Month: August 2014

Secrets of Bonding #69: Actual, Consequential and Liquidated Damages. Wazzat?

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You may encounter these legal terms when handling construction contracts and surety bonds. Bid and performance bond request forms typically ask about “Liquidated Damages.” Does this refer to marine contracts?

A typical Performance Bond form may not mention liquidated damages – whether they are covered or excluded. So why does the bond request ask for this detail?

Let’s start by identifying the parties involved:

  • The contractor that applies for the bond is the principal. They would be the defendant in a lawsuit relating to the bond.
  • The owner of the contract, the party protected by the bond, is the obligee. In that lawsuit, the obligee would be the plaintiff, bringing suit against the bond principal and surety.
  • The third party to all such transactions is the bonding company or surety.

Bonded contracts can be between the project owner and a general contractor (GC), or between the GC and a subcontractor (sub). We mention this because sometimes the problems and claims “trickle down” from contract to contract and then onto the bond.

What does a Performance Bond Cover?

The bond language is specific. But remember, it is a guarantee of the contract it references. Construction contracts typically DO establish liability for contract delays, unanticipated increased expenses and other financial losses that may be attributable to the contractor’s actions or inactions. It is through the contract language that the surety becomes responsible for such losses. For this reason, damages are always an issue for bond underwriters. Let’s learn enough about them to be dangerous.

Liquidated Damages (also referred to as ascertained damages) are damages whose amount the parties designate during the formation of the contract for the injured party to collect as compensation upon a specific breach (such as late performance). Such penalties for failure to complete on time can amount to thousands of dollars per day and thus may deter a surety from supporting the contract.

It is not uncommon for general contractors (GC) to pass down the Liquidated Damage penalty in their contract, to the subs below them. The concern is that the subcontractor’s lack of performance could jeopardize the timely completion of the entire project.

When parties contract for liquidated damages to be paid, the clause will be enforceable if it involves a genuine attempt to quantify a loss in advance and is a good faith estimate of economic loss.

Actual Damages In a breach of contract case the prevailing plaintiff may be entitled to actual, or compensatory, damages.

Actual damages can be split into direct and consequential damages.

  • Direct damagesresult naturally from the defendant’s wrongful conduct. The defendant will have foreseen the damages would result from the breach. The benefit of the bargain that is directly and strictly tied to the contract is a measure of direct damages.
  • Consequential damagesresult naturally but not necessarily from the defendant’s wrongful conduct. Consequential damages must be foreseeable and directly traceable to the breach of contract. Lost profits, lost sales, incidental damages and most other damages are consequential damages.
  • Consequential damages (also sometimes referred to as indirect or special damages) may be recovered if it is determined such damages were reasonably foreseeable or “within the contemplation of the parties” at the time of contract formation. This is a factual determination that could lead to the contractor’s liability for an enormous loss. For example, the cost to complete unfinished work on time may pale in comparison to the loss of operating revenue an owner might claim as a result of late completion.

It is important to note that the definition of what the bond covers is only limited by the imagination of the presiding court. Certainly it is true that the interpretation of bond coverage has expanded the exposure of sureties. Here are some examples of losses courts have determined are covered by performance bonds:

  1. Municipal Bond Interest
  2. Loss of Use of Building Site
  3. Interest on Construction Loan
  4. Loss of Rents
  5. Liquidated Damage
  6. Lost Profits
  7. Loan Interest
  8. Delay Damages
  9. Lost Rental Income
  10. Unemployment Insurance Taxes
  11. Prevailing Wage and Overtime Violation Penalties
  12. State and Federal Taxes
  13. Lost Equity Delay Damages
  14. Over payment
  15. Loan Repayment

In conclusion, we must keep in mind that the surety’s obligation is defined by the bond and the contract.

Does the surety have the opportunity to review the upcoming contract when considering the bid bond? It would be unusual if they did! This is why the underwriting questions are so important.

We all know contracts can vary, but bonds can vary too. It is imprudent to make assumptions in this area. Read the bond and read the contract. If necessary, ask for a written legal interpretation.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

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Secrets of Bonding #68: Get Your Surety Bond for Free!

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There’s no question about it.  The only reason bonding companies issue surety bonds is because they want your money. But how, when, and if you pay are all up for grabs!

Let’s look at some of the realities and options when it comes to paying for surety bonds.

Payment Practices

 INSURANCE – You may know that you can pay for insurance with installments.  You may also finance the premiums. Eventually, if you fail to pay the installments, the coverage is cancelled. It is this ability to terminate the exposure that enables the insurer to offer payment terms and the finance company to assume the risk.

 COMMERCIAL BONDS – These common types of bonds are usually issued for low amounts.  For example, the face amount on license and permit bonds may be $5,000 or less.  The premium on them is low and may be a minimum charge. Such bonds may contain a cancellation clause.

 These facts may seem to make installments possible, but the practice is often to require payment in advance. It could be that for a small premium or commission, the issuer is not willing to face any collection problems or related expenses.

 CONTRACT SURETY: BID BONDS – Bid bonds are not issued until the underwriting is completed, so the surety always incurs expenses.

