**Chapter 8**

**8 - [Contract Clauses ]{.underline}**

8.1 [Federal Requirements]{.underline} (1/98)

> 8.1.1 [Sources of Model Federal Clauses and Applicability]{.underline}
> (1/98)

8.1.2 [Davis-Bacon Act]{.underline} (1/98)

> 8.1.3 [Cargo Preferences]{.underline} (1/98)
>
> 8.1.4 [Buy America]{.underline} (6/03)
>
> 8.1.5 [Fly America]{.underline} (1/98)
>
> 8.2 [Surety Bonds]{.underline} (4/05)

8.2.1 [Performance Bonds]{.underline} (4/05)

> 8.2.2 [Options]{.underline} (1/98)
>
> 8.2.3 [Liquidated Damages]{.underline} (1/98)
>
> 8.2.3.1 [Relationship with Default Termination]{.underline} (1/98)
>
> 8.2.4 [Intellectual Property Rights]{.underline} (1/98)
>
> 8.2.4.1 [Disclosure of Trade Secrets]{.underline} (1/98)
>
> 8.2.4.2 [Contract Work Products, Patents and Copyrights]{.underline}
> (1/98)
>
> 8.2.5 [Termination]{.underline} (1/98)
>
> 8.2.5.1 [Termination for Convenience]{.underline} (1/98)
>
> 8.2.5.2 [Partial Terminations]{.underline} (1/98)
>
> 8.2.5.3 [Termination for Default]{.underline} (1/98)

**8.1 FEDERAL REQUIREMENTS**

**8.1.1 [Sources of Model Federal Clauses and
Applicability]{.underline}**

+-----------------------------------------------------------------------+
| **REQUIREMENT**                                                       |
+-----------------------------------------------------------------------+
| § 16 of FTA Circular 4220.1E requires that grantees evaluate Federal  |
| statutory and regulatory requirements for relevance and applicability |
| to a particular procurement.                                          |
|                                                                       |
| Appendix A.1 of this Manual contains a discussion of each of the most |
| generally applicable requirements, including the types of contracts   |
| to which each applies, any specific wording that must be incorporated |
| in your contracts, suggested wording where specific wording is not    |
| mandatory, and the applicability to subcontracts.                     |
+-----------------------------------------------------------------------+

**DISCUSSION**

**FTA grantees recognize that the most significant of the strings
attached to the receipt of federal funds is the requirement to comply
with federal statutes and regulations applicable to their project or
particular contract.**

**You will want to be able to determine exactly which clauses are
required for a specific procurement because the incorporation of
unnecessary or loosely drafted clauses can:**

-   **discourage competitors,**

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-   **cause confusion for anyone involved with the contract, and**

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-   **ultimately result in additional costs for your agency.**

**Appendix A.1 of this manual discusses each of the most generally
applicable clauses. Knowing that a particular law must be complied with
and that appropriate language must be included in a third party
contract, still leaves the Grantee trying to draft or incorporate a
clause that meets those requirements. The clause‑by‑clause discussions
in Appendix A.1 have been developed by FTA to assist you.**

**Best Practices**

Appendix A.1 of this Manual contains thirty model contract clauses that
are either federally required or are suggested model clauses that you
may include in contracts. The clauses contained in this Appendix include
the following common elements, which will be helpful to grantees in
deciding if a specific clause is required in a particular procurement:

[Applicability to Contracts]{.underline} ‑ discusses the types of
contracts for which the clause is applicable.

[Flow Down]{.underline} ‑ discusses to which prime contractors and which
level of subcontractors the clauses apply.

[Mandatory Clause/Language]{.underline} ‑ includes the model clause,
identified by FTA as either a required (specified) clause or a
suggested‑language clause.

The narratives provided with the individual clauses in the Appendix
indicate the source of the clause, if required. Many of the required
clauses come directly from requirements in various sections of the Code
of Federal Regulations (CFR), which is published by various executive
departments of the federal government. The most common requirements for
FTA grantees come from various parts of Title 49 of the CFR, published
by the Department of Transportation. Requirements of the Department of
Labor (such as Davis‑Bacon Act clauses) originate as specific language
in Title 29 of the CFR. Where clauses are not mandated by an executive
department, they are frequently modeled after clauses in the Federal
Acquisition Regulations (FAR) which are applicable to those executive
departments.

Even though the FAR does not apply to grantee procurements, one
advantage of using FAR clauses in the absence of a specific requirement
imposed upon your Agency is that a body of federal law has been
developed which interprets those clauses. [^1]

Your State, local jurisdiction, or transit Agency may have enacted a
procurement code or body of regulations that actually establishes
specific clauses which you must use. In that case, you will be obligated
to use what has been established for you. Many of the recent enactments
of those codes or regulations are adaptations of the American Bar
Association\'s *Model Procurement Code for State and Local Governments*.
[^2]

You may have the ability to incorporate clauses by reference (such as,
title, date and where it can be found) in your contracts. To the extent
clauses you want to incorporate are published in a Federal, State, or
local statute, code, or ordinance, or in an official regulation such as
the CFR, you should be able to incorporate those provisions directly
into your contractual document by reference only. You can check with
your supporting legal counsel on what clauses you can and cannot
incorporate by reference and the manner in which they may be
incorporated. It is doubtful you would ever be able to incorporate by
reference a clause that was only published in an FTA Circular, because
of the way FTA Circulars are published (i.e. they are not officially
published in the *Federal Register*).

**8.1.2 [Davis-Bacon Act]{.underline}**

  -----------------------------------------------------------------------
  **REQUIREMENT**

  § 24 of the Master Agreement delineates the Grantee\'s obligations to
  comply with the employee protection requirements of the Davis‑Bacon
  Act. For construction activities exceeding \$2,000 performed in
  connection with an FTA‑funded Project, the Recipient of those funds
  agrees to comply with, and assure compliance with, the requirements of
  49 U.S.C. § 5333(a), the Davis‑Bacon Act, [^3] and the implementing
  regulations of the Department of Labor at 29 CFR Part 5. In addition to
  the requirements of the statute and regulations, the Recipient also
  agrees to report to the FTA every suspected or reported violation of
  the Davis‑Bacon Act or its Federal implementing Regulations.
  -----------------------------------------------------------------------

DISCUSSION

**The Davis‑Bacon Act (the Act) provides that contracts in excess of
\$2,000 to which the United States is a party (i.e., federal funds are
involved) for construction, alteration, or repair (including painting
and decorating) of public buildings or public works within the United
States shall contain a clause that no laborer or mechanic employed
directly upon the site of the work shall receive less than the
prevailing wage rates as determined by the Secretary of Labor.** [^4]
**The clause mandated by the Act and its implementing federal
regulations is found in Appendix A.1 of the Manual. The purpose of this
section in the Manual is to discuss the practical issues surrounding the
requirements of the Act and the regulations implementing it.**

**Best Practices**

[Federal Wage Determinations]{.underline} ‑ When a construction project
is being performed with federal funds, laborers and mechanics employed
directly upon the site of the work shall be paid a minimum wage which is
determined by the Secretary of Labor. That rate of pay is referred to as
the \"Davis‑Bacon wage rate\" and is specifically identified in the
contract between the Recipient and the Contractor.

[Types of Wage Determinations]{.underline} - Federal wage determinations
are of two types: (a) General Wage Determinations and (b) Project Wage
Determinations. *General wage determinations* contain prevailing wage
rates for the types of construction designated in the determination, and
they are used in contracts performed within a specified geographical
area. They contain no expiration date and remain valid until modified,
superseded, or canceled by a notice in the Federal Register by the
Department of Labor. These determinations should be used whenever
possible.

*Project wage determinations* are issued at the specific request of the
grantee. They are used only when no general wage determination applies
and they are effective for 180 days from the date of the determination.

It is the obligation of the contracting officer to ensure that a copy of
the most current wage determination of the Department of Labor (DOL) is
actually included in the solicitation and ensuing contract. The Wage and
Hour Division of the DOL is responsible for the publication of wage
determinations. Such determinations are numbered, dated, and issued as
different rate schedules, depending upon the type of construction
involved (building, residential, highway, or heavy construction). [^5]

[State Wage Determinations on Federally Funded Projects]{.underline} -
Your state may also prescribe minimum wages and benefits for public
works projects. *If your state has established prevailing wages that are
higher than Davis-Bacon Act rates, you should get advice of counsel to
determine whether or not the state law or Davis-Bacon Act rate prevails,
however in no event can rates be lower than Davis-Bacon Act rates.*

[Where to Obtain Wage Determinations]{.underline} ‑ General wage
determinations may be found in the Government Printing Office document
entitled *General Wage Determinations Issued Under The Davis‑Bacon and
Related Acts.*

Subscriptions to this information are available electronically [^6] and
by hard‑copy. [^7] The decisions are included in six different volumes,
arranged by state. If ordering a hard‑copy subscription, only get the
volume that includes your state. An annual edition is published in
January or February of each year and then updated weekly throughout the
year as part of the loose‑leaf service.

This publication is available at each of the 50 Regional Government
Depository Libraries and many of the Government Depository Libraries
across the country. In large metropolitan areas, this document may also
be available in a central public library as well as through local
offices of your state\'s department of transportation. In addition, The
Davis-Bacon Act wage rates can be accessed on the Internet at
[www.access.gpo.gov/davisbacon](http://www.access.gpo.gov/davisbacon).

If you are involved in a project that will involve the issuance of
multiple construction‑related solicitations over an extended period of
time, you may want your own copy of this document. This is not only for
convenience but also ensures that your solicitations and contracts
contain the most up‑to‑date determinations. [^8]

[Requesting a Wage Determination]{.underline} ‑ As you start a project
involving construction, one of the best personal contacts you can make
is with the local DOL representative who will be monitoring your
contract for compliance with the Davis‑Bacon minimum wage requirements.
If a general wage determination is available for your area, you may use
it without notifying the Department of Labor. If a general determination
is not available for your area, you can work with your local DOL
representative in requesting either a general wage determination or a
project determination.[^9] Do not hesitate to utilize the services of a
project\'s design services professional to assist in obtaining
information about the latest wage determinations. In all likelihood,
that firm will know precisely what the requirements are and who to
contact at the DOL.

Because the process to make a determination takes at least 45 days, it
is important to know early in the project whether or not a determination
is available for your area. The request to have a determination made
needs to be submitted to the DOL 45 to 60 days before the solicitation
is to be issued.

[Wage Determinations and Your Solicitation/Contract]{.underline} ‑ The
clause and regulations require that the wage determination be physically
attached to the solicitation. The wage determination cannot be
incorporated by reference. If the solicitation is issued without a wage
determination included, bids may not be opened until a reasonable time
after the wage determination has been furnished to all bidders and
incorporated into the solicitation by amendment.

**What if the wage determination expires before award?** It should be
noted that *general wage determinations* never expire and remain valid
until modified, superseded or canceled by DOL. But *project wage
determinations* do expire. In the event that your project wage
determination expires or your general wage determination is superseded
by a new determination *before bids* *are received*, you must request a
new project determination (if using a project wage determination) and
incorporate the new rates in a solicitation amendment in sufficient time
for bidders to amend their bids. If the new determination does not
change the wage rates and would not cause bidders to change their bid
prices, you should amend the solicitation to include the number and date
of the new determination.

