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Green Building and Performance Bonds

In the first installment of our audio Q-and-A series, we talk with Chris Cheatham, a Washington, D.C., construction attorney and an expert in the green building issues facing the surety industry. His blog, Green Building Law Update, has become a hub for information and insight into the future of green building in the nation's capital and beyond.

Transcript

Birk: (Intro) Hi, this is Chris Birk with SuretyBonds.com. Welcome to the first installment of our audio Q&A series. Each month we’ll talk with an industry leader about key topics and trends for both consumers and sureties. To kick off our series, we spoke to Chris Cheatham, a Washington D.C. construction attorney who specializes in green building. Through his blog Green Building Law Update, Chris has provided extensive coverage of Washington’s Green Building Act, a landmark 2006 piece of legislation that has major implications for sureties, contractors and communities nationwide. At issue is the idea of a green performance bond. Here, Chris talks about the hurdles the surety industry and builders face when confronting the challenges of environmentally conscious construction.

Birk: Well, we’ll start at the beginning and see, first off, if you could talk a little bit about the Green Building Act that was passed in 2006 in D.C. and sort of lay out a little bit about its aims and what it was asking the developers and project owners and some of the implications that have arisen out of that.

Cheatham: The act was called the D.C. Green Building Act of 2006, and it phased in green building requirements for the real estate industry over a number of years. So it started with public buildings, and it moved onto schools. On January 1st, 2012, private buildings — you know, private owners, private financing — will have to meet the requirements, which is you have to achieve LEED certification. So if you’re building over a certain size — I believe it's 50,000 square feet — then you have to hit that certification in order to build in the city.

Birk: And it’s based on achieving certain energy efficiency measures?

Cheatham: Well, the LEED certification process, in order to be certified, you have to meet certain energy efficiency requirements. There are generally five categories for green building if you are pursuing LEED certification. Water usage, energy usage, the products you’re using — I knew I was going to blank on the other two — where you’re located, like your site location, and there’s one other. It will come to me in a little bit. But energy usage is one of the big components of LEED certification. So by requiring LEED certification for a building, you’re requiring the building at least is modeled to reduce its energy usage compared to a normal building.

Birk: I’m just curious about the uniqueness of the act. I mean was there anything comparable in the United States, or is it sort of a first-of-its-kind piece of legislation?

Cheatham: It was the first; D.C. was the first major metropolitan city to require LEED certification for private projects. There were other small towns that required LEED certification for private projects, not many. There was about one or two and then there were eight that required LEED certification for public buildings, but D.C. was really the first major city to require private projects to comply with LEED certification.

Birk: And from what I read, it seemed like the act, overall, was mostly met with praise and with interest. But it seems like, I’m guessing, that the weeks and months following, if you’ll sort of look at the language, there started to be concerns from those within the surety industry. I wanted to know if you could talk a little bit about what’s causing some of the concerns for surety companies and insurers related to bonding with the Green Act.

Cheatham: Tthe issue with the Green Building Act and its requirements for private buildings is that you have to have an enforcement mechanism whenever you’re mandating LEED certification or some other type of component in a building. So you have to ensure that if a person or an owner doesn’t comply, then there is some sort of penalty. In this case the Green Building Act stated that if an owner doesn’t comply with LEED certification — if they don’t achieve LEED certification with their new project — then the owner has to put up a performance bond and forfeit that performance bond to the city. It caused a lot of angst within the surety industry, and there are a couple reasons why. The first reason is that I think it’s important to define what a performance bond typically is in the surety industry.

A performance bond is usually obtained by a contractor to guarantee that the contractor will build according to the plans and the specifications. So a performance bond involve three parties; it’s a tri-part type agreement between the contractor, the owner who receives the guarantee and the surety that’s guaranteeing, to the owner, that the contractor is going to perform according to the plans and the specifications.

So the performance bond — and I’ll call it the green performance bond — in the D.C. Green Building Act wasn’t actually a performance bond, despite the language that they included. What the city was looking for was a guarantee by the owner to the city that the project would achieve LEED certification. So it’s a different party — an owner instead of a contractor — and the owner’s not guaranteeing that the building is going to be built according to the plans or specifications. The owner is guaranteeing that he is going to comply with the requirement to achieve LEED certification. So it’s more like a compliance or a license bond that also exists on the market.

Birk: In the weeks and months debate has arisen about this, has there been a path toward reconciliation that you have seen? I mean, is this really a matter of semantics more than anything else? Are they going to have to go back in and change some of the language of the act?

Cheatham: Yeah, you know some people, I think, thought it was just an issue of semantics. The two big issues with a performance bond — if they kept it as a "green performance bond" — number one it was going to create massive confusion in the surety industry because owners were going to be going to sureties, bonding companies, and saying "I need this performance bond." Well the sureties were going to say, "We can’t issue this performance bond because this isn’t a performance bond." So that was the first issue. The second issue — and it’s a bigger issue, it’s more difficult to address — is whether or not these performance bonds, or whether any type of bond, is available to guarantee green building certification. So the issue there is when you’re seeking green building certification, when you’re seeking LEED certification, all three parties — an owner, the architects and the contractors — along with all the other parties you can imagine - engineers, the sub-contractors - all those parties, each of them can affect whether or not you can actually obtain LEED certification or green building certification.

