When developer Glenn Harz began work in 1978 on a low-income housing project in the Bronx, he obtained two routine insurance bonds to guarantee his performance.

The bonds were written by a convicted felon who was working for the FBI, and they turned out to be worthless. When his prime contractor later defaulted on the project, Harz was left holding the bag, one of several unintended victims of the FBI's Operation Frontload.

After years of litigation, the government last fall paid Harz $1.8 million to settle the case. But the Justice Department obtained a court order Monday that requires Harz to give back the money and begin negotiations all over again.

"The sad part is I thought it was settled," said Harz, 34, who has been out of work since the bonds bounced. "When someone gives me a check, to me a deal is consummated."

The government has already paid out $1.9 million on nine claims stemming from Opertation Frontload, one of the most embarrassing "sting" operations in FBI history. The construction industry probe is one of several undercover investigations that has raised questions about the FBI's ability to control the informants it frequently relies upon.

FBI spokesman Lane Bonner said the administration plans to propose legislation that would financially protect innocent third parties harmed by undercover operations.

"By far, most undercover operations produce tremendous returns," Bonner said. "Occasionally, some do go awry. We constantly strive to perfect them."

Bonner said undercover techniques are not used in most investigations and that the FBI relies on middlemen and informants only when necessary.

"You try to control them to the extent you can without giving away your operation," he said. "We are working very hard to ensure that innocent people, and I underscore the word innocent, do not get burned."

The House Judiciary subcommittee on civil and constitutional rights, headed by Rep. Don Edwards (D-Calif.), takes a dimmer view of the FBI's undercover work. In a report last year, the panel said that a number of undercover probes have caused "substantial harm" to innocent bystanders.

In fiscal 1984, the FBI said such investigations led to 1,200 arrests, nearly 1,000 convictions and more than $100 million in recoveries. FBI Director William H. Webster said last spring that the FBI may allow informants to engage in "some minor illegal activity" if it will lead to more important criminals. But all informants are told they will be prosecuted if they violate FBI guidelines, he said.

Some FBI stings have worked well. In Brilab, a convicted insurance man helped obtain bribery convictions against Carlos Marcello, a reputed organized crime figure in New Orleans, and several state officials.

Others have a mixed record. In Abscam, a convicted swindler used the FBI's cover in the successful bribery probe -- Abdul Enterprises -- to run his own investment scam, defrauding dozens of at least $150,000.

In Operation Recoupe, the FBI acted as a middleman in the sale of stolen cars in an effort to shut down stolen-car rings in the Midwest. FBI officials have said they recognized the cars might be resold to innocent buyers.

John Lightner, a used-car dealer in Dixon, Ill., bought eight of the cars at a 1981 auction and resold them to customers. State police officials, working with the FBI, assured Lightner the cars were legitimate. But the government later seized the cars, and Lightner's customers demanded their money back.

"My business won't recover until this thing is over," said Lightner, who is suing the FBI and others for $600,000 in damages. "I've been drained financially and in every other way."

"It was devastating when the word got out that we were handling hot cars," said Phil Bollman, a Rock Falls, Ill., dealer who ended up with 13 stolen cars. He has filed a $10 million suit.

The stolen-car probe yielded a number of indictments. But the main result of Operation Frontload, aimed at uncovering organized-crime influence in the construction industry, was more than $150 million in lawsuits. The probe did aid a related investigation that led to racketeering convictions for the mayor of Union City, N.J., and seven others.

The FBI's undercover man in Operation Frontload was Norman Howard, a former Chicago police officer who had served time in jail on a fraud-related conviction. The FBI had Howard pose as an insurance salesman peddling performance bonds to construction firms.

A respected firm, the New Hampshire Insurance Co., agreed to provide a cover for Howard after being assured that the FBI would defend any lawsuits that resulted. Howard was given blank bonds and a corporate seal, but was warned not to actually sell any bonds.

Howard allegedly stung the FBI instead. According to documents filed by the FBI and the insurance company, he sold more than 60 bonds in 1978 without the company's knowledge and pocketed hundreds of thousands of dollars in premiums.

The FBI has been unable to explain why Howard was not charged in connection with the bond sales. He served nine months in prison in 1981 on unrelated fraud charges in Illinois and, after a period as a fugitive, has been rearrested and faces new fraud charges in Georgia.

Two of Howard's bonds were bought by Glenn Harz's prime contractor, who was helping him put up a Bronx project financed by the Department of Housing and Urban Development. When the contractor could not complete the job in 1979, Harz tried to collect on the bonds. But the insurance company denied knowledge of the bonds and referred him to the Justice Department.

Harz's lawyer, Gilbert Wallach, said that Howard "was under the umbrella of the FBI. They gave him an opportunity to steal because they weren't watching him . . . . They didn't know he was writing bonds all over the United States."

Harz said he put up more than $1 million to finish the housing project. But because he is deemed to have defaulted on the job, he has been barred from all future HUD contracts.

Deep in debt, Harz won a court ruling that he is entitled to damages. He spent nearly three years negotiating with the U.S. attorney's office in Manhattan. Last fall, aides to U.S. Attorney Rudolph W. Giuliani told Harz they had received the required approval from Justice Department officials in Washington to settle the case for $1.8 million. Harz got the check in December.

But Giuliani's office recently did an about-face, saying the settlement was invalid because it was never approved by Deputy Attorney General D. Lowell Jensen. A federal judge in New York agreed Monday that Harz must return the money and resume negotiations in the case.

Peter C. Salerno, Giuliani's deputy chief of civil litigation, blamed the settlement on "a communications failure." He said the government considers the settlement excessive because it is about $600,000 more than the value of the bonds.

"I can't comment on the fairness or unfairness," Salerno said. "Whether or not it is fair, the law is clearly established that the taxpayers' funds should not be expended unless it is clearly authorized. It's more important that the Treasury be protected from improper payments than that some people suffer."

But Harz, trying to start a new career in Denver, is bitter. He has already spent a third of the money on his attorney's $560,000 fee and other debts. And he is frustrated that the Guiliani aides he negotiated with have moved on to private jobs and been replaced by other young prosecutors.

"They don't know me," Harz said. "They look at textbooks and say, 'Some muckamuck in Justice didn't sign off on it. Maybe we can squeeze a few hundred thousand more from this guy.' They're trying to beat me on technicalities."