A Bold Individual Surety Claims His Coal-Backed Bonds Are Rock Solid

Special Investigative Report Individual surety has had plenty of shady dealings. One of the regulars in the field, Robert Joe Hanson, has received cease-and-desist orders for insurance-related violations in at least 10 states in as many years. His latest scrape with the law came last year in Montana, where state regulators accused him of selling bogus surety bonds to Native American contractors under a new alias, Chief Joe Blue Eyes.

Created by federal regulations for small contractors as an alternative to more risk-averse corporate sureties, individual sureties are people willing to provide payment and performance bonds—guarantees made in exchange for a premium based on a small percentage of the contract—to small firms that would otherwise fail to qualify for public-works projects.

The website of Scarborough's Charlottesville, Va.-based company, IBCS Fidelity, boasts of being capable of providing bonds as high as $50 million, "far surpassing most other sureties."

Corporate sureties and brokers view these individuals with disdain, calling their practices a taint on the industry and citing examples such as Hanson, who has pledged assets of questionable value that may not exist at all. The corporate sureties want to tighten the rules on assets via legislation in a way that would knock most individual sureties out of business—including an antagonist who claims he is providing a service for an underserved market that corporate sureties avoid.

Unlike individual sureties who have stayed in the shadows, Edmund C. Scarborough is the founder and chairman of the U.S. Individual Surety Association. The website of Scarborough's Charlottesville, Va.-based company, IBCS Fidelity, boasts of being capable of providing bonds as high as $50 million, "far surpassing most other sureties."

"If you or your clients have been told NO by traditional sureties, try one of our many services," the website proclaims.

A burly former Florida contractor who claims to have written 6,000 to 7,000 bonds for small federal, state and local contractors, Scarborough says he has developed a business with revenue from bond premiums of $5 million to $6 million a year. He says he backs his bonds with about 15 million tons of Kentucky and West Virginia usable coal waste. He also says the bonds are as solid as those provided by A.M. Best-rated insurance companies, such as Travelers and Liberty Mutual.

 

 

Scarborough has a gift for hitting the corporate surety world, deploying a narrative in which he plays a noble, unbending David struggling valiantly against corporate surety's imposing Goliath—all for the benefit of small and minority contractors.

"We've had hundreds of bonds accepted by the federal government—and hundreds also rejected—and the only common denominator among the rejected bonds is that they were all minority contractors," he says. If Congress adopts the proposed asset rule changes, eliminating coal products and requiring a federal Treasury bond or something similar, corporate sureties would have "won their battle at the expense of the overwhelming majority of small, up-and-coming or independent contractors, who would no longer exist."

In Scarborough's view, the surety playing field tilts steeply to the corporate side. Everything works against the individual surety providers and their clients. For one thing, corporate sureties can leverage the assets backing their bonds, while an individual surety must back them on a dollar-for-dollar basis.

"The surety world is the only entity that [generally accepted accounting principles] say you don't have to report the liability on your books because it's a third-party guarantee," says Scarborough. "And they call me a crook."

Scarborough's adversaries may agree with that quote but keep quiet because they fear what they call his litigious streak. Scarborough has kept several lawyers skilled in the art of litigation quite busy.

Does Scarborough deserve a place in a small-business Hall of Fame or in a rogues' gallery with figures such as Robert Joe Hanson? The answer may depend on the value of Scarborough's hard-to-verify coal holdings and his opponents' will to outlast him in court battles.

For eight years, Scarborough has engaged the U.S. government and the corporate surety industry in the judicial equivalent of trench warfare. In 2005, he sued the U.S. Army and the National Association of Surety Bond Producers (NASBP) over their disclosure of information about an Army investigation of individual sureties and possible fraud. Although he and NASBP settled long ago, on Jan. 15 Scarborough filed an amended complaint in his claim against the U.S. Army. The complaint alleges the Army violated the federal Privacy Act in divulging details of Scarborough's business publicly.

A separate matter carried the bond battle from federal court to Capitol Hill. In 2011, surety bond brokers, insurers and major contracting associations threw their support behind H.R. 3534, the Security in Bonding Act, which passed the House of Representatives last year but died in the Senate. It would have tightened asset rules, requiring U.S. Treasury bonds or related debt securities to be placed in escrow and held by the obligee. Rep. Richard Hanna (R-N.Y.) reintroduced the measure this year on Feb. 15. It included an expansion of the Small Business Administration's surety loan guarantees.

Data Lacking at Federal Agencies

In an effort to gauge the impact of individual sureties, ENR sent Freedom of Information Act requests to eight federal agencies to determine how many are in use on federal projects. Most had no data about how often individual surety bonds have been accepted.

