes to a secure portal and all of the credit backup goes to a centralized place. In the US, what’s known as the USGBC, US Green Building Council, and they’ll eventually approve the credits for the project.
There are people at the USGBC evaluating credit applications every single day, and these credit applications themselves, they can potentially not be simple. There’s a significant amount of documentation that’s required to be submitted properly and by “properly” I mean that there is correct documentation and templates that have to be utilized. In some cases, for example, that could be somebody knowing how to properly mark up a map where there are surrounding locations such as bus stops or pharmacies or secondary resources that LEED designs or puts forward as being important to that building. And this whole credit process can become strenuous if either you are not used to it or the project itself doesn’t have the resources to have the people put forward the documentation. And like I said, some of these credits are actually mandatory, so they don’t add up to the total, they are mandatory in order to be certified.
And there are different mandatory credits for each LEED certification. So, depending on what building you are in, they might change. Some examples of these might be construction pollution prevention or water use reduction plans and how that building is using that water over time. These are just mandatory, not optional. Waste management is also very important. You have to keep track of where the waste is going from your building, particularly during construction and you have to measure indoor air quality as well. There is a number of credits as well deemed innovation credits, which are a third tier of credits, meaning that if you are using technology that is not commonplace in the industry, you can earn additional points towards your total credit requirement. So to quickly summarize, so far there are three different credits. There’s optional, mandatory, and innovative. To add a fourth, there’s regional priority. Depending on where your project is located in the country, those regional credits will change. To be succinct, your designer or your green building consultant should be able to apply these credits and they should be able to give guidance on what is truly required. And that includes the contractor performing the work. You should evaluate the contractor based on if they have done this in the past and if they have built under this type of certification.
Q: Alright, so that is the background, the basics of green building and the certification process. So, talk a little bit now about how all of this could impact a surety performance bond claim.
A: I will say generally, and I do not have underwriting experience I will fully admit to, but I have worked with a lot of underwriters in the past and from that perspective there is not a whole lot that would change in the evaluation of a green building project when you are looking to write a bond as far as financial review metrics. From my understanding, there really is not much that you can flag in these situations. You can always increase considerations for character and capacity, two of the three C’s, and whether or not that contractor has experience in that certification type. But I know in many cases underwriters may not get that level of information upfront depending on what type of contract it is.
So, sometimes it is just not possible. But, as long as there are not any large red flags and that contractor is known to have done that certification type in the past, there really is not much additional to review. Most contractors that have completed green buildings in the past have gotten really good at it. It is not rocket science. It does take an additional level of knowledge and understanding in order to keep the proper records and document process during the construction phase. But this is particularly important, the majority of the mandatory credits are actually incurred or monitored during the construction phase. If the contractor were to forget something, there may not be a way to go back and document that in retrospect, and very well this could result in the certification potentially being rejected because that credit was not achieved or that backup information did not accompany the credit. That credit may be denied by the authority. If it is a mandatory credit, you cannot achieve that certification. This is not really something that an ownership group can intervene on. It is up to the contractor, general contractor, and subcontractors to be performing this appropriately and that risk needs to be carefully monitored.
Once you start to hit the initial stages of a performance claim, if a contractor is not performing to the standard, there is now an additional reason the obligee might put forward a default notice or performance claim. This is an added risk. While every bond and contract are different, it is an additional consideration and it is an additional reason that a contractor could be defaulted for. In general, let’s say we have an insolvent contractor and they are no longer able to complete the project, a default is declared, and the surety’s intervention is requested. The surety will have its typical options. You could take it over, you could relet, or pay the costs if that was required.
But in the case of a takeover or a relet process, both cases should spur the response of the surety or a consultant. Certification adds an entire level of risk that isn’t on a typical construction project or on a typical performance claim. We know it is not possible for a surety company or consultant to recover all of the project documentation if a contractor becomes insolvent. The documentation for these credits is absolutely critical if it is lost, like I said, it may not be able to be replicated. If a load of waste material, for example, were to leave the site and there’s record that it left the site, but you cannot show where it went as a final destination, that’s part of the backup information that can impact a claim as well.
For example, there are credits that require 10% of the materials to be locally sourced. You can reach out to your subcontractors and your suppliers on the projects, but that’s also administrative burden. It is an additional level of detail that is not typically required and that’s part of what a surety or its consultants have to do during that claim. A loss of the knowledge from the original contractor also tends be very negative and difficult to remediate. Trying to piece together how items have been documented if they are not already, within a default scenario, is strenuous. While you likely can get access to the USGBC site and take a look at the past documentation, if it has not been uploaded and it does not exist, these are responsibilities that could be placed on the surety or the takeover contractor.