*If the wage determination expires after bid receipt but prior to
award*, you should request an extension of the determination from DOL\'s
Wage and Hour Division. If necessary, award of the contract should be
delayed until the request for extension has been granted or a new wage
determination has been issued. If the request for extension is denied
and a new wage determination issued that changes the wage rates for
classifications to be used in the contract, the contracting officer may
either cancel the solicitation and re‑advertise with the appropriate
determination or award the contract and incorporate the new
determination effective on the date of contract award. [^10] If the new
wage determination did not change any wage rate, the contracting officer
should award the contract and modify it to include the number and date
of the new determination. [^11]

**What if the wage determination is modified before award?** *If the
wage determination is modified (as opposed to expires) before bids are
received*, whether or not it must be included in the solicitation is
determined by the time of receipt of the modification by the contracting
agency or the time of its publication in the *Federal Register*. The
modification is effective and must be included in the solicitation if
(a) it is received by the contracting agency, or notice of the
modification is published in the *Federal Register*, 10 or more calendar
days before the date of bid opening or (b)  it is received by the
contracting agency or notice of the modification is published in the
*Federal Register*, less than 10 days before bids are due to be opened
unless the contracting officer finds that there is not reasonable time
to notify bidders of the modification.

*If the modification is received (or notification of the modification
published in the Federal Register) after bid opening,* it is not
effective and shall not be included in the solicitation.[^12]

You may have a situation where an \"effective modification\" (i.e.,
received by the contracting agency or published in the *Federal
Register* 10 days prior to the bid opening date) is received by the
contracting officer at some time later than it was received by the
contracting agency. In this case, if the \"effective modification\" is
received by the contracting officer prior to bid opening, the bid
opening date shall be postponed to allow a reasonable time to amend the
solicitation to incorporate the modification and permit bidders to
consider the impact of the modification on their bids. If the
modification is received after bid opening, but prior to award, the same
procedures apply as in our earlier discussion about new wage
determinations received after bid opening, but prior to award. If the
effective modification is not received by the contracting officer until
after award, the contracting officer must modify the contract to
incorporate the wage modification retroactively to the date of contract
award and equitably adjust the contract for any increased or decreased
cost of performance resulting from any changed wage modifications. [^13]

**What if the Wage Determination is modified after award?** It is
recommended that grantees incorporate language such that contractors are
obligated to pay prevailing wages throughout the life of the project and
are not entitled to change orders for increased costs associated with
any change in the prevailing wage made after award.

As you can see from this discussion, you should not wait until you are
ready to issue the solicitation to start checking on the Davis‑Bacon
wage rates for your area and it should be equally obvious that a good
working relationship with your local Department of Labor officials is
very important. They generally are very cooperative and helpful in
answering any questions you may have and notifying you of impending
changes or revisions to existing wage determinations that would impact
your contract because it is in their best interests that your project
run smoothly from a minimum wage standpoint.

[Contract Administration and the Davis‑Bacon Act]{.underline} ‑ Once the
contract is awarded, it is initially the responsibility of the
contracting officer to ensure that the contractor comply with the
provisions of the contract clause. This means ensuring that the
appropriate signs are available and posted, as well as ensuring that the
appropriate payrolls and certificates are submitted not less frequently
than weekly. If you have a construction management contractor, you may
want to assign that firm the task of checking payrolls on a regular
basis and spot- check the pay of individuals against the actual work
that they are performing. The failure of the contracting officer to
properly monitor the contractor's compliance with Davis-Bacon may result
in a determination by DOL that your agency is responsible for payment of
the back wages.

If you do not have such a contractual relationship and your construction
management is done \"in‑house,\" the contracting officer will have
responsibility for compliance checks. Once you have reviewed the
payrolls, they should be retained unless requested by an appropriate FTA
official. In your initial meeting with the FTA regional officials for
your project (or this particular contract) make sure it is clear to whom
the payrolls should be transmitted. FTA may request that you hold them
on‑site or at the agency for them to review and not actually transmit
them. FTA may also delegate the review function to its Project
Management Oversight contractor.

[Complaint Process]{.underline} - If DOL comes to the site to
investigate a complaint (often the way minimum wage discrepancies are
uncovered), you (and the contractor) will want to cooperate in that
investigation. If a determination is made that the contractor is not in
compliance with the Davis‑Bacon Act contractual provisions, it is the
contracting officer\'s responsibility to ensure that DOL and the FTA are
informed of the discrepancy. If it is determined that back wages are
owed, you will receive written communication to that effect from the DOL
and the FTA and you should comply very strictly with that direction ‑‑
at this point in time, it is an issue between the contractor and the
DOL, and the DOL regulations govern the reviews and appeals from
determinations of that type.

**8.1.3 [Cargo Preference]{.underline}**

  -----------------------------------------------------------------------
  **REQUIREMENT**

  § 14.b of the Master Agreement sets forth the Grantee\'s obligations to
  comply with the requirements of the United States Maritime
  Administration regulations entitled \"Cargo Preference ‑ U.S.‑Flag
  Vessel,\" found at 46 CFR Part 381. Specifically, the grantee is
  obligated to incorporate the clause found at 46 CFR Section 381.7(b)
  into contracts in which equipment, materials, or commodities may be
  transported by an ocean vessel.
  -----------------------------------------------------------------------

**Best Practices**

The fourth model clause in Appendix A.1 to this Manual contains a
suggested clause that complies with the requirements of the United
States Maritime Administration at 46 CFR Section 381.7(b), which
provides a suggested clause for use as well.

If your contract contemplates the shipment of any equipment, materials,
or commodities by ocean vessel, a clause that meets the requirements of
46 CFR Part 381 must be included in the contract. Additionally, if a
subcontractor at any tier would be responsible for the ocean vessel
shipment, the clause would flow down to that subcontractor. The clause
in Appendix A.1 or as found at Section 381.7(b) meets that requirement
and it is recommended that either of these clauses be utilized.

If it appears you have a contract in which ocean vessel transport would
be required, it is recommended you check with your legal counsel and
ascertain if there are any changes to the law or the clause. Questions
about this clause frequently come up in the context of rail car
procurements which, until recently, invariably required the shipment of
rail cars from overseas locations. It is recommended that you either be
prepared to address this requirement, or be prepared to respond to any
questions offerors may have at any pre‑bid or pre‑proposal conferences
held in conjunction with those procurements.

**8.1.4 [Buy America]{.underline}**

  -----------------------------------------------------------------------
  **REQUIREMENT**

  § 14.a of the Master Agreement requires compliance with 49 U.S.C. §
  5323(j) and FTA\'s Buy America regulations found at 49 CFR Part 661, as
  well as implementing guidance issued by the FTA.
  -----------------------------------------------------------------------

**DISCUSSION**

Please see Section 4.3.3.2.2 of this Manual for a thorough discussion of
the Buy America requirements. Please see the Appendix for the required
clauses.

**8.1.5 [Fly America]{.underline}**

  -----------------------------------------------------------------------
  **REQUIREMENT**

  § 14.c of the Master Agreement states that if the contract or
  subcontracts may involve the international transportation of goods,
  equipment, or personnel by air, the contract must require contractors
  and subcontractors at every tier to use U.S.‑flag air carriers, to the
  extent service by these carriers is available. 49 U.S.C. 40118 and 4
  CFR Part 52.
  -----------------------------------------------------------------------

**DISCUSSION**

A contract for goods or equipment must contain a Fly America provision
as discussed in Appendix A.1, just as it contains a Cargo Preference
provision, if there is reason to expect that international air travel
would be involved. Although there is no Federally prescribed language
for this provision, model language is contained in Appendix A.1. If
there is no possibility of international shipments or travel under the
contract, these provisions are not required.

8.2 SURETY BONDS

History

The idea behind surety bonding is straightforward. One person guarantees
to another that a third person will perform.

The first corporate surety bonding company in the United States, the
Fidelity Insurance Company, was formed in 1865. In 1894, Congress passed
the Heard Act, which required surety bonds on all federally funded
projects as a result of the large number of contractors working on
public projects who had defaulted and in response to complains from
unpaid suppliers and subcontractors. The Miller Act (40 U.S.C. §270a et
seq.) was passed in 1935 to replace the Heard Act. The Miller Act
requires performance and payment bonds for all public work contracts in
excess of \$100,000 and payment protection, with payment bonds the
preferred method for contracts in excess of \$25,000. [^14] Almost all
states and most local jurisdictions have enacted similar legislation
requiring surety bonds on public works. These generally are referred to
as "Little Miller Acts.

Today, surety bonds protect virtually every public construction project
in the U.S. In 1977, nearly \$160 billion in public works projects were
so protected with surety bonds. From 1990-1997, more than 80,000
contractors failed, with losses of \$21.8 billion, according to Dun and
Bradstreet's *Business Failure Record*. From 2001-2003, surety companies
incurred more than \$1.8 billion in losses from surety bonds, according
to The Surety Association of America.

# [Types of Surety Bonds]{.underline}

[Surety Bond]{.underline} - A written agreement whereby one party,
called the *surety*, obligates itself to a second party, called the
*obligee* (the owner, grantee), to answer for the default of a third
party, called the *principal* or *obligor*. Surety bonds used in
construction are called *contract surety*

*bonds*. There are three primary types of contract surety bonds: *bid
bonds*, *performance bonds,* and *payment bonds*.

[Bid Bond (or Bid Guarantee)]{.underline} *--* A promise from a surety
(or a certified or cashier's check given by a bidder) for a supply or
construction contract to guarantee that the bidder, if awarded the
contract within the time stipulated, will enter into the contract at the
price bid and furnish the prescribed performance and/or payment bond.
Default ordinarily will result in liability to the obligee for the
difference between the amount of the principal's bid and the bid of the
next low bidder who can qualify for the contract. The liability of the
surety is limited to the bid bond penalty. Contractors that have a
relationship with a surety can normally obtain bid bonds at no cost. Bid
bonds are not usually appropriate for negotiated procurements due to the
nature of the process.

[Performance Bond]{.underline} ‑ A promise from a bonding company (\"the
surety\") to perform (or cause to be performed) those obligations of the
contractor (\"the principal\"), when the contractor fails to perform its
obligations, in an amount up to but not exceeding the amount of the bond
(\"penal sum\"). Performance bonds can incorporate payment bond (labor
and materials) and maintenance bond liability (see below). A performance
bond protects the owner (grantee) from financial loss should the
contractor fail to perform the contract in accordance with its terms and
conditions. Once a surety bond is issued, it cannot be withdrawn or
cancelled. General contractors may also act as the obligee when bonding
subcontractors. General contractors may require subcontractor bonds if
the subcontractor is a significant part of the job or a specialized
contractor that is difficult to replace.

[Payment Bond]{.underline} ‑ A promise from a surety that guarantees
payment to certain subcontractors, laborers and suppliers for the labor
and materials used in the work performed under the contract. Payment
bonds are also called *labor and material bonds*. These bonds protect
laborers and suppliers in the event the contractor fails to pay them.
The surety's obligation is limited by the amount of the bond.

