This guest post was written by Kevin Kaiser of SuretyBonds.com, specializing in teaching consumers about surety bonds through the Surety Bond Education Center.  I do not represent Kevin or his company, nor do I sponsor any of their products.  Kevin has some great things to say about the surety’s perspective in green construction, which is particularly timely given the announcement of a recent challenge to a LEED certification in Wisconsin. 

The Green Performance Bond

Green building continues to gain momentum across the country, as project developers and consumers look for ways to incorporate environmental consciousness into everyday life.

Last year, Energy Star homes accounted for almost 20 percent of all new single family construction, up from 12 percent the year before. There’s also greater interest this year in LEED-certified homes and other more involved green-certified standards from the U.S. Green Building Council.

But it isn’t all smooth sailing. In fact, green construction is proving extremely problematic for the surety industry, which ensures that construction projects are completed and in accordance with contracts by issuing bonds.

And until that’s rectified, a nationwide wave of green construction might be on hold.

The Friction

In short, the issue is a performance bond. These are a key part of the normal construction bonding process that guarantee a contractor completes all work up to contract and code.

Surety companies typically scrutinize a contractor’s financial health, expertise, work history and likely ability to perform the job before underwriting a bond. They also look at a given project’s specific contract. Performance bonds are tied to specific, quantifiable goals grounded in industry standards and accepted practices.

That’s why green building performance standards are becoming a significant and mounting problem for surety companies.

To obtain certain green building designations, third parties like the U.S. Green Building Council look for specific levels of energy efficiency and other quantifiable improvements. But most sureties will steer clear of bonding a company with a contract that calls for third-party certification or requires specific energy reductions.

The reasons revolve around risk mitigation and responsibility: Who’s on the hook financially if the building falls to meet those third-party requirements?

“It’s not always the party that has to post the bond that’s responsible for that element of LEED certification,” Bob Duke, director of underwriting and assistant counsel for the District-based Surety and Fidelity Association, told the Washington Business Journal. “Maybe the party posting the bond doesn’t have control of the total obligation.”

Because of those lingering questions, most surety companies will not issue a bond for a contract that calls for any type of green or energy efficiency benchmarks, which are not performance standards but prescriptive requirements.

“In the event that a building fails to perform to a specified level of resource efficiency, should the surety be required to compensate the owner to rebuild the structure?” Mark Rabkin, a risk manager for Althans Insurance Agency, noted in a recent blog post. “That is not what they are in business to do and will not bond contracts guaranteeing efficiency and performance specifications.”

The D.C. Green Building Dilemma

The green performance bond issue has garnered headlines in the last year because of new regulations in Washington, D.C.

The District in 2006 created a green building requirement for certain private and public projects. The regulation basically requires the use of a bond that doesn’t really exist yet — a green performance bond.

Surety companies and associations have lobbied against the new regulations, which take full effect in 2012.

Projects that fail to meet the new green standard would pay claims of up to 4 percent of building costs to a city green building fund. Compounding the situation is a clear conflict of interest: The District agency that maintains the green building fund is the same that can determine whether a project is in compliance with the new regulations.

Last fall, surety claims attorney Bryan M. Seifert addressed the D.C. green building regulation in a piece on Entrepreneur.com:

This type of legislation involves a fundamental misunderstanding of the marketplace, the type of products available in the insurance and surety industry and how those products respond to today’s construction needs. Performance bonds typically guarantee the performance of a quantifiable objective. Rather than legislate a performance bond to guarantee a quantifiable goal based on an objective standard for which the bond is written, the District has chosen to legislate a particular prescriptive rating system with attendant unknown risks. The surety product will more likely end up contributing to the District’s green building fund and not the sustainable performance objectives of the District’s projects.

Owners, stakeholders, contractors, risk managers, insurers and sureties must be keenly aware of the flurry of legislative activity and its implications for their interests. Much of the recent green building legislation is a result of advocacy for intangible outcomes with little analysis given to the overall performance of the public asset and little consideration for the industries that support and sustain the construction process such as insurers and sureties. The D.C. Act is just one of many examples of legislative activity that may have profound and unknown affects on these industries.

Sureties continue to balk at the vague and risky language of this and other proposed green building bonding measures. If that persists, the burden will fall to contractors and developers to assume greater risk when taking on some green public and private projects.

Current Environment

After consistent outcry from the surety industry, officials in Washington, D.C., are trying to rework the language regarding performance bonds.

Industry officials and observers alike are unsure when or how the issue will likely get resolved. D.C. environmental officials have staked a claim that green performance bonds are feasible.

Now they have to find a practical way to prove it to the nation’s surety industry.