If the contractor has not been adhering to the waste management plan, or if they have not been monitoring materials like carpets and paints being installed, these are all issues. In the best case scenario, say the surety intervenes, recovers all of the backup documentation, and is left with the insolvent contractor and the potential relet process. The surety still has to ensure that that takeover contractor is adhering to the original credit plans. So, it is not simple for any party in the situation if they are not experienced in the certification to get it across the finish line. Certifications take a lot of planning and documentation, and really the submission phase is the biggest burden. It would be a misconception if a surety expected the owner, the designer, or the architect was going to step in. In my experience they are not. They typically are requirements that are going to be within the general contract and have to be met by the original contractor or the takeover contractor.
There is also a real concern regarding funding considerations tied to green certification. If your project is intended to be, or the project you are bonding is intended to be LEED Platinum, and it does not achieve that goal, who is responsible? So similar to if you were to buy an electric car, you might get a federal rebate or a tax consideration for buildings. There might be entities that are providing funding in whole or in part for new green technologies or for achieving a certification they can publicly showcase. If these goals are not met, not only is there the surety’s investigation and a potential remediation under the performance bond, but extreme circumstances could trigger a funding issue with the external bodies to complete that project, being a true valid claim or not.
So that owner might decide to pursue the surety for amounts lost. And while it probably will not be a valid claim, it is something that becomes a mess very quickly. It becomes a reality when you are trying to review these projects and select a relet contractor, you have to manage that risk. While there are some items you can attempt to get ahead of for a relet, you should require your potential contractors to provide applicable backup experience, whatever that might look like. Having those documents should be tied to your either bid assessment process or your internal selection process. If you are looking to take over a project with a trusted contractor instead of a relet, ensure that that contractor is aware of those requirements and that they are aware that they need to be in compliance with them.
In both of these instances, you very well might have a hard time finding a contractor who is willing to take over a project. I am sure many have had experiences where a project is a “black sheep” and a contractor or many contractors do not want to touch it. An additional option is always to bring on either a typical green building consultant, an architect, or a surety consultant to operate on behalf of the surety to work with that contractor. This will build-in an overarching construction management contract style to focus on certification compliance. This alleviates a portion of the documentation requirement from your completion contractor and would let that contractor focus on the completion of the work while that consultant deals with the documentation from the certification side. This approach would efficiently serve as a risk management tool, and it would ensure that credits are complied with under that certification. It is an early intervention tool that I know surety companies would utilize.
It is worth mentioning that any good contract written appropriately should not have the green building certification legally tied to as one of the “primary completion indicators”. That means the certification should not be held over the original contractor or the bonds head. Those certification requirements should be held separate from the actual completion of the project, and while are attempted to be achieved, are secondary to the physical construction specifications. Obviously, we do not live in a perfect world and the reality is when reviewing the contract as part of the underwriting process, that might be something to flag.
In summary, the certifications are far from new, they have been around for a long time. The industry and contractors have all adapted to them and they have adapted actually so well in many cases that we forget they are even undertaken on many projects. Code requirements are getting more stringent – carbon requirements, water use is a factor and these factors are being legislated. All of this results in an additional risk and considerations should your contractor become insolvent or should you encounter this on a performance claim.
Q: We have been seeing in the industry for some time now that premiums for reletting at 150% or more, so if you add on this extra layer of the green building compliance, I cannot even imagine what that does to the premium for trying to relet a project.
A: I would think that in general it would have to be either as bad or worse. I do not think you would run into the situation where a contractor would be happier or more willing to take on more risk and additional documentation requirements. So, it likely only goes up. I know I have spoken to some of our team’s experience, it is definitely on the higher end of the premiums side for claims.
Stover: I think with climate change becoming more and more a topic of discussion, you are going to see, as you said, more and more legislation on it, more and more strict requirements on it. So, I think we are all going to start having to deal with it. And I like the consultant approach. I think that would be very helpful for a Surety to bring in somebody as a third party to make sure the compliance is happening. I have done some research on it, but I have not really seen a lot of case law on claims against bonds and what owners can claim as far as damages, if anything. And I am generally aware that there are some actual bonds for green certification that is specific to that issue. But in any event, it is coming our way.
We at Surety Today want to thank Connor for joining us and providing all of his insights and expertise. If you have questions regarding the issues discussed in this post, please do not hesitate to contact Michael A. Stover, Esq. (410-659-1321/mstover@wcslaw.com) or any member of the Surety and Fidelity Practice Group, or our guest, Connor Chow, MRAIC, Assoc. AIA, P.GSC, AScT, PMP, LEED AP BD+C, Senior Consultant, Surety Division, The Vertex Companies, (984-301-2086/cchow@vertexeng.com).