[Maintenance Bond]{.underline} - A maintenance bond normally guarantees
against defective workmanship or materials. However, maintenance bonds
occasionally may incorporate an obligation guaranteeing "efficient or
successful operation" or other obligations of like intent and purpose.

It is important to note that surety bonds are not intended to protect
the contractors that post them. These bonds are for the protection of
the owner of the construction project and for the protection of
laborers, material suppliers and subcontractors. Since mechanic's liens
cannot be placed against public property, the payment bond may be the
only protection these claimants have if they are not paid for the goods
and services they provide to the project. Under normal circumstances,
sureties do not charge a separate premium for Payment Bonds.

### 

### General Indemnity Agreement

When a surety guarantees the performance of a firm (the principal), the
principal remains liable for this obligation to the surety in the event
of a contract default by the principal. The principal is obligated to
reimburse the surety for whatever sums the surety is required to pay out
to complete the principal's contract. Many contracting firms do not have
the capital to assure this repayment, and so most surety companies
require a general agreement of indemnity (GAI) to be signed not only by
the firm, but by individuals willing to support the firm. This might be
the owner of the firm, the spouse of the owner, a parent corporation or
other individuals willing to risk their assets for the firm.

## [Public vs. Private Sectors]{.underline}

Performance bonding is not typical in large private sector contracts but
is required in the public sector. Public construction contract
performance bonding is more common because:

-   The public interest is served by the surety industry's protection of
    taxpayer dollars expended for public sector projects;

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-   the public sector undertakes large, fixed price public works
    projects;

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-   unforeseen costs could easily bankrupt a construction contractor
    that is a pure service organization with few assets;

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-   public agencies accept the lowest responsive bid from a responsible
    bidder without an opportunity to fully consider and adjust the
    contracting strategy and terms to the apparent low bidder; and

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-   if a contractor is unable to perform, (e.g. because it is having
    difficulty obtaining funds to pay suppliers and employees) and if
    the work is slowed down and ultimately turned over to other forces
    to complete, the cost to the public agency of mobilizing the
    substitute forces and picking up each of the work tasks where the
    failed contractor left them is higher than in a typical supply
    contract where there are usually a number of suppliers offering the
    product at competitively established market prices.

Payment Bonds have a related but secondary purpose. Usually in the
public sector, a contractor\'s suppliers cannot place liens on the
material and work supplied when payment to the subcontractor is overdue.
States often protect public property and services by exempting public
works from materialmen\'s liens. Therefore, although performance bonds
alone would often guarantee payment to subcontractors, additional
payment bonds are often required in construction contracts to assure
there are no disputes over potential performance bond liability to
satisfy second and third tier subcontractor claims.

# [Prequalification of Contractors]{.underline}

Most surety companies are subsidiaries or divisions of insurance
companies, and both surety bonds and traditional insurance policies are
risk transfer mechanisms regulated by state insurance departments.
However, traditional insurance is designed to compensate the insured
against unforeseen adverse events. The policy premium is actuarially
determined based on aggregate premiums earned versus expected losses.
Surety companies operate on a different business model. *The surety
prequalifies the contractor based on financial strength and construction
expertise*. Since the bond is underwritten with little expectation of
loss, the premium is primarily a fee for prequalification services and
the allocation of the surety's capital to protect the obligee against
the possibility of loss.

Although the bonding companies perform this prequalification for their
own purposes and their interests are similar to those of the transit
agency, the transit agency is still required to review potential
contractors' responsibility before award. While surety bonds are a
necessary condition in the determination of responsibility, they alone
are not sufficient. Prequalification of contractors is the primary focus
of surety underwriters. Surety bond underwriters must analyze applicants
closely since they are committing the assets of their companies to
guarantee the contractor's performance and payment of its suppliers.
Underwriters must be certain that only those contractors who can
complete a project receive a bond, and they must be fully satisfied that
the contractor's business is well-managed and profitable.
Prequalification is one of the most valuable services of the surety bond
process. The process involves underwriters satisfying themselves that
the contractor has:

-   Good references and reputation;

-   A track record of successful operations in the past and the ability
    to meet current and future obligations;

-   Experience matching the contract requirements;

-   The necessary equipment to do the work or the ability to obtain it;

-   The financial strength to support the desired work program;

-   An excellent credit history, and an established bank relationship
    and line of credit.

Surety bonds are obtained through insurance agents and brokers, called
*producers.* These producers help their contractor clients during the
prequalification process and assist them in developing a business
relationship with the surety bond company. [^15]

# [Surety Bonds vs. Bank Letters of Credit]{.underline}

**Bank letters of credit are discussed below for consideration under
"Best Practices" in the context of non-construction contracts. At first
glance it may appear that letters of credit and surety bonds offer the
same degree of financial protection. However, a more thorough review
reveals that surety bonds provide greater benefits to both the grantee
(obligee) and the contractor (principal).**[^16]

+-----------------------------------+-----------------------------------+
| **A Comparison**                  |                                   |
+-----------------------------------+-----------------------------------+
| **Bank Letters of Credit**        | **Surety Bonds**                  |
|                                   |                                   |
| *[Prequalification                | ::: Definition-Term               |
| Services]{.underline}:*           | The essence of surety             |
|                                   | underwriting is prequalification. |
| The underwriting bank focuses     | The surety examines the           |
| primarily on the quality and      | contractor's entire business      |
| liquidity of the underlying       | operation, checking for adequate  |
| collateral; i.e., on the ability  | finances, necessary experience,   |
| of the contractor to repay any    | organization, existing work- load |
| draws on the LOC.                 | and its profitability, and        |
|                                   | management skills to successfully |
|                                   | complete the project for which    |
|                                   | the bond is required.             |
|                                   | :::                               |
+-----------------------------------+-----------------------------------+
| *[Claims - Access to              | In most cases, a bond covers      |
| Funds]{.underline}:*              | liabilities that were incurred    |
|                                   | during the bond term. A claim may |
| The beneficiary must make a       | be made on the bond after the     |
| demand prior to expiration date.  | termination of the bond for       |
| No funds are available after      | liabilities incurred prior to     |
| expiration date, even for         | cancellation or nonrenewal.       |
| liabilities incurred prior to     |                                   |
| expiration. The bank has no       | The surety has obligations to     |
| obligation to complete the        | both the owner and the            |
| project.                          | contractor. If the contractor and |
|                                   | owner disagree on contract        |
| There is no completion clause in  | performance issues and the owner  |
| a LOC. The task of administering  | declares the contractor in        |
| completion of the contract is     | default, the surety must          |
| left to the owner. The owner must | investigate the claim.            |
| evaluate work done, develop       |                                   |
| detailed specifications for       | ::: Definition-Term               |
| completion of the work and        | The surety has several            |
| solicit bids or negotiate         | alternatives if the               |
| (depending on state law) for a    | :::                               |
| new contractor to complete the    |                                   |
| work. Under a performance bond,   | Contractor defaults:              |
| these tasks are the               |                                   |
| responsibility of the surety.     | 1.  Finance the original          |
|                                   |     contractor or provide support |
| The owner must determine the      |     necessary to allow the        |
| validity of claims by             |     contractor to finish the      |
| subcontractors, laborers, and     |     project;                      |
| material suppliers. If there is   |                                   |
| not enough money from the letter  | 2.  Arrange for a new contractor  |
| of credit to pay all of the       |     to complete the contract;     |
| claims, then the owner has to     |                                   |
| decide                            | 3.  Assume the role of the        |
|                                   |     contractor an subcontract the |
| which claims will be paid and     |     remaining work;               |
| which will be rejected.           |                                   |
|                                   | 4.  Pay the penal sum of the      |
|                                   |     bond.                         |
|                                   |                                   |
|                                   | ::: Definition-Term               |
|                                   | With payment bonds, the surety    |
|                                   | pays the rightful claims of       |
|                                   | certain subcontractors, laborers  |
|                                   | and suppliers.                    |
|                                   | :::                               |
+-----------------------------------+-----------------------------------+
| *[Borrowing                       | With few exceptions, performance  |
| Capacity]{.underline}:*           | and payment bonds are issued on   |
|                                   | an unsecured basis. They are      |
| Specific assets are pledged to    | usually provided on the strength  |
| secure bank letters of credit.    | of the corporate and personal     |
| LOCs diminish an existing line of | signatures of the company owners. |
| credit, and are reflected on the  | The issuance of bonds has no      |
| contractor's financial statement  | effect on the contractor's bank   |
| as a contingent liability. The    | line of credit.                   |
| tying up of assets, or the        |                                   |
| reduction of an available line of | Subcontractors and material       |
| credit, is counter-productive to  | suppliers may be more willing to  |
| both the owner and the            | provide labor and materials to    |
| contractor. This can adversely    | the contractor when they are      |
| affect the contractor's cash flow | protected by a payment bond.      |
| during contract performance.      |                                   |
|                                   |                                   |
| ::: Definition-Term               |                                   |
| Subcontractors and material       |                                   |
| suppliers may be reluctant to     |                                   |
| provide labor and supplies to the |                                   |
| contractor since they have no     |                                   |
| access or rights to funds         |                                   |
| available from the LOC.           |                                   |
| :::                               |                                   |
+-----------------------------------+-----------------------------------+
| *[Cost]{.underline}:*             | Generally ½ - 2% of contract      |
|                                   | price. The premium includes 100%  |
| ::: Definition-Term               | performance bond, a 100% payment  |
| Cost is generally 1% of the       | bond, and normally a one-year     |
| contract amount covered by the    | maintenance period.               |
| LOC- e.g., if the LOC covers 10%  |                                   |
| of contract, Cost = 1% x (10% x   |                                   |
| Contract Amount).                 |                                   |
| :::                               |                                   |
+-----------------------------------+-----------------------------------+

# [Cost of Bonds]{.underline}

The price or premium for a bond will vary depending on the type of
construction, the contract amount, the duration of the project, the
surety company, and the experience and financial strength of the
contractor. Premiums range, on average, from ½ % to 2 % (or perhaps
higher, and not necessarily tied to business strength) of the contract
price for contractors with established bonding credit. If the contract
amount changes, the bond premium will be adjusted for the change in
contract price. There is usually no additional cost for bid bonds or
payment bonds when purchased with a performance bond.

Bond premiums cannot be reduced by lowering the percentage of the bond
from, say, 100% to 50%. Thus, it usually makes sense to require 100
percent performance and payment bonds so the

owner receives maximum protection. [^17] *The advantage, however, in
considering a lower*

*percentage is that more contractors may be allowed to compete because
some may not have the bonding capacity to get a 100% bond, but may
qualify for a lesser amount.* [^18]

Surety bonds issued through the SBA *Surety Bond Guarantee Program* (see
below) carry an additional 0.6 percent fee.