Another fact: You can have a claim on a bid bond and the surety could suffer a net loss.  So there are costs and exposures attached to these instruments.  Bonding companies normally have filed rates that entitle them to make a charge for every bid bond. But do they? No! The majority of sureties do not charge for them. “Free bonds!” Their motivation could be that the fee is so small; it is unprofitable to bill it.

 PERFORMANCE AND PAYMENT BONDS – These obligations are typically irrevocable. Put simply, if the surety issues the bond and bills later, they cannot terminate the obligation for failure to pay. Even a casual observer would be forced to conclude that P&P bonds MUST be paid for in advance. It’s logical, but the industry practice is often to wait 45 to 60 days until the client has collected their first payment on the contract.  This gives the contractor the luxury of not having to “front” the bond fee.

 A portion of the industry does charge in advance for P&P bonds.  You’ can’t argue with their logic!

 COURT & PROBATE – These bonds are normally paid for in advance, and may be fully earned upon issuance.  In a legal action, the mere ability to issue the bond can have a beneficial effect for the applicant.  Knowing this, sureties would be foolish to offer any form of return premium.

 PREMIUM FINANCING – This would seem to be the client’s solution to the pre-payment requirement, but most finance companies will not support bonds due to their non-cancellable nature.

 Conclusion

If you’ve been looking for the thread of logic, there is none!

Billing practices are traditional, and may not make much sense.  We should charge for bid bonds but often don’t. A bid bond for a large project could cost more than a small one.

P&P bonds should be paid in advance but we often collect payment later.

Since the methodology defies logic, you must ask the underwriters in every case.  Don’t assume you can predict when to pay or if you have to pay for it at all!

There’s no question about it.  The only reason bonding companies issue surety bonds is because they want your money. But how, when, and if you pay are all up for grabs!

Let’s look at some of the realities and options when it comes to paying for surety bonds.

Payment Practices

INSURANCE – You may know that you can pay for insurance with installments.  You may also finance the premiums. Eventually, if you fail to pay the installments, the coverage is cancelled. It is this ability to terminate the exposure that enables the insurer to offer payment terms and the finance company to assume the risk.

COMMERCIAL BONDS – These common types of bonds are usually issued for low amounts.  For example, the face amount on license and permit bonds may be $5,000 or less.  The premium on them is low and may be a minimum charge. Such bonds may contain a cancellation clause.

These facts may seem to make installments possible, but the practice is often to require payment in advance. It could be that for a small premium or commission, the issuer is not willing to face any collection problems or related expenses.

CONTRACT SURETY: BID BONDS – Bid bonds are not issued until the underwriting is completed, so the surety always incurs expenses.

Another fact: You can have a claim on a bid bond and the surety could suffer a net loss.  So there are costs and exposures attached to these instruments.  Bonding companies normally have filed rates that entitle them to make a charge for every bid bond. But do they? No! The majority of sureties do not charge for them. “Free bonds!” Their motivation could be that the fee is so small; it is unprofitable to bill it.

PERFORMANCE AND PAYMENT BONDS – These obligations are typically irrevocable. Put simply, if the surety issues the bond and bills later, they cannot terminate the obligation for failure to pay. Even a casual observer would be forced to conclude that P&P bonds MUST be paid for in advance. It’s logical, but the industry practice is often to wait 45 to 60 days until the client has collected their first payment on the contract.  This gives the contractor the luxury of not having to “front” the bond fee.

A portion of the industry does charge in advance for P&P bonds.  You’ can’t argue with their logic!

COURT & PROBATE – These bonds are normally paid for in advance, and may be fully earned upon issuance.  In a legal action, the mere ability to issue the bond can have a beneficial effect for the applicant.  Knowing this, sureties would be foolish to offer any form of return premium.

PREMIUM FINANCING – This would seem to be the client’s solution to the pre-payment requirement, but most finance companies will not support bonds due to their non-cancellable nature.

Conclusion

If you’ve been looking for the thread of logic, there is none!

Billing practices are traditional, and may not make much sense.  We should charge for bid bonds but often don’t. A bid bond for a large project could cost more than a small one.

P&P bonds should be paid in advance but we often collect payment later.

Since the methodology defies logic, you must ask the underwriters in every case.  Don’t assume you can predict when to pay or if you have to pay for it at all!

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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Secrets of Bonding #67: Get to Know FedBizOpps

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“FedBizOpps” or www.FBO.gov, is a federal website presented by the General Services administration. It is officially described as a “web-based portal which allows vendors to review Federal Business Opportunities.”

This site can be a great help to bonding agents and is a critical resource for contractors pursuing federal work.  Open another browser while you read this and and connect to the site.  We’ll go through the highlights.

The main purpose of this site is to connect contractors with upcoming federal projects.  Let’s try the Quick Search on the front page.  For Type select Presolicitation. For Keyword enter Janitorial, then press Search. A list of upcoming janitorial projects appears. They are all available for bidding!

Do another search using Place of Performance: Alaska. For Keyword, enter “snowmachines” then click Search.  This should take you to a page showing an Air force contract award for $35,500. Here you see the details of a company that successfully acquired a contract.

