Secrets of Bonding

“If you are a bonding company, why won’t you bond subcontractors?”

It might seem odd, but some Sureties do not embrace the opportunity to serve subcontractors.  So what’s different about subcontractors and subcontracts?  Why do some sureties red line this entire segment of the market?

The Food Chain

One complaint underwriters may have about subcontractors is that they are farther down the food chain than General Contractors. GCs have a “prime” contract, meaning they work directly for the project owner, and are the first recipient of monetary payments.  The subcontractors are subsequently paid by the GC.  Subs may face delays and sometimes even harassment at the hands of GCs. Remember, subcontracts are all private contracts not regulated by governmental rules even if the prime contract is public. Put simply, subs have a harder time collecting their money.

Other Issues for Subs and Their Sureties

• GCs do not normally disclose bid results (2^nd & 3^rd  bidder’s figures).  This makes it difficult to evaluate contract price adequacy – a disadvantage for both the sub and surety.
• Unregulated procurement procedures and contract administration – GCs may be aggressive in their procurement methods, pressuring subs for price concessions: “Knock their heads together.” Such practices make the subcontracts less profitable and therefore more risky for the sub and surety.  Subs can also be victimized with verbal awards and unwritten change orders.
• Contract documents (including bond forms) may be non-standard, drafted by GCs specifically to give strong advantages over subs and sureties.  In some cases the normal Performance bond is transformed into a forfeiture type financial obligation.
• Flow-down or pass-through clauses in subcontracts force subs to assume obligations rightfully belonging to the GC. An example would be wording that makes the sub responsible for the liquidated damage amount on the prime contract if they are found to have caused a delay on the subcontract.
• “Pay when paid” language can result in delayed payment to the sub.  “Pay if paid” can result in the sub never being paid.
• Unbonded public work is rare, but in such cases there is no Payment Bond at the GC level to protect the sub, and liens (filed against the project for failure to receive payment) may be prohibited.
• Indemnification: Broad form indemnity clauses in the contract can make the sub financially responsible even if they are not at fault.
• Delay damages: Subs may be barred from seeking financial recovery.
• Lien waivers: When read literally, these documents may operate to waive and release claims for which the subcontractor has not yet been paid. (Learn about Conditional and Unconditional Lien Waivers: Click!)
• Termination for Convenience: This contract clause can enable the GC to terminate the contract and leave the sub with a series of unreimbursed expenses and lost profits.
• Some trades perform their work late in the project, meaning the bond is carried for a lengthy period with no progress on the contract.
• Certain trades can operate with minimal capitalization, so the field may be populated with lightly financed companies. Such competitors can drive down contract prices making it harder to bond their work.
• Financial reporting may be less sophisticated than for GCs (CPA financial statements vs. bookkeeper or QuickBooks).
• Due to their size and circumstances, subs may lack bank support, such as a working capital line.

Conclusion

Subcontractors literally perform the majority of all construction work.  They are the backbone of the construction industry and cannot be ignored by sureties.

When it comes to bonding, subcontractors need to demonstrate that they are well-managed companies that reflect the same attributes as a successful GC.

Secrets #5 and #15 contain important guidance to help agents get subcontractors approved.

Start by choosing a surety that is actively seeking to support subcontractor accounts without requiring collateral.

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Steve Golia
First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

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