# 

# [Government Oversight]{.underline} 

Surety bond companies are regulated by state insurance departments.
Surety bonds on state public works must be issued by a surety bond
company licensed by the insurance department in that state. [^19]

On the federal level, the U.S. Treasury Department maintains a list of
surety bond companies that it has qualified to write surety bonds
required for federal construction projects. To be on this list, a surety
bond company must file financial and other information with the Treasury
Department and undergo the Department's financial analysis. [^20]

# [Bonding Assistance Programs]{.underline}

Since the early 1970s, the Small Business Administration (SBA) has
operated its *Surety Bond Guarantee Program*, which provides some
repayment of losses to surety bond companies from bonds they would
otherwise not provide. Small contractors have performed more than \$1
billion of contracts per year with the help of this SBA program.

The U.S. Department of Transportation (DOT) has established a *Bonding
Assistance Program* that is administered by the Office of Small and
Disadvantaged Business Utilization (OSDBU) within the Office of the
Secretary. The Bonding Assistance Program offers certified minority,
women-owned and disadvantaged business enterprises (DBEs) an opportunity
to obtain bid, payment and performance bonds for transportation-related
projects. The Program provides surety companies an 80% guarantee against
losses on contracts up to \$1,000,000. Bond approval and issuance are
performed by the DOT approved surety companies.

A number of states have also established bond guarantee programs for
contractors, as well as other special bonding assistance programs.

The Surety Association of America (SAA) is a nonprofit trade association
that represents more than 650 U.S. and eight foreign surety bond
companies. SAA has developed a *Model Contractor Development Program*
(MCDP) to increase and promote the availability of surety bonds to
small, minority and women contractors. The objectives of this program
include:

-   Educating emerging contractors about surety bonds and helping them
    become bondable,

-   Identifying resources available to emerging contractors in obtaining
    their first bond, such as the SBA Surety Bond Guarantee Program and
    similar state and local programs,

-   Providing assistance and referrals to emerging contractors in
    obtaining appropriate accounting, project management and financing
    expertise,

-   Assisting these contractors with increasing their bonding capacity.
    [^21]

SAA also offers an educational tool for contractors and subcontractors,
*Your First Bond*, a videotape and brochure of what contractors need to
do to apply for bonds, and other educational materials. [^22]

**[Ratings Organizations]{.underline}**

A.M. Best Company (Best's) is a private company that analyzes and rates
insurance companies. Each year it publishes *Best's Insurance Reports,
Property-Casualty,* which includes detailed profiles and financial
information on almost every insurance company operating in the United
States. Best's gives each company a rating (designated by an alphabetic
character) and a financial size category (designated by a Roman numeral
scale). Best also publishes an abbreviated version of its *Best's Key
Rating Guide, Property-Casualty*, which contains only the alphabetic
ratings and financial size categories of each insurance company. These
books are available in many public and financial libraries or may be
purchased from A.M. Best. [^23]

Other ratings organizations include Dun & Bradstreet, [^24] Fitch
Ratings, [^25] Moody's Investors Service, [^26] Standard & Poor's [^27]
and Weiss Ratings Inc. [^28] FTA does not endorse any particular company
or program.

**8.2.1 [Performance Bonds]{.underline}**

+-----------------------------------------------------------------------+
| **REQUIREMENT**                                                       |
+-----------------------------------------------------------------------+
| **[[For Construction Activities]{.underline}:]{.smallcaps}**          |
|                                                                       |
| § 15.m. (1) of the Master Agreement states that:                      |
|                                                                       |
| > [Construction Activities]{.underline}. The Recipient agrees to      |
| > provide bid guarantee, contract performance, and payment bonding to |
| > the extent deemed adequate by FTA and applicable Federal            |
| > regulations, and comply with any other bonding requirements FTA may |
| > issue.                                                              |
|                                                                       |
| FTA Circular 4220.1E states the specific minimum bonding requirements |
| for construction or facility improvement contracts with a value       |
| exceeding \$100,000:                                                  |
|                                                                       |
| 11. [BONDING REQUIREMENTS]{.underline}. For those construction or     |
|     facility improvement contracts or subcontracts exceeding          |
|     \$100,000, FTA may accept the bonding policy and requirements of  |
|     the grantee, provided FTA determined that the policy and          |
|     requirements adequately protect the Federal interest. FTA has     |
|     determined that grantee policies and requirements that meet the   |
|     following minimum criteria adequately protect the Federal         |
|     interest. [^29]                                                   |
|                                                                       |
| > a\. A bid guarantee from each bidder equivalent to five (5%)        |
| > percent of the bid price. The \"bid guarantee\" shall consist of a  |
| > firm commitment such as a bid bond, certified                       |
+-----------------------------------------------------------------------+

+-----------------------------------------------------------------------+
| > check, or other negotiable instrument accompanying a bid as         |
| > assurance that the bidder will, upon acceptance of his bid, execute |
| > such contractual documents as may be required within the time       |
| > specified;                                                          |
| >                                                                     |
| > b\. A performance bond on the part of the contractor for 100        |
| > percent of the contract price. A \"performance bond\" is one        |
| > executed in connection with a contract to secure fulfillment of all |
| > the contractor\'s obligations under such a contract; and            |
| >                                                                     |
| > c\. A payment bond on the part of the contractor. A payment bond is |
| > one executed in connection with a contract to assure payment, as    |
| > required by law, of all persons supplying labor and material in the |
| > execution of the work provided for in the contract. Payment bond    |
| > amounts determined to adequately protect the federal interest are   |
| > as follows: (1) 50% of the contract price if the contract price is  |
| > not more than \$1 million; (2) 40% of the contract price if the     |
| > contract price is more than \$1 million but not more than \$5       |
| > million; or (3) \$2.5 million if the contract price is more than    |
| > \$5 million.                                                        |
| >                                                                     |
| > d\. A grantee may seek FTA approval of its bonding policy and       |
| > requirements if they do not comply with these criteria.             |
|                                                                       |
| *State laws are sometimes specific in requiring or prohibiting        |
| security and guaranties in public procurements; performance bond      |
| requirements may apply even when the Federal requirements do not, and |
| the state requirement may also affect bid guaranties.*                |
|                                                                       |
| **[[For Non-Construction Activities]{.underline}:]{.smallcaps}**      |
|                                                                       |
| *FTA does not require bonding in any amount for non-construction      |
| contracts, including rolling stock.* FTA leaves the decision to       |
| require bonds for non-construction contracts to the discretion of its |
| grantees. [^30]                                                       |
+-----------------------------------------------------------------------+

**DISCUSSION**

**[Construction]{.underline}: For construction contracts with a value
exceeding \$100,000, your solicitation documents must include the
performance bond, payment bond, and bid security requirements specified
above. Bids that do not include the required bid security are to be
rejected. Your state law may require additional bond protection (e.g.,
for even smaller construction contracts).**

**[Non-Construction]{.underline}: You may decide to include bond
requirements in other procurements where your agency has a material risk
of loss because of a failure of the prospective contractor. This is
particularly so if the risk arises from the potential for contractor
bankruptcy or financial failure at the time of partially completed work.
If you require a performance bond, you may also require bid security
that assures the execution of the performance bond as described in
Section 4.3.3.3.2, \"Bid Guaranty.\" Payment bonds are most typically
used in construction contracts or contracts where the risk of failure of
the prime contractor with debts to subcontractors is material.** **Since
the contract is incorporated into the bond, it is essential that the
grantee complies with the terms of the contract or the bond may not be
enforceable.**

**In recent years sureties have been paying much more attention to the
terms of their customers' contracts. One area of great concern to
sureties in the current environment is the *length of contracts*. Here
the issues tend to be *parts warranties* and *option* provisions.
Sureties are tending to limit their exposure to five years, including
warranties.** [^31] **Another major surety issue affecting the transit
industry, especially bus manufacturers, is the *poor financial condition
of many suppliers*. The financial strength of the contractor affects the
cost of the bond, as well as the ability of the contractor to secure a
bond. If a grantee asks for a 100% performance bond on a bus procurement
in the current environment, it may very well preclude potential
suppliers from bidding. Another practice causing surety problems
concerns liquidated damage*s*; i.e., some agencies have contractual
provisions that produce *unlimited liquidated damages.***

**Alternative forms of acceptable security include *letters of credit*
from financially secure institutions, such as banks, and cash deposits.
Letters of credit are frequently used in a field or for a principal with
which bonding companies have little experience. Letter of credit terms
differ from bonds in that they do not provide for completion of the
contract, in the event the principal is unable to perform. Procedures
should be established to make certain the letter is issued by a bank or
other financial institution that offers financial security similar to a
bonding company. Cash deposits are not typically used except as bid
security.**

**The FTA requirement discourages unnecessary bonding because it
increases the cost of the contract and restricts competition,
particularly by disadvantaged business enterprises. Bonding companies
exercise their discretion and assure their profits primarily by
declining to undertake excessive risks. Consequently many bidders have
limited \"bonding capacity.\" Unnecessary performance bonds reduce their
ability to bid on bonded work. Small businesses with short histories may
have particular difficulty obtaining a bond.**

##### Best Practices

[Bond Authenticity]{.underline} - It is essential that bonds be verified
as being authentic when they are presented to owners. It is a fact that
unscrupulous contractors have on occasion presented fraudulent bonds.
*Owners (obligees) should always contact the surety company to confirm
the authenticity of the bond that has been presented.* The Surety
Association of America (SAA) maintains a list of surety companies that
will assist in verifying the authenticity of a surety bond. The
authenticity program is available via the Internet. [^32]

[Exclude Warranties from Bond]{.underline} -- It has become increasingly
difficult to obtain bonds of longer duration than two years. Since the
warranty periods will greatly extend the duration of the bond, it would
be best to remove any warranty requirement from the performance bond and
cover the warranty risk through other techniques. Suggestions include
withholding a reasonable portion of the contract price for warranty
repairs and releasing the withholding in increments as the warranty
time-period dissipates, or requiring a separate Maintenance or Warranty
Bond in a reduced amount sufficient to cover the potential obligations
of the Contractor for repairs or maintenance. This will remove a bonding
obstacle and keep the bonding costs more reasonable. The key message
here is to *keep long-term obligations with the manufacturers and not
attempt to give them to sureties*.

[Consider Letters of Credit]{.underline} -- On non-construction
contracts, where you are not required by FTA to have bonds, but where
you may be required to protect your progress payments to the contractor
prior to delivery of final products, consider the use of a bank *letter
of credit* (LOC) from the contractor instead of a bond. A bank letter of
credit (LOC) is a cash guarantee to the owner. The owner can call on the
letter of credit on demand without cause. [^33] Once called upon, the
letter of credit converts to a payment to the owner and an
interest-bearing loan for the contractor. Bonds may be an expense that
you don't need to incur, and bonds may not even be available in the
amounts you would need at reasonable prices. [^34]

[Cap the Liquidated Damages]{.underline} -- The Contractor's maximum
risk must be clearly expressed in the contract so that the surety will
know how to price the risk. Damages should not be open-ended.
Additionally, if damages are expressed "per day," make the daily damages
accrue for *business days* only. Do not include Saturdays or Sundays
since you cannot take delivery on those days.