FedBizOpps provides all the federal contract activity centralized in one web site.  What a great resource!

How to get involved

Contractors are considered “vendors” to the government, so step one is to follow the Vendor / Citizen registration link near the bottom of the front page.

After you register and classify your business, you are ready to perform a contract search. Log in to the site if necessary, and do a Quick Search under My FBO. Use Presolicitation and Janitorial again.

My search resulted in a list of 25 contracts. If you click on the first one it immediately shows you the nature and location of the work, the response date and other key details.  If you wish to pursue this contract, additional information is provided.  When you click Add Me To Interested Vendors, your company info is immediately included under the third tab “Interested Vendor List.”  This entitles you to automatic updates that will arrive in your email.  You will be advised as this opportunity moves through various stages resulting in an award.

When listed as an Interested Vendor, you may find that suppliers and other companies will contact you.  They may offer to assist in your solicitation effort or be your supplier if you win.

As a prospective bidder, you will also see who you are bidding against.  Good stuff!

Saved Searches

Here is an excellent feature of the site. Under My FBO, follow Search and Create Saved Searches. You can use very specific parameters.  After you run the search, choose Save Search Agent. At the bottom follow Save and Schedule Search Agent.  You can instruct the site to run this search every day and email you the results!  You can also set up any number of additional searches you may desire.

There is always a button near the top for the User Guide, which is a very helpful “FedBizOpps for Dummies” type resource.

For Bond Agents, the site provides the names and contact info of federal contractors.  Other vendors and suppliers use the site for the same purpose.

If you have an interest in federal contracts, get to know FedBizOpps!  Make it work for you every day.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site and Subdivision Bonds since 1979 – we’re good at it!  Call us with your next one, Bid and Performance bonds, too.

Steve Golia: 856-304-7348
First Indemnity of America Ins. Co.

Don’t miss our next exciting surety article: “Follow” this blog in the top right hand corner.

Secrets of Bonding #66: Timing, the Cart, the Horse

Steve GoliaLeave a comment

 

Being in the right place, or the wrong place, can make all the difference. In the world of surety bonding, particularly contract bonds, timing plays an important role.

Here is a typical scenario.  It is a question of timing:

The client comes to us to get their bond account set up for the first time.  We send over the “laundry list” of documentation that is normally required.  It’s a bit daunting.  For companies that have never been bonded, they probably do not have all the info readily available.  They must gather documents, others must be filled out, they must be scanned and shipped. There are better ways to spend a Friday evening!

The cause of this activity is usually that the first bonded project has popped up.  We had a case like this recently where the project was being negotiated.  No bid bond was required. If the effort was successful, the contractor would need a bond.  If not, the bond monster goes back to sleep.

Our new client seemed unconcerned about the bond.  They didn’t want to take the time to develop their file unless they won the project.  Only then would they find out if it is easy, hard, or impossible to get the bond!

For this applicant, the project comes first – then the bond. Is this a smart approach?  Maybe not, because sometimes the first bond is a harder, slower process than expected!

Let’s look at some aspects that could cause unexpected delays (assume this is not for a small contract):

  1. Financial Information – The underwriters will request business financial statements, not just tax returns. Not all companies automatically prepare these. If the year-end date is not close, it can be very inconvenient to go back and reconstruct the financial picture.
  2. Accounting Methods – Companies that have been using Cash Method statements will find they need to re-issue the document using a different accounting method.  To accomplish this, the accountant will require an additional body of financial information, then they commence with their processing.
  3. CPA – Don’t have one? You will need to choose/engage a firm then allow time for their due diligence and procedures.
  4. Accounting Presentation – If a CPA Compilation has been the norm, it may be necessary to upgrade and re-issued as a Review. The CPA will need time to perform the additional services.
  5. Outside References – These are sent to creditors and vendors for handling, then you wait for their response.
  6. Historical Data – The project history of the company and its key people, including contract details, will be required. Prior financial data is needed. Three years of complete tax returns are often requested.
  7. Work In Process Schedules – Many contractors do not employ a sophisticated method of analysis. All sureties do! It may be necessary to upgrade the reporting with highly detailed individual project cost records and profit projections.
  8. Credit Reports – Erroneous or incomplete reports can have a devastating effect on the underwriting, and such problems are slow to correct. Adjustments to the credit report are only accomplished after a time consuming process with the rating bureau.

Issues like these can throw the timing off, and delay the bond issuance, but they are all correctable.

There may be other unexpected problems that cannot be easily fixed.  For example, unacceptable financial ratios.  The company could be solvent and profitable, but with poor ratios, some underwriters will say “Come back and see us next year.”  An unacceptable company or personal credit report can have the same effect.

Contractors often dread the bond underwriting process.  We’re not trying to foment anxiety by describing these pitfalls – actually just the opposite!  By allowing enough time, we often can help the client through them.

Summary: Get your bonding set up in advance. Then you have it when you need it with no last minute surprises or disappointments.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision, Bid and Performance Bonds since 1979 – we’re good at it!  Call us with your next one.

Steve Golia, Marketing Mgr.: 856-304-7348

First Indemnity of America Ins. Co.

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)