This article explores Federal Acquisition Regulation (“FAR”) 28.106-5 and its effect on limiting the ability of the United States government to increase a Miller Act surety’s bond coverage without the surety’s consent. FAR 28.106-5 provides a clear requirement that Consent of Surety is required for contract modifications over $50,000 or 25% of contract value. This Consent of Surety requirement is a powerful sword for the Miller Act surety when negotiating with the government, both before and after a default termination of its principal.
Overview of FAR 28.106-5
FAR 28.106-5 provides as follows:
28.106-5 Consent of surety.
(a) When any contract is modified, the contracting officer shall obtain the consent of surety if –
(1) An additional bond is obtained from other than the original surety:
(2) No additional bond is required and –
(i) The modification is for new work beyond the scope of the original contract; or
(ii) The modification does not change the contract scope but changes the contract price (upward or downward) by more than 25 percent or $50,000; or
(3) Consent of surety is required for a novation agreement (see Subpart 42.12).
(b) When a contract for which performance or payment is secured by any of the types of security listed in 28.204 is modified as described in paragraph (a) of this subsection, no consent of surety is required.
(c) Agencies shall use Standard Form 1414, Consent of Surety, for all types of contracts.
Advantages Offered By FAR 28.106-5
FAR 28.106-5 provides the Miller Act surety with protection from excessive government-initiated contract modifications by assuring that the original underwriting expectations are not changed without the surety’s consent. Consider the following example: Principal A has a contract with the government to build a project for $50 million. The government issues a unilateral contract modification adding $20 million of work to the principal’s scope, which the principal does not dispute. In the event that the principal defaults, does the surety’s Miller Act bond cover the additional work? FAR 28.106-5 says no – not without the surety’s consent. The significance of such a safeguard offered by FAR 28.106-5 is that, oftentimes, circumstances can change. A bond principal’s financial capability may change over the course of the project. A surety may lose confidence in the principal’s ability to do the work. Regardless of the circumstances leading to the surety’s reluctance to expand its coverage, the good news is that it may not have to if the additional work increases the original contract price by more than 25 percent or $50,000.
Consider this second example: Principal B has a contract with the government to build a project starting on January 1, 2015. Due to issues solely within the control of the government, notice to proceed on the project is suspended indefinitely. During the suspension, the principal suffers delay damages, which the government acknowledges and agrees to compensate by contract modification, thereby increasing the contract price by $51,000. Does the surety’s Miller Act bond cover the additional work? FAR 28.106-5 says no – not without the consent of the surety. Furthermore, if the financial circumstances of the principal have changed during the delay period, such that the principal can no longer perform the work, the surety has an argument that the unauthorized delay exonerates the surety’s bonds. In our example, the principal may have been financially capable to perform the bonded work in 2015. Nevertheless, the delay not only cost $51,000 to remedy, but it pushed the principal (and surety) into a period when the principal could no longer perform the work.
Authority Governing FAR 28.106-5
Case authority interpreting FAR 28.106-5 is sparse, thereby leaving the clear and obvious wording of the regulation as the only guidance. See Am. Contractors Indem. Co. v. United States, 111 Fed. Cl. 240, 249 (2013) aff’d sub nom. Am. Contractors Indem. Co. v. United States, 557 F. App’x 979 (Fed. Cir. 2014) (“As stated above, ACIC was a prior approval surety and the increase in the bond amount [$240,000] is greater than the $50,000 minimum stated in the regulation. Thus, there is no dispute that 13 C.F.R. § 114.19(e) applies. The question, rather, is whether ACIC agreed or acquiesced to this alteration before it received written approval from the SBA on June 2, 2004.”). Cf. In Re C.H. Hyperbarics, Inc., ASBCA No. 49375, 04-1 B.C.A. (CCH) ¶ 32568 (Mar. 23, 2004) (“When the Contract was later amended and the new contract price exceeded the total contract award by more than 25 percent, the surety consented to increase the amount of the bond by 100 percent of the dollar amount of Modification No. P00003.”).
Limitations On The Application of FAR 28.106-5
Notably, FAR 28.106-5 is a defense of the surety, not the principal. The fact that a particular change increases the contract price by 25% or $50,000 does not mean that the principal is relinquished from having to obtain a bond or that the extra work is not bondable. Rather, the original surety is not “required” to bond the extra work without its consent. FAR 28.102-2(d) provides that when the contract price increases, the government may secure additional bonding through one of three methods:
(d) Securing additional payment protection.
If the contract price increases, the Government must secure any additional protection by directing the contractor to –
(1) Increase the penal sum of the existing bond;
(2) Obtain an additional bond; or
(3) Furnish additional alternative payment protection.
The requirement to provide additional bonding exists for the principal, but there is no similar requirement for the existing surety on the bonded contract.
The FAR provisions requiring the surety’s consent stem from a well-established understanding that “[t]he surety bond embodies the principle that any material change in the bonded contract, that increases the surety’s risk or obligation without the surety’s consent, affects the surety relationship.” Nat’l Sur. Corp. v. United States, 118 F.3d 1542, 1544 (Fed. Cir. 1997). “Specifically, a surety will be discharged entirely from its obligations where the change to the underlying agreement is cardinal, i.e.,amounts to a substituted contract or imposes fundamentally different risks on the surety than those to which it had agreed. Where the alteration is less than cardinal, the surety’s obligation ‘is reduced to the extent of loss due to the modification.’” Preferred Nat. Ins. Co. v. United States, 54 Fed. Cl. 600, 605 (2002). “For example, one ground for discharge is when material modifications that increase the surety’s risk are made to the bonded contract without the surety’s consent.” Lumbermens Mut. Cas. Co. v. United States, 654 F.3d 1305, 1313 (Fed. Cir. 2011).
Arguments That Protection Under FAR 28.106-5 Has Been Waived
In practice, negotiating with the government over FAR 28.106-5 issues has been very straightforward. Lacking significant contradictory case authority to fight over, the parties are left with the plain wording of the regulation. In one recent negotiation, a clever Assistant United States Attorney tried to equate “notice” to “consent.” The form Miller Act bond contains the following language: “Notice of those modifications to the Surety(ies) are waived.” Relying upon this notice language, the government relied on a body of case law wherein the surety was not relieved when it was not given notice of particular changes. See, e.g., United States for the use of T.M.S. Mechanical Contractors, Inc. v. Millers Mutual Fire Ins. Co., 42 F.2d 946, 952 (5th Cir. 1991); Continental Bank & Trust Co. v. American Bonding Co., 605 F.2d 1049 (8th Cir. 1979).
When relying upon FAR 28.106-5, the surety is not suggesting that its express waiver of notice of changes is meaningless. The government is entitled to rely upon the express terms of the Miller Act bond. However, “notice” and “consent” are different. Regardless of what notice is or is not given by the government, the surety retains the right to “consent” to contract modifications over the regulatory thresholds. The government cannot expand the notice waiver provision beyond its intended scope, and rely upon the same to require unlimited extra work from the surety.
These issues arise regularly in our construction practice in all arenas – local, state and federal. Fortunately, in the federal arena, the FAR provides a clear rule regarding when consent is and is not required.