[Design-Build Projects]{.underline} -- For design-build projects and
large transit capital projects (those over \$200M) it would be advisable
to *talk to prospective sureties before the solicitation is issued to
see if the Design-Build contractors will have problems securing bonds
because of the size of the project*. There are two problems to be aware
of: (1) The lack of bonding capacity in the industry at the current
time, and (2) The fact that surety practice has historically been based
on the conventional *Design-Bid-Build* method, where design and
construction are performed by separate companies and where sureties have
detailed designs completed for which they can assess the performance
risks. On a Design-Build project, the lack of detailed designs desired
by sureties to evaluate project risk may make it difficult to obtain
performance bonds for the full value of the contract. When this is the
case, the grantee will want to involve their FTA regional office and
request a waiver from the standard bonding requirements. It should also
be noted that consultation with FTA would be advisable in any
design-build project to create a reasonable bonding strategy. In any
case, if a 100% bond were required by your agency, it would apply only
to the value of the construction work within the design-build contract.

[Technology]{.underline} - Surety companies like "brick and mortar"
business because they understand it. They are adverse to *technology
(e.g., projects requiring software development)*, and do not like to
bond the *Operation and Maintenance* phase of contracts where rail cars
are being bought with O&M responsibilities. If you are considering a
bond in these situations, you should contact prospective sureties to
determine if bonds will be available before you issue your solicitation.

[Notify Surety of Problems Early]{.underline} -- It is very important to
*notify the surety of problems as soon as they occur*. When the surety
is notified, and becomes involved, contractors are strongly motivated to
perform because the *threat of losing the ability to obtain bonds is a
very serious concern to contractors*.

If the Contractor is experiencing financial difficulties, the surety
will often provide working capital to keep the contractor going. This
*financial assistance* may occur without a formal declaration of default
by the owner. Another form of financial assistance often provided by
sureties is to guarantee a line of bank credit. This will assure a
steady flow of materials to the job site and payments to subcontractors.

Sureties frequently will provide *technical assistance* in order to
minimize problems and losses on a project. Many sureties employ
professional engineers, accountants, and other technical staff or
advisors who can help a contractor who is experiencing problems.

Sureties can provide *mediation between an owner and Contractor*. When
problems occur on a construction project, it's likely that the
relationship between the owner and Contractor is strained. The surety,
as a third-party participant, can investigate the issues that are
dividing the parties and offer workable solutions before the owner
declares a default.

Subcontractor failure is a frequent cause of a prime's problems.
Sureties can become involved in *assisting a subcontractor* with
financing and technical help, just as they do with the prime

contractors they are bonding. They will do this to protect their bonded
contractor from default. Once again, it is important that the surety be
informed early of performance problems on all levels of the project so
they can assist when circumstances require it.

[Subcontractor Bonds]{.underline} -- Grantees can help their prime
contactors manage risk by *requiring performance bonds from major
subcontractors*. If a subcontractor is a significant part of the job or
so specialized that it will be difficult to find a replacement, bonding
is a cost-effective way to limit the exposure of both the grantee and
the prime contractor.

Remember the important contribution of the surety in *prequalifying the
subcontractor.* This is an important step in ensuring that a responsible
subcontractor is selected by the prime for a critical role on the
project. While the cost of the subcontractor's bond will have to be paid
by the prime and will be passed on to the grantee, it is nevertheless an
insurance policy that can help avoid significant problems for the prime
and thus for the grantee. It is also well to keep in mind that a
subcontractor that is experiencing financial difficulties is more likely
to complete a bonded project because corporate assets, and possibly
personal assets, are at risk. This may be a singularly important factor
in keeping the subcontractor performing on the job. Be sure to
investigate the quality of the subcontractor's surety, using one of the
industry rating companies mentioned above, and always confirm the
authenticity of any bond presented.

Subcontractor bonding may also be beneficial when the prime contractor
is not financially strong. For example, New York City Transit (NYCT)
recently had a situation where the cost of a warranty bond was very
expensive to a vehicle manufacturer because of their financial
condition. In order to overcome this, the manufacturer had its major
parts supplier provide the bond, and as a result the manufacturer saved
\$2,000 per vehicle. The supplier's cost for the bonding was
significantly less since they were in excellent financial condition.

[Consider More Stringent Prequalification/Responsibility
Criteria]{.underline} ‑ If performance bonding is a problem because the
project is so large that few bidders can be fully bonded, or because of
its effect on competition, you can consider other ways of reducing your
agency\'s risk. You may (through prequalifying only strong bidders, or
requiring a high standard of responsibility) be able to reduce your risk
in a way that allows more competition than would result from a full
performance bond requirement.

[Balance the Costs of Bonding against Risks Present in a Range of
Contractors]{.underline} ‑ In addition to construction contracts,
specialty supply contracts that involve custom manufacturing, e.g., for
rail cars or buses, involve some risk of failure and consequences
similar to construction situations. However, performance bonds are far
less common in these situations than in construction contracts.
Information technology development contracts also hold the potential for
loss in the event of contractor failure, but performance bonding is less
common in developmental work because the risks of failing are too
expensive to insure and because the surety/contractor relationships have
not developed as they have in the construction industry.

If you are seriously concerned about one or more of the following,
considering your possible successful offerors, you can evaluate the need
for a performance bond, in light of its cost, its effect on competition,
and effect on DBEs:

-   financial strength and liquidity of the offerors,

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-   inadequacy of legal remedies for contractor failure and the effect
    that failure of the contractor could have on your agency,

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-   difficulty and high cost of completing the contractor\'s work if it
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-   experience of the contractor on other contracts -- whether there is
    a history of contract failure in a particular activity,

-   degree of technical difficulty; e.g., where new working methods are
    required.

[Consider Corporate Guaranty]{.underline} ‑ Where your concern is partly
that the proposers have limited financial resources, but they have
relationships with financially stronger corporate entities, you could
consider requiring a corporate guaranty of the contract rather than a
performance bond. In this case, the parent corporation of your
contractor, whose liquidity might rival the bonding company\'s, would
promise to perform the contract should the contracting corporation fail
to do so. This arrangement may not only be less expensive than a
performance bond, but may also result in more influence on the
contractor where contract disputes are involved.

[Return Unnecessary Bid Guaranty]{.underline} ‑ Because guarantees have
a financial impact on proposers as long as they are in effect, unused
bid guarantees should be returned to proposers as soon as it is
determined that they have no reasonable chance of winning the contract.
This is discussed in Section 4.3.3.3.2, \"Bid Guaranty.\"

[Surety Bond Claims and Counsel]{.underline} -- Before a surety will
assume responsibility for a contractor that you have defaulted, *the
surety must be satisfied that its contractor owes a debt.* *The surety
will conduct an investigation as a result of receiving your notice of
claim*. Keep in mind that the issues of default and claims under the
bond are predicated on the legal interpretation of a contractual
relationship, as developed through statutes and legal precedents. This
means it is critical that you seek legal assistance from counsel who is
familiar with surety bonds and construction, which is a specialized
field of law. Never rely on a layperson's interpretation of the
contract. *Experienced counsel can save time, money, and frequently,
unnecessary litigation.* The American Bar Association (ABA) Trial Tort
and Insurance Practice Section's Fidelity and Surety Law Committee
includes lawyers who specialize in surety law. Many state bar
associations also have surety committees or construction law committees.
For names of lawyers in your area, call the ABA (312) 988-5607 and ask
for the FLSC membership directory or the pages for a particular state,
or call the state bar association for a reference.

It is also of the utmost importance that you document the progress of
your project. Remember that the surety promises to complete the contract
when the "principal is in default of the contract and has been declared
to be in default by the obligee." Well documented project files will be
a great asset to facilitate the surety's initial investigation and
especially if the matter goes to court. See BPPM Section 11.2 --
*Claims, Grievances and Other Disputes With Contractors,* paragraph
titled "Avoiding Disputes Through Proper Documentation."

[Indemnification Clauses]{.underline}-- One of sureties' concerns in any
construction contract today is the increasingly broad and unlimited
indemnity that contractors are contractually required to provide. If
this indemnification is needed to satisfy political constituencies or
due to other factors, clearly stating that the liability is to be
covered through insurance and not the performance and/or payment bond
would eliminate one potential obstacle that sureties sometimes raise as
an underwriting road block.

Grantees should not assume that contractual indemnification, whereby the
contractor agrees to indemnify and hold the grantee harmless from and
against various risks, is an adequate substitute for bonds or insurance.
These contractual promises are only as good as the contractor's
financial resources backing them. If the contractor fails to perform the
contract, it is likely that the contractual indemnification provisions
will be of little value. It is important, therefore, to ensure the
contractor is bonded or has adequate insurance to support the
indemnification clauses in the contract.

[Resources]{.underline} -- Following is a list of organizations offering
information and resources related to surety bonds and insurance:

1.  Surety Information Office (SIO)

> 5225 Wisconsin Avenue NW, Suite 600
>
> Washington, DC 20015-2014
>
> \(202\) 686-7463
>
> [www.sio.org](http://www.sio.org/)
>
> SIO is the information source on contract surety bonds in public and
> private construction. SIO is supported by The Surety Association of
> America and the National Association of surety Bond Producers.

2.  National Association of Surety Bond Producers (NASBP)

> 5225 Wisconsin Avenue NW, Suite 600
>
> Washington, DC 20015-2014
>
> \(202\) 686-3700
>
> [www.nasbp.org](http://www.nasbp.org/)
>
> NASBP is the international organization of professional surety bond
> producers and brokers. NASBP represents more than 5,000 personnel who
> specialize in surety bonds for the construction industry and other
> types of bonds such as license and permit bonds.

3.  The Surety Association of America (SAA)

> 1101 Connecticut Avenue NW, Suite 800
>
> Washington, DC 20036
>
> \(202\) 463-0600
>
> [www.surety.org](http://www.surety.org/)
>
> SAA is a voluntary, non-profit, incorporated association of companies
> engaged in the business of suretyship. SAA represents more than 500
> companies that collectively underwrite the majority of suretyship and
> fidelity bonds in the United States.

4.  U.S. Department of the Treasury

> [www.fms.treas.gov/c570](http://www.fms.treas.gov/c570)
>
> This website offers a free download of the Federal Treasury List
> (Circular 570), which lists all surety companies qualified to
> underwrite surety bonds on federal construction.

5.  The International Risk Management Institute (IRMI)

> [www.irmi.com](http://www.irmi.com/)
>
> The IRMI site offers articles and information on surety bonds and
> other risk management tools, along with contact information for risk
> management professionals and advisors. The Expert Commentary section
> includes more than 500 articles on a variety of risk management
> issues.

6.  The National Association of Insurance Commissioners

> [www.naic.com](http://www.naic.com/)
>
> The National Association of Insurance Commissioners site verifies that
> a surety company is licensed to conduct business in a particular
> state, and provides access to state insurance department websites.

7.  The Risk & Insurance Management Society

> [www.rims.org](http://www.rims.org/)
>
> The Risk & Insurance Management Society website offers a number of
> helpful tools to assess and manage risk.

8.  U.S. Small Business Administration (SBA)

> [www.sba.gov/osg](http://www.sba.gov/osg)
>
> The SBA website offers information on the Surety Bond Guarantee
> Program, including free copies of forms required to be submitted for
> approval into the program and contacts for local SBA offices.