So an architect could design a building perfectly and include enough green building components to achieve certification, but if a contractor doesn’t build it properly — let’s say the contractor forgets to install the proper windows that would have reduced the energy usage. The contractor can impact whether or not the certification is obtained, and that goes the other way, too. An architect could design a building so that it is actually not going to achieve LEED certification or green building certification. The contractor then, if he builds the building according to the plans and the specifications, he did what he was supposed to do. But the building still doesn’t achieve certification. So you have all these different parties that can affect certification, and the city is asking just the owner to put up the guarantee. So it’s not clear whether surety companies, sureties, are going to be willing to guarantee green building certification when they really can’t control what all the different parties are doing. It’s difficult to measure the risk at this point in the market.

Birk: So where specifically are the parties and stakeholders in D.C. with this? I mean, I know there’s been a public meeting scheduled in December, and parties continue to talk. Do you have a sense where things stand right now?

Cheatham: Yeah, actually in December. I believe in the December revisions and corrections to the Green Building Act, a bill was brought before the D.C. city council. I don’t believe they’ve voted on it yet, but what they are planning to do is revise "performance bond" and actually make it just a "bond." So instead of using the word "performance bond," it would strike "performance." And the reason why they’ve gone that route, I believe, is because Arlington County, which is a Virginia suburb, Virginia County, which is just outside Washington D.C., they have a green building regulation in place that also requires a bond, and that bond has actually successfully been put up. There is a surety that’s issued that type of bond to back up the green building certification that was promised. So, I think, the D.C. council, or whoever is revising the legislation, believes these bonds will be available if you just take out the word "performance."

Birk: I know you don’t work exclusively in the surety industry, but do you have a sense whether there is a long term viable bonding solution for green building?

Cheatham: Yeah, it’s a good question, and I do talk to a lot of sureties, and I try to gauge whether or not this will be feasible one day. I do think there is going to be a market for these kinds of bonding instruments, so that’s the first key. There will be a market. There are people, you know, there are people right now that would buy these bonding instruments if they were available. The problem is it’s difficult with this stage of green building to understand the risks that are involved. So it’s not clear how often projects fail to achieve their green building certification that they’re seeking. When you’re a surety, you’re like any other insurance company; you have to understand the risks because you’re not out there to lose money. You’re out there to, most of the time, not have failures on your projects. So if you don’t understand how often you could be receiving failures on projects you’ve bonded, or on these green building bonds, it’s difficult to provide that type of instrument. But once we start getting a handle on how often green building certifications don’t happen — how often there’s a failure to achieve the certification — then you will see somebody go out there and start bonding, providing those type of bonds. The sureties and the insurance companies, they keep pushing the bar a little further in terms of providing insurance for green building projects. So architects and engineers can now get specific insurance to protect them if they’re working on one of these projects. So we’re inching closer and closer, but we’re not quite there yet.

Birk: What sort of long term, like beyond the district, implications are there in this. I mean, why should people in Washington state or California or here in the Midwest, why should they care about what’s happening in D.C.?

Cheatham: Yeah, you know, this same issue will pop up wherever there is a green building regulation that’s being proposed of being put forward. Whenever you are mandating some type of certification, some type of green building certification, you have to have an enforcement mechanism. Because if you don’t, people won’t comply, and then it’s pointless to have the regulation. So you have to have some sort of penalty, and I’ve had other cities actually call me up and say you know, "What about these performance bonds? Is this a good idea?” and I have to explain to them why not. So my concern is you’ll start seeing performance bonds used in other green building regulations throughout the country.

So it’s really important to think through if you’re another city or another state, how you're going to require and how you’re going to enforce your green building regulations. In a broader picture, the Green Building Act was drafted, you know, pretty early on back in 2006 before there were a lot of these green building regulations. So you know, one thing that I would say to the benefit of the D.C. council and the people that drafted the legislation, they gave themselves some time to make corrections. Since they’re phasing in these requirements, people are able to look at this legislation and figure out the problems, and they can go back and revise it and it will be ready to go when 2012 hits. So when you phase in requirements, I think, you’re setting yourself up to do well in the green building industry.

Birk: Is there a sense of when this is coming to a head in D.C.? I know you said the council, to the best of your knowledge, hadn’t voted yet.

Cheatham: Yeah, you know, I think it should. To be honest, I’m not sure — sometime soon I imagine. But, you know, the real issue will be 2012, January 1st 2012, when the first owner has to go out there and try to get this bond in order to ensure his building will achieve LEED certification. So I really think that’s when this thing comes to a head. It’s not going to be a big issue in 2010, 2011, because nobody has to try and get these bonds. But when they do, that’s really when, you know, I think the issue will come forward.

Birk: (Outro) Chris Birk here again with SuretyBonds.com. We would like to thank Chris Cheatham for taking time to talk with us. You can check for updates on the green performance bond issue on our blog www.SuretyBonds.com/blog and at Chris Cheatham’s blog www.GreenBuildingLawUpdate.com. To suggest a topic or an interview subject for the next SuretyBonds.com Q&A conversation, e-mail me at chris@suretybonds.com. Thanks for listening!