Construction Law Signal - Insights & Information on Current & Emerging Developments affecting the Construction Industry

Lane F. Kelman contributed to this post.

A recent increase in fraud investigations relating to disadvantaged business enterprises (DBEs) has caused companies to revisit the qualifications of the DBEs they work with. Two recent investigations in New York State resulted in multimillion dollar settlements after investigators determined two companies were using DBEs as so-called “pass-through” entities. These pass-through entities were retained to perform certain work on projects, but performed none of the work and instead allowed other entities to fulfill the contractual requirements. Unfortunately, this scenario is not uncommon.

DBE Fraud

The reality is that some general contractors will use a DBE firm solely as a pass-through entity. In other cases, the DBE firm should never have received certification at all, or changes in ownership and management have caused the company to lose its qualification while maintaining certification. In October 2009, The U.S. Government Accountability Office, the investigative arm of Congress, conducted a detailed study on the use of DBEs in order to determine whether ineligible firms certified as DBEs were being awarded contracting opportunities, thus taking opportunities from legitimate DBEs. The study’s authors concluded that the unqualified DBEs were benefiting by obtaining contracting opportunities with federal government entities and the DBE certification system was vulnerable to fraud.

Additionally, DBE fraud can occur over decades. In a recent case, an officer of Perini Corporation pled guilty to conducting DBE fraud from 1988 through 2001, using several pass-through DBE entities to obtain contracting opportunities and paying the entities 3% to 5% of the subcontract value as a fee to run payroll. The officer pled guilty to criminal charges of money laundering and conspiracy, and the company paid several million dollars to settle the civil suit against it stemming from the fraud.

Who Qualifies as a DBE?

DBEs include women-owned businesses, minority-owned businesses, small businesses who qualify through the Small Business Administration, service-disabled veteran-owned businesses, and HUBZone businesses, which are located in historically economically disadvantaged areas and employ persons residing in such areas. Though requirements differ slightly among states and governmental organizations, the following requirements generally apply:

• The firm must be at least 51% owned by disadvantaged individuals, whether they be women, minorities, or other disadvantaged individuals;
• Those individuals must have managerial control and operational control over the business’s activities; and
• The individual disadvantaged owners’ net worth cannot exceed a certain amount (generally, $750,000, but this amount varies).

Managerial and operational control means, in a practical sense, that the individuals must have sufficient functional knowledge of the business so that they can successfully manage it. For example, though a woman owner of a plumbing business need not be a plumber, she must be able to effectively direct the work of the plumbers working under her, as well as to determine the equipment, man-hours, and materials required to complete any particular job, without relying on any other person to advise her.

Bid Protests

With the current highly competitive climate, competitors are seeking to use every advantage to obtain contracting opportunities, including using the bid protest process to question the legitimacy of a DBE entity, whether that entity is a prime contractor or a subcontractor. For example, a general contractor submitting an unsuccessful bid may challenge the awardee’s bid on the basis that the DBE firms which the successful bidder proposes to use (or the DBE proposing to act as general contractor) are either not legitimate DBE firms, or do not have the capability to perform the work proposed.

In order to protect against such an investigation, before submitting a bid using a DBE subcontractor, it is critical to examine the DBE entity in light of the work that must be done before submitting a bid. Do the disadvantaged owners have the requisite knowledge to plan the project, direct the work, and ensure its completion? Will the DBE be capable of performing the work it proposes to do? Will the DBE need to obtain additional employees or subcontract part of the work to another entity? Performing this type of preliminary investigation prior to submitting a bid could save a company millions of dollars, as well as avoid criminal liability for the use of a fraudulent DBE.

Although entering the public bidding arena presents contractors with a plethora of opportunities, these opportunities do not come without risk. As many contractors can attest, oftentimes public bidding can seem more like gambling than bidding. This holds true not only when a contractor steps into the public bidding area for the first time, but also when experienced public bidders decide to cross state lines to pursue new opportunities.