**8.2.2 [Options]{.underline}**

+-----------------------------------------------------------------------+
| **REQUIREMENT**                                                       |
+-----------------------------------------------------------------------+
| § 9.i. of FTA Circular 4220.1E requires grantees to evaluate options: |
|                                                                       |
| > \(1\) [Evaluation of Options]{.underline}. The option quantities or |
| > periods contained in the contractor\'s bid or offer must be         |
| > evaluated in order to determine contract award. When options have   |
| > not been evaluated as part of the award, the exercise of the        |
| > options will be considered a sole source procurement.               |
| >                                                                     |
| > \(2\) [Exercise of Options]{.underline}.                            |
| >                                                                     |
| > \(a\) A grantee must ensure that the exercise of an option is in    |
| > accordance with the terms and conditions of the option stated in    |
| > the initial contract award.                                         |
| >                                                                     |
| > \(b\) An option may not be exercised unless the grantee has         |
| > determined that the option price is better than the prices          |
| > available in the market or that the option is the more advantageous |
| > offer at the time the option is exercised.                          |
|                                                                       |
| § 7.m. of FTA Circular 4220.1E states that:                           |
|                                                                       |
| > Grantees shall not enter into any contract for rolling stock or     |
| > replacement parts with a period of performance exceeding five (5)   |
| > years inclusive of options.                                         |
+-----------------------------------------------------------------------+

**DEFINITIONS**

[Option]{.underline} ‑ A unilateral right in a contract by which, for a
specified time, a grantee may elect to purchase additional equipment,
supplies, or services called for by the contract, or may elect to extend
the term of the contract.

**DISCUSSION**

**If you include terms in a contract that permit you to choose, at the
time of award or later, quantities and items in addition to the base
amount (options), you must include the price of those quantities or
items in the price evaluation of the offer before selecting an apparent
low bidder or determining the competitive range for negotiations.
Otherwise you may not use Federal funds for the additional quantity
without a separate, non‑competitive procurement process (i.e.,
processing as a sole-source procurement).**

**If you include the price in the evaluation and later choose to order
the additional quantities or items, you must again review the prices to
ensure that they are advantageous.**

**Purpose**

Options are most often used where there is uncertainty as to the
quantity of goods and services you will require under a contract. Rather
than planning a separate, later procurement when the requirement becomes
certain, and incurring potential delays in delivery of the items because
of the procurement lead-time to buy additional items, you may want to
specify the option to buy more in your present contract. Options may
also be appropriate when there is a need for standardization of parts or
interchangeability and it is best to get proposers to bid competitively
on the entire potential need at the time of the first procurement,
rather than processing a sole-source add-on at a later date when the
supplier will be under no competitive pressures.

Another common use of options is to fit a construction project to a
budget. For example, a number of elective items such as additional
landscaping, signage that could be purchased separately, and a higher
quality, lower maintenance finish are specified as options in a
construction solicitation. When the bids are evaluated, you can elect
the base construction plus those options that can be procured with the
available funds. Those options that are not purchased under the basic
contract would be established as options and ordered when future funding
becomes available. When this approach is used, the optional items are
often called \"deductible options\". In this case, the stated bid amount
already includes the options, and each option is associated with a
deduction from the stated bid. This method generally caries the clear
implication to the offerors that the cost of optional items will be
evaluated in determining the successful bid. If you award the contract
minus certain options, and then wish later to add those optional items
back, you must comply with the requirement to make a new determination
that the option prices are advantageous.

**Best Practices**

Whenever the option quantities are a significant portion of the total
potential requirement, you should carefully consider whether a
*requirements* or *indefinite delivery* type of contract would better
suit your circumstances and needs. A *requirements* contract would
provide for filling all of your requirements for certain supplies or
services during a specified time period by placing orders with the
contractor who wins the competition. Your solicitation and contract
would state what you believe to be a realistic estimated total quantity
but you would not be legally required to order that quantity. The
contract would also state the maximum limit of the contractor\'s
obligation to deliver as well as the minimum quantities that you may
order under an individual order. The contract would contain
competitively bid, fixed unit prices for the items being procured.

An *indefinite quantity* contract works like the *requirements* contract
above except that you do not obligate your agency to fill all of your
requirements for a particular supply or service from any given
contractor.

Orders placed under a requirements or indefinite delivery contract are
not treated as sole-source procurements and do not have to be evaluated
like option orders and found to be advantageous from a price standpoint
before being placed.

When options are justified by the degree of uncertainty, the difficulty
of conducting a separate procurement in a timely manner, or the
importance of a single source, then include in your solicitation a clear
statement that the full option price will be included in your evaluation
of prices to determine the lowest bid.

When options may be exercised at a time of your choosing over a long
contract period, you may wish to reduce the offeror\'s risk by including
a price escalation provision. Consumer price indices or other indices of
prices germane to your suppliers may be obtained from the Bureau of
Labor Statistics of the U.S. Department of Labor.

In the case of rolling stock and similar custom equipment for which you
have an ongoing need, you may find that the advantage of having an
option for identical equipment at a predetermined price outweighs the
pricing difficulties introduced by options.

You may also benefit from a competitive procurement conducted by another
transit agency by asking that agency to specify optional quantities for
rolling stock you expect you may need in the same time frame as the base
procurement. The advantage of specifying your options in the other
agency\'s original solicitation, rather than piggy‑backing after the
offers are submitted, is that you will take advantage of a competitive
environment instead of a sole-source add on at a later date.

**8.2.3 [Liquidated Damages]{.underline}**

+-----------------------------------------------------------------------+
| ##### REQUIREMENT                                                     |
+-----------------------------------------------------------------------+
| § 13 of FTA Circular 4220.1E states:                                  |
|                                                                       |
| > A grantee may use liquidated damages if it may reasonably expect to |
| > suffer damages from late completion and the extent or amount of     |
| > such damages would be difficult or impossible to determine.         |
| >                                                                     |
| > The assessment for damages shall be at a specific rate per day for  |
| > each day of overrun in contract time; and the rate must be          |
| > specified in the third party contract. Any liquidated damages       |
| > recovered shall be credited to the project account involved unless  |
| > the FTA permits otherwise.                                          |
+-----------------------------------------------------------------------+

**DEFINITION**

[Liquidated Damages]{.underline} ‑ Liquidated damages are a specific sum
(or a sum readily determinable) of money stipulated by the contracting
parties as the amount to be recovered for each day of delay in delivery
of the product or completion of the contract. They do not represent
actual damages but are established in the initial contract as a
substitute for actual damages. They should represent, however, the most
realistic forecast possible of what the actual damages are likely to be.

**DISCUSSION**

**Liquidated damages are a widely used method of ensuring contractors
perform timely. These provisions are regularly used in construction
contracts and sometimes in supply and service contracts.**

**Liquidated damages clauses are most appropriately used when:**

-   **The time of delivery or performance is of particular importance
    and you may reasonably expect to suffer damage if the delivery or
    performance is delinquent; and**

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-   **The extent or amount of such damage would be difficult to prove.**

When determining whether to use a liquidated damages clause, you will
wish to consider such factors as:

-   **The probable effect on pricing and competition; and**

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-   **The costs and difficulties of contract administration.**

**Liquidated damages may be used for supplies, services and
construction.**

**Best Practices**

[Rate Determination]{.underline} ‑ The rate of liquidated damages must
be a reasonable estimate to compensate for possible damages and not be
so large as to be construed as a penalty. If it is construed as a
penalty it will be held unenforceable. The most prudent approach is to
formulate the liquidated damages on a case-by-case basis. You will find
it useful to briefly document the calculation of the rate of damages
each time you use liquidated damages in a contract and keep the
documentation on file. Appendix B.3 is an example of a *Liquidated
Damages Checklist* being used by a Transit Authority. [^35] Once
liquidated damages are included in a contract, you will be unable to
recover actual damages in many jurisdictions.

[Application]{.underline} ‑ When it is determined that a liquidated
damages clause will be included in the contract, the applicable clause
and appropriate rate(s) must be contained in the solicitation. For
construction contracts, the rate to be assessed can be for each day of
delay, and the rate typically, at a minimum, covers the estimated cost
of inspection and superintendence for each day of delay in completion.
If you will suffer other specific losses due to failure of timely
completion, the rate can also include an amount for these items (for
example, the cost of substitute facilities or the rental of buildings or
equipment). The contract may include an overall maximum dollar amount or
period of time, or both, during which liquidated damages may be
assessed. This will help ensure that there is not an unreasonable
assessment of damages.

*It is important to note, that in your establishment of liquidated
damages, you may use whatever consequential damages may result from a
failure to deliver or perform, even damages for items which are not
within the scope of the grant. However, it must be understood that all
liquidated damages collected from the contractor must be credited to the
grant and treated as a reduction to the allowable costs of the grant, in
accordance with § 13 of FTA Circular 4220.1E. This will have the effect
of making the funds collected (or the contract price reduction taken)
available to the grantee for other activities/costs which are within the
scope of the grant. In other words, while you may use the incurred cost
of activities which are not within the scope of the grant to estimate
and establish liquidated damages amounts, you will not be able to
directly apply the collected damages to those impacted activities unless
they are within the scope of the grant. The funds returning to the
grantee must be credited to the grant where they become available for
other activities which are within the scope of the grant.*

[Collection]{.underline} ‑ If your agency has a financial obligation to
the contractor under the contract, you may simply credit the amount of
liquidated damages due from the contractor to your agency as payment by
your agency of part of its remaining obligation to the contractor. Some
contracts in which liquidated damages are particularly critical contain
retainage provisions which are activated when liquidated damages are
anticipated. In most jurisdictions you may also have a right of offset
to credit the liquidated damages as payment to the contractor under
other contracts it holds with your agency. If you decide to pursue this
approach be sure you comply with the FTA approval requirements in
Circular 4220.1E concerning the crediting of the project account with
the amount of the liquidated damages. Finally, like any claim, you may
settle your claim for liquidated damages in exchange for credit on
future purchases such as spare parts or other items within the scope of
the contract.

[Excusable Delay]{.underline} ‑ Contracts with liquidated damages
clauses should also contain excusable delay clauses. These typically
provide that if the contractor is delayed by certain specified causes
that are beyond the contractor\'s control (e.g., weather, strikes,
natural disasters) then the resulting delay is excused and liquidated
damages will not be assessed. Whenever a contractor incurs liquidated
damages, the precise counting of each day\'s delay based on these
conditions directly affects the sum paid; therefore, it is worth making
the calculation of delay in your contracts as clear as possible. When
excusing construction delay caused by rainfall beyond normal, for
example, you may specify in the contract what normal rainfall is and how
the number of days of greater than normal rainfall will be computed.

