This is a proposal designed to protect governments entering into contracts, businesses in the course of their regular businesses, and other members of the general public, from the risk that a company that enjoys the benefits of limited liability becomes insolvent or goes bankrupt, except when these persons are consciously evaluating this risk because they are intentionally making an investment.
This would make our economy more robust and would make bankruptcies for covered businesses much less expensive, simpler, more swift, and much less likely to have contagion effects that propagate beyond the bankrupt firm.
It basically generalizes the model of agencies like the the FDIC and the Pension Benefit Guaranty Corporation (a government agency that partially pays obligations of insolvent defined benefit pension plans), which have proven to be very effective at mitigating the harm caused by insolvent major private institutions, especially during recessions and financial crises, thereby making the economy more robust and reducing systemic risk in the economy, and making the navigation of institution insolvency more smooth collectively and for innocent people affected by these insolvencies.
It is also inspired by regulations in other countries of limited liability entities that is more robust than in the U.S. and regulation of limited liability entities used in the practice of law in Colorado.
There is a good argument that some insurance requirement should be present for all limited liability entities. Realistically, almost all covered entities below already have insurance and the bonding requirement is the innovative part.
Who Would Be Subject To The Bonded And Insured System?
The basic idea is that certain companies would have to be bonded and insured. This would include:
Every company with publicly held equity or debt doing business in the United States or traded on a securities exchange in the United States.
Every privately held limited liability entity with 50 or more persons providing services to it during the course of the most recent calendar year, for whom a W-2 or 1099 had to be issued.
Every privately held limited liability entity bidding on or performing a significant contract or grant with a government in the United States.
Every privately held limited liability entity bidding on or performing a significant contract or grant with a public charity doing business in the United States. A public charity would be a non-profit defined as such in the Internal Revenue Code. A public charity is doing business in the United States if it is organized under the laws of a government in the United States or if the contract or grant is to be performed for an office of the public charity in the United States or the contract is to be performed in the United States.
A significant contract or grant would be a contract that is either more than $1,000,000, or more than $100,000 if the amount of the contract is more than 10% of the government entity or public charity's annual expenditures in its most recent fiscal year.
Any company or non-profit that opts into the system even though it is not required to do so. A company that opted in would be authorized to advertise that fact. False claims of being bonding and insured voluntarily would be handled by the Fair Trade Commission (FTC).
What Would Participants Be Required To Do?
Participants would be required to obtain federal government regulatory agency approved bonding and insurance.
The company would be required to have certain kind of liability insurance in placxe. This would include: (1) comprehensive general liability insurance, (2) worker's compensation insurance, (3) automobile insurance and the equivalent for other vehicles, (4) construction defect coverage for firms engaging in construction, (5) professional liability insurance for firms providing professional services, (6) flood insurance for business with operations in flood plains, and (7) earthquake insurance for businesses located in high earthquake risks. There would be no deductible as to third-parties on these insurance policies, but the insurance company could reserve a right to reimbursement for a deductible from the company up to an amount allowed by a formula or rule. The insurer would also provide a legal defense to the claims and eroding policies (where defense costs were paid from the policy limits) would be prohibited.
The company would be required to be bonded with a bonding agency meeting certain standards up to a dollar amount determined by a simple formula. Bonding agencies in the program would also have to pay a tax to fund a firm that would guarantee claims on bonds that are owed by insolvent bonding agencies. The bonding agency would be required to pay on demand any covered claim up to the dollar amount of the bond on a covered claim.
Covered claim types would include properly "perfected" claims for essentially all trade creditors of a company including deductibles owed to insurance companies, money market loans (up to some formula cap amount), mechanic's lien claims where the company doesn't have primary contractual liability, and tax obligations other than income taxes (e.g. withholding taxes, sales taxes, excise taxes, and property taxes). The main liabilities that would not be covered claims would be (1) finance debt (i.e. loans of cash for more than 91 days or large short term loans up to some formula cap amount, obligations on guarantees of such loans such as corporate bonds, unsecured bank loans, deficiency judgments on secured loans, and derivative instrument debts), (2) claims for income taxes, (3) claims on insurance claims in excess of policy limits, (4) civil claims for uninsurable tort claims, punitive damages and penalties, and (5) criminal penalties, fines and costs.
The most common way to "perfect" a claim would be to get a money judgment against the bonded company that has been unstayed and unpaid for five weeks (35 days) from entry of judgment. But insurance company deductible claims would be perfected if certified by the insurance company as having been paid by it and not reimbursed within 91 days but not more than three years, by the bonded company. Tax claims would be perfected when assessed. In the case of companies that have ceased to be going concerns, a Bond Claims Receiver, a public official similar to the U.S. bankruptcy trustee, would be appointed by a federal district court or bankruptcy court upon the petition of the company or its bonding agency or other claimant representatives where a mass claim filing was underway or imminent.