Public Bidding in New York

Unlike the public bidding laws in New Jersey and Pennsylvania, the New York public bidding laws give contractors the option of withdrawing their bids after the expiration of a firm offer period. Under Section 105 of New York’s General Municipal Law, New York’s public bidding statute, a public agency must award a contract within 45 days of bid opening. During this period, which cannot be expanded by contract or local laws, a contractor’s bid is irrevocable. Once the 45 day firm offer period expires, however, a contractor may withdraw its bid if the public agency has not yet awarded and entered into the contract. Providing notice of the award is not sufficient. As such, contractors can withdraw their bids when the public agency has indicated its intent to award a contract, but has not yet bound itself to the contract within the 45 day firm offer period.

Guy Pratt, Inc. v. The Town of North Hempstead

The case, Guy Pratt, Inc. v. The Town of North Hempstead, is a long-standing example of a New York contractor’s ability to withdraw its bid when a public agency does not unequivocally enter into the contract. In Guy Pratt, the Appellate Division of the Supreme Court of New York held that contractor Guy Pratt, Inc.’s withdrawal of its bid after the expiration of the 45 day period was valid and effective. The Court upheld the withdrawal even though counsel for the Town of North Hempstead (Town) notified the contractor by letter within 45 days of bid opening that the Town had awarded it the contract, and even though Guy Pratt, Inc. had already executed and returned the proposed contract to the Town prior to withdrawal of its bid.

In issuing its ruling, the Court relied upon language in the subject contract that stated that a contractor was proceeding at is own risk unless and until:

an Award of the Contract to him is consummated by the delivery of an executed duplicate of the Agreement which has been approved by and filed in the Office of the Town Clerk.

The Court found that this language made it clear that the Town was not bound by the contract until it had delivered an executed copy of the contract to Guy Pratt, Inc. Since it was undisputed that an executed contract had not been delivered to the contractor within the 45 day period, and since the contractor’s notice of withdrawal of its bid came before the delivery of the contract, the withdrawal was valid and effective.

In this case, the Court held that an award must be unequivocal in order to bind a contractor within the 45 day period and to prevent a contractor from executing its right to withdraw its bid. The fact that this case is still good law demonstrates just how serious New York courts take the contractor’s ability to withdraw its bid after the 45 day period.

There has been much public discussion centered on the appropriateness of building a mosque in close proximity to Ground Zero. The controversial project to develop an Islamic cultural center in New York City is known as Park51. The political aspects of the Park 51 project are hotly debated; however, most commentators fail to recognize the practical hurdles facing the planned construction. Construction industry experts may recognize the significance of these obstacles, but these more mundane aspects of the Park51 project rarely make the news.

Permits

Acquiring the necessary permits for the Park51 project will not be easy for developers. The construction involves the repurposing of a 152-year-old building that was formerly a retail clothing store. The design of the Park51 project is expansive and includes a 500-seat auditorium, swimming pool, restaurant, and retail space. The building’s existing certificate of occupancy was issued in 1987 and is limited to retail use of the building. Currently, the building is a worship center that is operating under temporary permits. Additional occupancy permits will be required if the building is to be converted from retail use to a community center with all the planned amenities.

Labor

Finding construction workers willing to work on the project will be very difficult, and without skilled workers, the project may be unable to get off the ground. Although it has been estimated that the Park51 project could create approximately 150 full-time and 500 part-time jobs, some New York construction workers have refused to work on the project. Although the unions have not yet taken a position on the project, Louis Coletti, president of the Building Trades Employers’ Association, said that he understands why the union’s members would be hesitant to work on the Park51 project:

It's a very difficult dilemma for the contractors and the organized labor force because we are experiencing such high levels of unemployment . . .Yet at the same time, this is a very sacred site to the union guys.

Financing

Finally, as with any construction project, it will be a struggle to obtain sufficient funding. The Park51 project is estimated to cost $100 million and fundraising has not yet begun. The controversy surrounding the project could cause potential supporters to withdraw their funding, forcing abandonment or scaling down of the project. Even if financing is secured, it could take months to hammer out all the details of construction loans.