[Substantial Completion]{.underline} - Liquidated damages are not
assessed after the date on which the work is substantially completed.
Substantial completion is usually defined as the time when the
construction site or the supplies delivered are [capable of being used
for their intended purposes]{.underline}. [^36] There is no
predetermined percentage that will establish substantial completion and
the decisions place more emphasis on the availability of the work for
its intended use than on the use of formulas as to the percentage of
completion of the work. [^37]

**8.2.3.1 [Relationship with Default Termination]{.underline}**

**DISCUSSION**

**When a contract containing liquidated damages is terminated for
default the contractor will be liable for both liquidated damages and
the excess costs of reprocurement (i.e., the amount by which the
replacement contractor\'s price exceeds the terminated contractor\'s
price). You have an obligation to the defaulting contractor to mitigate
both his liquidated damages and the excess reprocurement costs. This
means that you need to not unduly delay your termination for default
action once the contractor is in default, and you will need to take
expeditious action to resolicit bids/proposals for the supplies or work
not performed. The time period for the liquidated damages will be the
time between the contractually required date of completion of the
defaulted contract and the actual completion date of the new contract
[assuming there is no unreasonable delay in awarding the new
contract]{.underline}. Contractors will not be assessed liquidated
damages for any period of delay caused by your agency. This
reprocurement must not only be done expeditiously to mitigate liquidated
damages but must also be in accordance with sound procurement
procedures, producing a fair and reasonable price, so as to mitigate
excess reprocurement cost damages. The contract to reprocure should be
awarded competitively, with bids/offers solicited from a sufficient
number of competent potential sources to ensure adequate competition.**

**8.2.4 [Intellectual Property Rights]{.underline}**

**8.2.4.1 [Disclosure of Trade Secrets]{.underline}**

**DEFINITIONS**

[Trade Secret]{.underline} ‑ A plan, process, tool or other intellectual
property which is used in some process of commercial value and which is
known to a group of individuals who have been intentionally restricted
by the trade secret owner. The key attribute of a trade secret is that
the owner has

diligently and effectively restricted knowledge so that its competitors
cannot obtain the information.

**DISCUSSION**

**If you gain access to trade secrets either to evaluate the offer or to
use and support use of the product or service, you may undertake an
obligation to protect the trade secret. More particularly, there may be
a direct conflict between the supplier\'s interest in the trade secret,
and sunshine laws that require you to disclose any information upon
request. By not retaining the proprietary documents or by use of
intermediaries, you may be able to reduce the potential for a violation
of trade secrets.**

**The laws permitting public access to government data vary by state. It
is helpful to contractors to disclose your obligations under the laws in
any solicitation document which calls for you to receive confidential
information from a supplier. Consideration for the suppliers\'
legitimate interests will be an important factor in their continuing
willingness to participate in your programs.**

**Best Practices**

[Return Data]{.underline} ‑ One method of accommodating the supplier\'s
interest in the confidentiality of the data is to return all the
documents to the supplier. This is particularly feasible at the
conclusion of a procurement in which you have been evaluating known
trade secrets.

[Inspect Data Off Site]{.underline} ‑ If concerns about trade secrets
and confidential information are particularly acute, you may find it
advantageous to visit the contractor\'s premises and inspect the
information or materials there, returning with only the minimum
necessary data in recorded form.

[Third Parties]{.underline} ‑ Another way to resolve the conflict is to
use a third party (e.g., one of your advisors) to evaluate the data or
retain the data. The possession of data by an agent of a public agency
is sometimes also subject to action under public access laws. However,
this method is common in software licensing agreements, where a trustee
retains confidential source code data until specified conditions occur
under which the supplier has agreed that the data can be disclosed to
the public agency.

[Opportunity to Defend]{.underline} ‑ A final strategy is to incorporate
into your contract clauses a provision granting (or requiring, depending
on the circumstances) the owner of the trade secret the ability to
defend your agency in any action against your agency to force
disclosure. Often, this takes the form of the contractor indemnifying
your agency for your cost in defending against disclosure, or, at your
agency\'s option, the contractor\'s own attorneys undertaking the
defense.

**8.2.4.2 [Contract Work Products, Patents, and
Copyrights]{.underline}**

+-----------------------------------------------------------------------+
| ##### REQUIREMENT                                                     |
+-----------------------------------------------------------------------+
| ::: Definition-Term                                                   |
| Appendix A.1 of this Manual contains the requirements for             |
| intellectual property rights created under research and development   |
| contracts. These requirements apply only where a primary purpose of   |
| the contract is research or development.                              |
| :::                                                                   |
+-----------------------------------------------------------------------+

**DISCUSSION**

**In research and development contracts, you are required to obtain
certain rights in the intellectual property created for FTA, and also,
incidentally, to obtain indemnification for**

**FTA in case the contractor violates another\'s rights. A clause
satisfying these requirements is contained in Appendix A.1.**

**In contracts that are not primarily research and development
contracts, you may also consider including portions of these provisions
for your agency\'s own benefit. You may consider this where intellectual
property (e.g., computer software) will be developed with your funds as
part of a larger effort which is not developmental.**

**In contracts that involve the use but not the development of
intellectual property (e.g., the use of patented equipment)
indemnification against the contractor\'s violation of another\'s rights
may be advantageous.**

**Best Practices**

[Indemnification]{.underline} ‑ The indemnification provision, in case
the contractor violates the intellectual property rights of a third
party, (e.g., reproduces copyrighted material or incorporates a patented
device in your equipment) is a useful provision wherever intellectual
property is involved. Even though you may have little knowledge of the
intellectual property the contractor is using, the intellectual property
owner may name you in the suit and you may have more funds to pay
damages than does your contractor.

[Secure Support Rights]{.underline} ‑ When you take delivery of
intellectual property which you will need for your program, you will
also need to carefully anticipate and define your agency\'s rights to
use, modify, or disseminate the material to others. If licenses control
the software or patents control the components of your vehicles, you may
wish to obtain the right to reproduce the intellectual property for your
agency\'s own internal use, without the right to resell it or distribute
it outside your agency. Whether the contractor is willing to grant that
right depends on the practices in the industry, the competitive value of
the intellectual property, and the contractor\'s policies. If a practice
is not well‑established, the matter may have to be addressed in pre‑bid
discussions or in negotiations. Where the contractor is unwilling to
grant access except through additional purchases, the contractor may be
willing to place the intellectual property in a trust arrangement
whereby the trustee would grant you access in case of the contractor\'s
demise or inability to support your ongoing use of the product.

[Evolving Law]{.underline} ‑ The law of intellectual property,
particularly as it pertains to information technology, is evolving
rapidly. If you are involved in procuring software or other intellectual
property with any substantial value, you may wish to have attorneys who
are current in this area review your contract provisions.

**8.2.5 [Termination]{.underline}**

+-----------------------------------------------------------------------+
| **REQUIREMENT**                                                       |
+-----------------------------------------------------------------------+
| § 15.b of FTA Circular 4220.1E requires grantees to include           |
| provisions in their contracts and subcontracts that allow for:        |
|                                                                       |
| > b\. Termination for cause and for convenience by the grantee or     |
| > subgrantee including the manner by which it will be effected and    |
| > the basis for settlement. (All contracts in excess of \$10,0000.)   |
+-----------------------------------------------------------------------+

**DISCUSSION**

**It is sometimes necessary to end a contractual relationship prior to
the completion of the work called for in the contract. In the public
sector, when that relationship is ended because of a problem with the
contractor\'s compliance with one or more terms of the contract, that
termination is most commonly referred to as a *termination for default
or a termination for cause*.**

**When the public agency decides to end the contract for a reason other
than the default of the contractor, that termination is most frequently
referred to as a *termination for the convenience of the public
entity*.**

**If you do not plan for the possibility of one or the other of these
events occurring in your contractual relationships, through the careful
drafting of clauses which define the rights and** **obligations of the
parties under a default and convenience situation, the consequences can
be substantial from a monetary and contract performance standpoint.**

**Because of the nature of the different types of contracts, you may
want to consider having different termination clauses for fixed price as
opposed to cost reimbursement contracts.**

**Because of the different nature of the product or services being
bought, you may want to have different termination clauses for
construction, supply, and services contracts, including professional
services.**

You may want to have an abbreviated termination clause for contracts
below a dollar threshold (say \$100,000). Likewise for purchase orders,
you will need to decide how sophisticated you want these to be.

**You need to address *partial* as well as *complete* terminations.**

**8.2.5.1 [Termination For Convenience]{.underline}**

**DISCUSSION**

**The development of clauses allowing the government to terminate
contracts for its convenience was a necessity growing out of the major
wars and the need to end the large number of procurement contracts once
the wars were ended. Without such clauses the government could terminate
its contracts but such action constituted a breach. This meant having to
pay profits to contractors on unperformed work (anticipatory profits).
Thus the need for and the development of these convenience termination
clauses, which give the government the right to terminate without cause
and which limit the contractor\'s recovery of profit based upon the work
actually performed up to the point of termination.**

**Best Practices**

You will note that the FTA Circular requires a clause which defines
\"the manner by which the termination will be effected and the basis for
settlement\". Appendix A.1, Model Contract Clauses, section 21, contains
model clauses with suggested language for both convenience and default
terminations. These model clauses are very broad in their definition of
the basis for settlement. For example, while the clauses clearly limit
the contractor\'s profit to work actually performed, and they commit to
pay the contractor its costs, they do not define how those costs will be
determined, i. e., the *cost principles* which will be used to determine
allowable costs. [It is highly recommended that you supplement these
clauses to stipulate the *cost principles* which will be operative in
the event of a termination]{.underline}, and which will determine which
costs are allowable and which are not. By using an objective and clearly
defined method for determining allowable costs you will avoid problems
which may otherwise arise in the negotiation of final costs.

The American Public Transit Association has published a procurement
manual with a Termination for Convenience Clause referencing Part 49,
*Termination of Contracts*, of the Federal Acquisition Regulations (48
CFR 49) as the basis for settlement of claims. [^38] Another approach is
to reference the FAR, Part 31.205, which deals very comprehensively with
*Selected Costs* and their allowability. [^39]

The APTA approach of referencing FAR Part 49 as the basis for settlement
of terminations for convenience would seem to be a very effective
solution to the problem of defining the basis for settlement. Part
49.113 of the FAR incorporates Part 31, *Contract Cost Principles and
Procedures,* thus covering all the normal cost issues which arise on
cost- type contracts, but going beyond the normal to define those costs
and issues peculiar to terminations in the rest of FAR Part 49. The
termination clauses themselves may be found in FAR Part 52, and you will
see that they refer to both Part 31 and Part 49 of the FAR in order to
define the cost standards to be used for the settlement.