Scarborough has never been charged or convicted of a surety-related criminal offense. But state regulators have ordered him not to do business in Iowa and Virginia, and he has been embroiled in numerous lawsuits. Civil court and state regulatory records provide a glimpse into the controversies that have flared over Scarborough's business dealings. As part of its investigation, ENR reviewed thousands of pages of court pleadings, evidence and cease-and-desist orders and interviewed a number of Scarborough's business associates, clients and adversaries.

About this time, Scarborough revamped his bond program, parting ways with Wright and Hanson ("I wasn't crazy about them," Scarborough says). To back his bonds, he started to acquire coal properties, including ones in West Virginia and Kentucky. He also continued to expand his reach and clientele, promising to provide up to $50 million in surety credit.

 

"Ed's the only one who could write a big bond," notes Karen Barbour, a Maryland-based surety broker.

Another change involved the bank that provided the irrevocable trust receipts related to Scarborough's asset. He switched that part of his business to a trust department of Wells Fargo Bank in Utah.

For some contractors lacking surety credit, individual surety is needed but unwelcome. "If there's something better than dealing with Scarborough, put him out of business," says one of his former clients, who declined to be identified due to the sensitivity of the topic. "Yet, he helped me get work." For others, individual surety was an unqualified godsend. Omar Karim, president of Laurel, Md.-based contractor Banneker Group, was genuinely grateful for the support.

Karim says he and his joint-venture partner needed the bond to qualify for $10 million worth of building construction work at Ft. Belvoir, Va. He remembered that his bond on the project was "backed by coal."

A Contracting Officer Rejects Coal Assets

In 2007, Wanda Peffer reviewed documents she had received from a small contractor on the island of Saint John in the U.S. Virgin Islands and didn't like what she saw. A contracting officer for the Federal Highway Administration (FHWA), Peffer was reviewing the documents for an intersection reconstruction project on which Tip Top Construction submitted a low bid of $1.8 million.

What held up Peffer's approval was the surety bond Tip Top submitted. She noticed the bond was from an individual and that it was backed by coal assets. The bond documents described the assets behind the bond as an "allocated portion of $191,350,000 of previously mined, extracted, stockpiled and marketable coal, located on property of E.C. Scarborough."

Scarborough was basically claiming that the coal-related material on the property is more like a share of actively traded stock, a type of asset that federal regulations permit to be used to back a bond, rather than a speculative asset (such as antiques) that is forbidden under federal rules.

As far as Peffer was concerned, coal fell outside the guidelines for acceptable assets in her understanding of Federal Acquisition Regulations. She exchanged information about the coal assets with Tip Top and Scarborough but ultimately rejected the bond and declined to accept a substitute asset.

Tip Top filed protests and eventually sued the federal government. Scarborough also sued it. Most of the pleadings concerned Peffer's right to say no to coal.

In his court submissions, Scarborough represented that the asset backing the Tip Top bond was a portion of 166,400 gross tons of previously mined surface coal on an irregularly shaped, 115.5-acre tract in rural Nicholas County, W. Va. The website of a separate Scarborough company, IBCS Mining, says that the company has another coal property in Kentucky and that it had sold coal to utilities and other buyers.

The website describes the material at the properties as waste coal piles. IBCS' team of engineers, geologists and lab technicians had determined the character of each waste pile, the website stated, and the firm planned to use "Green Technology" to reduce the troublesome piles and "America's dependence on foreign oil."

A federal judge eventually ruled in favor of FHWA, bolstering the contracting officer's authority to accept or reject a bond. During the lawsuit, much evidence found its way into the record about the coal properties.

For example, Scarborough's attorneys submitted a report from an engineering-and-mining consultant that provided a limited-scope estimate that the coal refuse on the West Virginia property could produce 3.3-million tons of recoverable coal and that, based on current coal pricing, "this may potentially equate to a gross value of approximately $261 million following processing." Qualifying their findings, the engineers said they had performed no testing or measuring of the actual, inplace material but had relied on an affidavit of the tract's former owner, a coal engineer.

Scarborough also submitted an affidavit from another coal expert attesting to the fact that coal is indeed a readily marketable asset and that, when already mined, extracted and stockpiled, coal is a very liquid asset. The expert also said it wasn't a mineral right because the material already had been mined.

Although critics claim the Federal Acquisition Regulations don't permit the use of mineral rights to back individual surety bonds, says IBCS Fidelity's Golia, "that's not what we use. Mr. Scarborough uses the actual mined minerals. This is coal you can go over and kick with your foot."

Kicking the coal may not be so easy at the Nicholas County site. Documents attached to the property deeds in West Virginia show a prior owner had been reclaiming the land under the state's direction, covering the coal waste with soil. One question is whether the property's environmental permit, No. R-707, actually allows Scarborough and IBCS Mining to remove the coal waste. The property's ownership chain and regulatory history is long and complex.