Hawkins: Green Building Performance Bond Requirement is Viable
Last week, I had the pleasure of testifying before the D.C. Council regarding green building policies in the district. As mentioned in my post last week, the focus of my testimony was the Green Building Act's "performance bond" requirement. Before my testimony, I had the opportunity to hear George Hawkins, Director of the District Department of the Environment. During his speech, Mr. Hawkins directly addressed the "performance bond" issue and many of the points I raised in my White Paper last Wednesday. After you review Mr. Hawkins testimony, I would be very interested in hearing your thoughts.
---
“Performance Bond” Requirement for Private Projects
I would now like to turn to the issue of performance bonds and criticism of this enforcement tool. Pursuant to the Act, commercial applicants will be required to submit a “performance bond.” If the building fails to meet the LEED certification requirements, “all or part of the performance bond shall be forfeited to the District.” Experts in the area of environmental finance analysis and DDOE’s research on the subject support this approach as an appropriate and sufficient enforcement mechanism to ensure compliance with the Act.
One of the concerns that has been raised is that “performance bonds” do not currently exist in the financial assurance world. There are, however, a number of laws and regulations that have required forms of financial assurance that at the time of the inception did not exist in the market. In each regulatory context, private financial markets have developed to provide the insurance, bonds, and other financial instruments necessary to demonstrate assurance. For example, before there were automobiles, there was no such thing as car insurance. When the law recognized a growing need to insure against harms that may be perpetrated by automobile drivers to others, the market rose to the demand.
The breadth of operations and environmental risks covered by current rules is an additional testament to the market’s ability to conform to and rise to the demand of a new form of financial assurance. For example, the Resource Conservation and Recovery Act (RCRA) requires that financial assurance be provided by the responsible party as proof that adequate funds will be available when needed to undertake the necessary corrective action at a RCRA treatment, storage, and disposal facility. Many states have their own laws requiring financial assurance, including our own DDOE requirement that developers post a bond equal to the cost of stormwater management infrastructure until DDOE verifies proper installation.
A second concern that has been raised is that it may prove difficult and financially burdensome for developers to provide letters of credit, collateral to obtain a bond, or escrow in amounts up to $3,000,000 (the maximum requirement under the Green Building Act). While opposition to new financial assurance rules is common regardless of industry, DDOE believes fears of business disruption from this new assurance requirement are unwarranted. When the District began to require condominium developers to place 10 percent of the cost of construction in an escrow account or provide a letter of credit under the Condominium Act, the same concerns were cited, and yet, this is now common practice.
An additional criticism of the current “performance bond” requirement is that the enforcement mechanism creates an inherent conflict of interest because those that would require forfeiture of the bonds would also directly benefit from the forfeiture. If forfeited, performance bond funds are to be “deposited in the Green Building Fund.” Under the Act, the Green Building Fund is to be used, in part, for “staffing and operating costs to provide technical assistance, plan review, and inspections and monitoring of green buildings.” On the contrary, it is important to note that many legally-required fees, fines, and penalties are used by governments to fund the operation of the program under which they are collected. For example, D.C. Official Code § 7-632 authorizes the establishment of a Regulatory Enforcement Fund to be used by DDOE to finance its regulatory practice. The Council has routinely authorized use of enforcement proceeds to finance future enforcement actions.
In summary, we believe the bond requirement under the Green Building Act is viable and can be implemented. We have already, and will continue to, participate in discussions with our sister agencies and stakeholders as to how this enforcement mechanism should best be implemented.
---
Do you think Mr. Hawkins is right? Will the financial sector come up with a green building performance bond?
In a word, no. This is my humble opinion, but I believe Mr. Hawkins is missing the point regarding the specific "performance bond" as referenced by the DC GBA. Performance Bonds do exist, and have existed for many years with little complication.
An instrument such as a performance bond is provided by a surety to guarantee to a project owner that a contractor will perform their role as specified in the contract. Should that contractor fail, the bond will provide the owner with the financial means to correct the failure(s) of the defaulting contractor.
Mr. Hawkins references the following from the RCRA: "financial assurance be provided by the responsible party as proof that adequate funds will be available when needed to undertake the necessary corrective action at a RCRA treatment, storage, and disposal facility." The DC GBA bond requirement does not provide funds for CORRECTIVE ACTION to be taken.