Suggested termination clauses are also contained in the ABA\'s *Model
Procurement Code for State and Local Governments* and implementing
suggested regulations. [^40]

**8.2.5.2 [Partial Terminations]{.underline}**

**DISCUSSION**

**Your Termination for Convenience clause must include a provision
allowing for a partial termination of the work, in which case the
contractor must continue with the unterminated portion. The Federal
government clause at FAR 52.249-2(k) allows the contractor to file a
proposal for an equitable adjustment of the price(s) for the continued
portion of the contract. Note that the model clauses in Appendix A.1 do
not address this issue of an equitable price adjustment for the
continued work, and you should consider this provision as a matter of
equity to the contractor. This price adjustment would allow the
contractor to recover those costs of a fixed nature which he would have
recovered in the prices of the terminated work, had there been no
termination. This is not anticipatory profit but recovery of fixed
overhead.** [^41] **An example might be the rental of a facility whose
costs would have been recovered over all the deliverable units of the
original contract but which can only be recovered over a smaller number
of units on the partially terminated contract, assuming you allow a
price adjustment for the unterminated portion of the contract.**

**8.2.5.3 [Termination for Default]{.underline}**

**DISCUSSION**

**[Fixed Price Supply Contracts]{.underline} - If you are using a
default termination clause similar to the federal clauses, the
termination is likely to have the following effects:**

-   **Your agency is not liable for the costs of unaccepted work. The
    contractor will only be paid for work which you accept.**

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-   **You are entitled to a return of all progress, partial, or advance
    payments.**

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-   **You have the right to take custody of the contractor\'s material,
    inventory, construction plant and equipment at the site, and of the
    drawings and plans, with the price to be negotiated.**

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-   **The contractor will be liable for the excess costs of
    reprocurement or completion.**

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-   **The contractor will be liable for either actual damages or
    liquidated damages if your contract provides for them.**

**[Services and Construction Contracts]{.underline} - Some of the above
consequences for supply contracts are also applicable to services and
construction contracts but a contractor furnishing services or
construction will be entitled to payment for work that was properly
performed prior to the default termination. Under supply contracts the
contractor will not be paid costs for producing supplies not accepted,
whereas services and construction contractors can recover costs because
your agency will be seen as having benefited from the contractor\'s
partial performance in the services rendered or the improvements made to
your property.** [^42]

**Best Practices**

[Defining \"Default\"]{.underline} - The clause must define what
\"default\" means ‑‑ i.e., failure to deliver the supplies or perform
the services within the time specified in the contract, failure to make
progress so as to endanger performance of the contract, refusal or
failure in a construction contract to prosecute the work or any
separable part within the time specified in the contract.

[Excess Reprocurement Costs]{.underline} - The model contract clauses in
section 21 of Appendix A.1 include default termination clauses for
various types of contracts. You will need to decide if you wish to hold
the contractor responsible for excess reprocurement costs and include an
appropriate provision in your clause. Only the construction contract
termination clause \[21.(h)\] in Appendix A.1 includes excess
reprocurement costs.

The APTA bus procurement *Guidelines* at § 2.2.6.2 (see note 20 in this
chapter) include a provision for excess reprocurement costs for
\"similar supplies or services.\"

[Excusable Reasons for Non-performance]{.underline} - The clause
typically defines acts or events that will excuse the contractor\'s
default ‑ i.e., causes beyond the control and without the fault or
negligence of the contractor, such as acts of God, unusually severe
weather, etc.

[Conversion to Convenience Termination]{.underline} - If you terminate a
contract for default, and it is later determined that the contractor was
not in default or that the default was excusable, it would be very
helpful if your default termination clause specifically stated that the
termination will be treated as if it had been issued for the convenience
of the agency. This will act to limit your liability for a wrongful
termination by invoking the procedures of the convenience termination
clause, thus precluding the contractor from recovering anticipatory
profits. The default termination clauses in Appendix A.1 contain this
stipulation.

[Notice Provisions]{.underline} - The clause typically defines what kind
of written notices, if any, must be furnished to the contractor prior to
the termination taking place ‑ i.e., *cure* and *show* *cause* letters.
Within a specified time after you notify the contractor in writing to
*cure* the deficiency in performance, the contractor has the opportunity
(without jeopardy of immediate termination) to *show cause* why it
should not be terminated; it may accelerate performance, present new
information, or offer additional promises. If the contractor does not
successfully show that it should not be terminated, your agency may then
proceed with a termination for default. If your clause grants the
contractor a cure period, you may wish to specify exceptions such as
where default is necessary to take over the work in the interest of
public safety.

**Acronyms**

ASBCA - Armed Services Board of Contract Appeals

BCA - Board of Contract Appeals

IBCA - Department of Interior Board of Contract Appeals

PSBCA - Postal Service Board of Contract Appeals

[^1]: \- Although the relevance of that law will vary from state to
    state, most individual states will not have interpreted federal
    statutes and clauses and will frequently look to the federal common
    law, as interpreted by the Comptroller General of the United States
    and the various boards and courts, for guidance in interpreting that
    law and those clauses.

[^2]: \- The Model Procurement Code and recommended Regulations may be
    available in your local public library or may be purchased from the
    American Bar Association. It is recommended that you contact the
    following for further information: Member Services, P.O. Box 10892,
    Chicago, Illinois 60612‑0892.

[^3]: \- Act of March 3, 1931, 46 Stat. 1491, as amended; codified at 40
    U.S.C. § 276a et seq.

[^4]: \- For a thorough discussion of the labor standards for contracts
    involving construction, *see* FAR Subpart 22.4.

[^5]: \- See generally, FAR § 22.404‑2(c) for discussion of the
    different types of construction.

[^6]: \- In a *Federal Register* Notice of June 14, 1996, the Chief,
    Branch of Construction Wage Determinations advised that wage
    determinations issued under the Davis‑Bacon and related Acts are
    available electronically by subscription to the FedWorld Bulletin
    Board System of the National Technical Information Service (NTIS) of
    the U.S. Department of Commerce. A telephone contact is (703)
    487‑4630.

[^7]: \- The same Notice advised that hard-copy subscriptions may be
    purchased from the Superintendent of Documents, U.S. Government
    Printing Office, Washington, DC 20402, with a telephone contact at
    (202) 512-1800.

[^8]: \- The cost of the hard‑copy subscription (between \$440 and \$830
    per volume) is a minuscule investment for your project library when
    considering the contractual impacts of the wage determinations,
    which will be discussed below.

[^9]: \- The procedures to be followed in requesting these
    determinations are found in 29 CFR Part 1 and in FAR § 22.404‑3.

[^10]: \- In this case, the grantee has the discretion, depending upon
    the terms of their solicitation documents, to either award to the
    low bidder at the price bid, or to equitably adjust the contract
    price for any increased or decreased cost of performance resulting
    from any changed wage rates.

[^11]: \- Rules relating to expiration of wage determinations are
    discussed in detail at FAR § 22.404‑5.

[^12]: \- If award of the contract is not made within 90 days after bid
    opening, the modification becomes effective unless the Wage and Hour
    Division Administrator extends the 90 day period. If an extension is
    not granted, the modification is treated the same as a new wage
    determination and the same procedures as discussed above apply.

[^13]: \- Rules relating to actions to be taken by the contracting
    officer in the event wage determinations are modified may be found
    in FAR § 22.404‑6.

[^14]: The Miller Act does not apply to grantees. Bonding requirements
    for grantees are prescribed in the common grant rule, 49 CFR
    §18.36(h).

[^15]: The National Association of Surety Bond Producers (NASBP) web
    site address is: [www.nasbp.org](http://www.nasbp.org/).

[^16]: An unforeseen bankruptcy by the contractor is especially
    troublesome, in that the bankruptcy court could freeze the funds
    committed by the LOC, rendering the LOC of no value to the grantee*.
    The grantee must be diligent to monitor the contractor's condition,
    and call the funds under the LOC if financial trouble is expected.
    There is no such danger with surety bonds.*

[^17]: It is not until one goes to the 20% level that premium rates may
    change.

[^18]: This appears to be true for bus manufacturers in the current
    business environment.

[^19]: To locate a state insurance department contact the National
    Association of Insurance Commissioners at
    [www.naic.org](http://www.naic.org/). See also the U.S. Treasury
    List at
    [www.fms.treas.gov/c570/index.html](http://www.fms.treas.gov/c570/index.html)

[^20]: The Treasury List may be downloaded on the Internet at
    [www.fms.treas.gov/c570/index.html](http://www.fms.treas.gov/c570/index.html).
    The Treasury List identifies the various states where the listed
    bonding companies are licensed and the state insurance departments
    with their phone numbers.

[^21]: For more information about the SAA's Model Contractor Development
    Program, contact the Surety Association of America at 202-463-0600
    or their Web site: [www.surety.org](http://www.surety.org/).

[^22]: For this and other materials, contact the Surety Information
    Office at 202-686-7463 or their Web site:
    [www.sio.org](http://www.sio.org/).

[^23]: Information and prices are available at
    [www.ambest.com](http://www.ambest.com/).

[^24]: [www.dunandbradstreet.com/us](http://www.dunandbradstreet.com/us).

[^25]: [www.fitchratings.com](http://www.fitchratings.com/).

[^26]: [www.moodys.com](http://www.moodys.com/).

[^27]: <http://www2.standardandpoors.com/servlet/Satellite?pagename=sp/Page/HomePg>.

[^28]: [www.weissratings.com](http://www.weissratings.com/).

[^29]: The language in this section has been amended from prior versions
    of the circular to better explain that FTA will accept a local
    bonding policy that meets the minimums of paragraphs a, b, and c but
    that a policy that does not meet these minimums still may be
    accepted where the local policy adequately protects the Federal
    interest. Grantees who wish to adopt less stringent bonding
    requirements generally, for a specific class of projects, or for a
    particular project may submit the policy and rationale to their
    regional office for approval.

[^30]: See FTA Dear Colleague Letter C-01-04, dated Jan. 20, 2004 --
    *Performance and Payment Bonding Requirements.*

[^31]: Transit agencies procuring rolling stock tend to ask for ten year
    warranties on parts.

[^32]: At [www.surety.org](http://www.surety.org/), click on "About the
    Industry," then "Bond Authenticity Program."

[^33]: A *conditional letter of credit* may require some burden of proof
    by the owner that the contractor has failed to perform before the
    bank will pay on the letter of credit. Most letters of credit are
    *irrevocable*, which means that both parties must agree to any
    changes to the letter of credit. Changes must be documented by an
    amendment signed by both parties.

[^34]: See BPPM Sections 2.4.4.2 -- *Advance Payments* and 2.4.4.3 --
    *Progress Payments* where adequate security for these payments is
    discussed.

[^35]: \- Bay Area Rapid Transit District (BART) Procurement Manual,
    Rev. 4, July 20, 1994, Attachment Y.

[^36]: \- Theon v. United States, 765 F.2d 1110 (Fed. Cir. 1985);
    Central Ohio Bldg. Co., PSBCA 2742, 92-1 BCA ¶ 24,399.

[^37]: \- Electrical Enters., Inc., IBCA 972-9-72, 74-1 BCA ¶ 10,400.

[^38]: \- American Public Transit Association, 1201 New York Avenue, N.
    W., Suite 400, Washington, D. C. - *Standard Bus Procurement
    Guidelines* § 2.2.6.1, January 1997. Phone: (202) 898-4089 to order
    copies.

[^39]: \- Washington Metropolitan Area Transit Authority - *Procurement
    Procedures* *Manual* § 1311.2, Dec. 1994.

[^40]: \- See the discussion of how this publication may be obtained in
    Note 3 under Section 8.1.1.

[^41]: \- Wheeler Bros., ASBCA 20465, 79-1 BCA § 13,642.

[^42]: \- John Cibinic, Jr. and Ralph Nash, Jr. *Administration of
    Government Contracts,* Third Ed. Washington, D.C.: George Washington
    University, 1995.