Bonding agencies would have a right to indemnification from the company bonded for the aggregate outstanding amount all claims paid by the bonding agency, plus a service fee in a contractually established amount subject to regulation by the federal government regulatory agency for each claim paid, plus interest at a rate similar to subordinated corporate bond interest rates on the outstanding balance owed each day. This indemnification right would be secured by a UCC-1 filed blanket security interest under the UCC in all of the tangible and intangible personal property of the company and recorded security interests in all of its real property, with these security interests subordinate only to purchase money security interests in the collateral (and refinancing of that debt), tax liens to the extent provided by law, HOA liens to the extent provided by law, and express subordinations agreed to by the bonding agency.
Bond premiums would be subject to an excise tax used to fund an agency that would pay some or all of covered bond claims in excess of bonding agency bond amount limits because the federal government agency's required bond amount limits were too low in the case of a particular company.
Establishing Regulations
A federal advisory board attached to the Commerce Department Bureau administering the program would establish regulations for the program.
The insurance coverages and minimum policy limits and maximum deductible amounts required for each type of insurance would be established with a rule or formula, and this agency would also establish a simple formula to determine the dollar amount of the bond required.
This advisory board would also establish regulations to determine which state licensed insurance companies and bonding agencies would qualify for use by companies in the program.
Primary regulation of bonding agencies and insurance companies would remain with state governments and would be ratified by this agency essentially providing a second look to make sure that state regulation of bonding company and insurance company reserves was not too lax.
Enforcement
Publicly held companies would have to certify to the SEC that they were still bonded and insured on each regular report or with a special notice if this ceased to be the case. Compliance by publicly held companies would be enforced by the SEC.
A small new Commerce Department Bureau with a tiny budget and few employees would enforce compliance with an administer the program in the case of non-publicly held companies, government agencies, and public charities. It would would have a system for sanctioning or bringing into compliance entities in its jurisdiction that should have been bonded and insured, but were not, and for dealing with bonding agencies and insurance companies that fail to comply with the rules.
The Commerce Department Bureau would also vet insurance and bonding companies that wished to participate in the program to determine if they complied with the regulations for the program and were eligible to provide insurance or bonding that satisfied the program's requirements.
Privately held companies with 50 or more employees would have to certify that they were bonded and insured on their tax returns each year with a notice given by the IRS to the Commerce Department Bureau, if they were not. Other privately held companies filing tax returns with the IRS would have to check a box that they were or were not covered on their annual tax return, and another box regarding whether they were or were not required to be covered which would be similarly reported if appropriate. Firms that were covered or required to be covered, but did not have to file their own tax returns with the IRS in a given year, would still have to file an annual report with the IRS certifying their compliance and informing it of their non-compliance with referral to the Commerce Department Bureau, if necessary. Public charities would certify compliance on their annual Form 990 filed with the IRS or risk losing public charity status and would also be referred to the Commerce Department Bureau if they were not.
Local governments and state agencies would be to certify compliance each year to a responsible state government official designated by the state, and that designated state official would certify compliance (subject to exceptions reported along with a report on the actions being taken by that state official to resolve the non-compliance) to the Commerce Department Bureau.
Bonding agencies and insurance companies of covered companies would have to notify the SEC or the Commerce Department Bureau, as the case might be, if their bonds or insurance policies were terminated by the company covered by them for any reason.
Complaints that a company required to be bonded and insured, or representing that it was bonded and insured, was not bonded and insured, could be made to the SEC for publicly held companies, to the designated state official for state and local governments, and to the Commerce Department Bureau otherwise.
Complaints that a bonding agency or insurance company of a bonded and insured company was not acting properly would be referred to the state regulatory licensing that company.
A corps of Bond Claim Receivers would be established as an additional division of U.S. Bankruptcy Trustee's office. The U.S. Bankruptcy Trustee's office would not have any direct dealing with the Commerce Department Bureau or the SEC.
What Would This Mean?
Bankruptcies involving reorganizations of going concerns be limited to allocating the assets of the company left over after payment of purchase money secured debt, priority tax and HOA liens, and the bond indemnification lien debt. The only claimants in the bankruptcy would be (1) finance creditors, (2) income tax claims, (3) claims on insurance claims in excess of policy limits, (4) civil claims for uninsurable tort claims, punitive damages and penalties, and (5) criminal penalties, fines and costs.
Finance creditors would have loan covenants requiring excess insurance policies if in their financial judgment, the federal regulatory agency's minimum policy limits were too low and management didn't already decide to put that in place to protect equity owners.
People other than finance creditors dealing voluntarily with bonded and insured companies would almost never have uncollectible debts, thus protecting innocent people who have no choice but to do business with some big business in many circumstances.
The fact that all of their legal obligations would be collectible would also encourage bonded and insured companies to act lawfully, relative to people who would be uncollectible vis-a-vis major tort or other debt obligations. This would prevent the contagion of unpaid claims of bonding and insured companies from taking down innocent firms that do business with them, governments that do business with them, and public charities.
This system would not impact the vast majority of existing small businesses or impede small business formation, but would highly the heightened default risk of dealing with these businesses as trade creditors. But individual small business defaults of non-government contractors don't pose the same systemic risk to the economy.