This is the point that Mr. Hawkins misses. Should a building project fail to achieve certification by the USGBC's LEED Rating system, what would the defaulted bond funds be used to correct? Were there any defects in construction? There are many reasons that a building could fail to achieve certification, but a surety bond is not currently designed to compensate the owner of a building project to correct such failures. Also, when a surety bond is called by an owner, the surety will attempt to collect the defaulted funds from the contractor that was in breach. It is like the mortgage company attempting to collect on a default after they have foreclosed on a home. There isn't a surety in operation that will give up their rights of subrogation.
In addition, the US GBC is not a governmental entity. They are a non-profit 501c(3) and are currently undergoing an overhaul of their rating system as determined by the members of the organization. It is true that many cities, counties, states and federal agencies utilize the LEED Rating system to mandate public and private development. The fact remains, however, that the rating system should be a guide to responsible building practices designed to create healthier and safer buildings from design through construction and throughout occupancy. It is not the law.
As someone much wiser once told me, LEED is not a magic wand. It is a comprehensive rating system that identifies responsible building practices, designs, and materials, and it does a very good job of emphasizing some critical aspects of a construction project.
I commend the District of Columbia for its efforts in creating a requirement for responsible building practices. There are many of us in the community that care very deeply about the future of our environment. We want to see these programs succeed and transform the way in which buildings are designed, constructed and operated. We also want to make sure that we don't drag these type of regulations down with poorly drafted legislation and endless litigation until we can get it right.
I agree with Mark. DC is asking for a Surety company to enforce against an ever-changing standard. By refusing to back down, DC is playing a game of "chicken" with a very conservative Surety market. The losers in this game will be the contractors.
In reverse order of importance, I think Mr. Hawkins misunderstands the objections and inaccurately compares the DC GBA with existing legislation.
I'll cede the conflict of interest angle. It's never been particularly convincing to me, and given the preponderance of impact fees and proffers in neighboring locales, I don't think it carries much weight.
I will challenge his perception that it does not impose an undue burden. The cumulative effect of regulations can become burdensome without necessarily identifying any one regulation as the linchpin of such a burden. Incorporating a post-construction fee/fine/penalty would reduce some of this cost concern. To take his condo fee example, a developer can withdraw the units from sale and convert the project to a rental should market events warrant. There is no such mitigation method for this proposal.
Mr. Hawkins also errs with auto insurance. Auto insurance exists to compensate a party for its loss, whether personal or property. These loses are known (cost of repair or treatment) or negotiated. In the case of the DC GBA, the party receiving compensation is not the party of loss. Furthermore, there is no method in the legislation to negotiate the severity of loss or even identification of the loss.
Hawkins mention of RCRA actually undermines his argument. Congress legislated RCRA and the EPA administers it. The policy and compliance mechanisms are known. The regulations can be modified through petition, legislation, or judicial appeal. LEED is administered by a 3rd party and modified through a non-public process with limited avenues of appeal. DC has simultaneously endorsed and abdicated the purpose of the policy to the USGBC without modification.
Finally, most regulations have a defined period for an agency to accept, review, and opine upon submissions. USGBC and LEED have no such review or timeline mechanism and could take as long as 24 months after construction completion or occupancy. This makes the developer and the District dependent upon a third party for verification or cure. Decision making and scheduling has been removed from the parties directly participating in the development, raising the broader question of how USGBC can be expected to act in the best interests of DC and its developers?
The argument Mr. Hawkins makes about the surety market always providing needed coverage without impeding innovation in practice is not always the case. In Vancouver, BC, in a well-meaning act to protect homeowners from risk, the Homeowner Protection Office required that for anyone to install a residential green roof they would first have to acquire a homeowner warranty policy - which didn't exist and which set back the installation of green roofs in the region - not just residential ones after the HPO issued an advisory to regional regulatory agencies recommending they not approve any without the the warranty. This did not result in the sudden creation of insurers competing for the new product. Instead it struck a serious blow to an emerging and vulnerable industry sector.
What confounds the whole situation, in my view, is that there are no similar obligations for the worst actors in the field - by which I mean the ones building to the absolute minimum code requirements and building the largest, most toxic, wasteful, highest impact buildings - the buildings with the greatest social, environmental, human health and economic costs to the community. Once again, we save our greatest scrutiny and most stringent requirements for those striving to do the best, not the least. If we are interested in assuring the higher performance levels sought, explore performance contracting options that tie some of the compensation to the actual performance of the project over time - either way - if the project meets or exceeds its targets the benefits accrue in part to the designers and builders and if not, they don't. That doesn't create a huge market impediment and puts everyone's incentives in line with the desired outcome.