Month: July 2016

Secrets of Bonding # 131: Maintenance Bonds – Breezy Free & Easy

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Free surety bonds.  Is there anything better? Actually we can think of a couple of things right off BUT…  are they good?  Sure they are.  

Everybody likes free stuff.  Trouble is, they’re not always breezy free or easy.  Sometimes they’re a huge P.I.A.  So let’s get into maintenance bonds and learn the issues.

The most common Maintenance Bond situation is a bonded public or private contract.  The specification stipulates there must be a 100% (of the contract amount) Performance and Payment Bond plus a Maintenance Bond, which is often for a lesser amount, maybe 20% of the contract price.  The maintenance bond covers the completed work for defective materials and workmanship, for a specified period of time.

The P&P bond is issued when the project commences, and the Maintenance Bond comes when the completed work is accepted.  It is common for the project owner (obligee) to write an acceptance letter regarding the proper completion of the contract, and stating that the Maintenance Bond must now be issued.

free-easyFor the surety, this bond is an easy decision.  They already got paid for the P&P bond. They already faced the risk of claim due to faulty workmanship or materials.  Now the contractor (Principal) will pay an additional premium to obtain another bond on the same work. 

In some cases the surety doesn’t even charge for this bond following their P&P obligation – breezy free and easy!  If they do charge, the rate may be less than for a P&P bond. So when is it not breezy free and easy… and why?

Timing

Maintenance bonds are normally required after the contract has been accepted (work completed). However, in some cases, the owner requires issuance concurrently – at the inception of the project. This is difficult for the surety to support because the approval of maintenance bonds may be relatively easy, but it is not automatic.  The surety must decide if they want to accept the risk associated with the maintenance obligation. In part, this is predicated on the smooth performance / completion of the contract. If the job was fraught with problems and difficult to complete, they may not want to support such an obligation.

Requiring the underwriter to issue the bond at the beginning takes away the opportunity to make an informed decision. 

General Underwriting Concerns

There is a time factor involved in each of these bonds. The surety must be confident that for the one or two-year period, the principal will be willing and able to respond to any call-backs (things that crack, malfunction, etc.)

If the applicant has recently deteriorated, such as declining credit scores or a poor financial statement, the underwriter may refuse to support their request.

Term

The duration of the maintenance obligation can present an underwriting issue. A one-year obligation is normal.  Two years may be possible.

What about five years or ten?  Probably not.

No P&P Bond

Sometimes a Maintenance Bond is requested, but there was no Performance Bond.  Or, another surety may have issued the P&P bond.

If there was another surety involved in the project, it will be very difficult to gain a new underwriter’s support – the thought being “this risk belongs to anther surety.”

If there was no P&P bond, the maintenance bond underwriter will require an Obligee’s Contract Status Report. This is the obligees written statement that the contract has been completed in a satisfactory manner, and related bills paid. A clean bill of health is needed to gain the underwriters support.

Conclusion

You wont get a maintenance request on every project.  But when you do, it may be very easy and cheap – but not always.  Now you know why.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision and Contract Surety 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 #130: Rob Peter to Pay Paul

Steve GoliaLeave a comment

It’s only human nature.  You have a problem, a need.  A financial issue has come up and the timing is inconvenient. So if you just move things around, you can handle the problem and back-fill later.

For construction companies managing multiple projects, not every job goes smoothly.  Construction work is complicated with many variables and uncontrollable elements.  Sometimes the only solution is to throw money at the problem. When cash flow on the project is “temporarily” insufficient, there is a natural temptation to borrow money out of another healthier contract, with the intention of paying it back at a later date. Is this bad?robbing_peter

Trust Funds

From a legal standpoint, money a general contractor (GC) holds, that is destined to pay the subcontractors (plumber, electrician, HVAC, etc.) he hired on the project, is held “in trust” for the benefit of those subs.  The law says it is their money, and the GC must safeguard it.  Therefore, any money in this trust fund category cannot be “loaned” to another of the company’s projects.

Bonded Contracts

When a Performance and Payment Bond covers a contract, the payment section of the bond guarantees that suppliers of labor and material will be paid.  This includes the subcontractors that were hired by the GC. The bonding company is guaranteeing that the trust funds will make it into the hands of the subs.

If money has been diverted into another project by the GC, and subs remain unpaid, they are entitled to make a claim against the payment bond.  Sureties are risk averse and strive to avoid all bond claims.  Underwriters are well-aware of the “Peter Paying Paul” scenario where the funds are never restored and a payment claim results.

Protective Measures

Bonding companies may take steps to prevent such misapplication of funds.  One is Joint Checking.  Under this procedure, the project owner (paying for the work) issues joint payee checks in the name of the GC and the sub or vendor.  Now there is absolute certainty that the funds will get to the sub as intended.

This procedure does not cost money to implement (other than the administrative expense), but is dependent on the willingness and continuing participation of the project owner.

Another protective device is the use of Funds Control, also called Funds Administration.  Think of this as a professional paymaster who pays everyone on the project, including the GC.  Money goes from the owner to the funds administrator, who then issues all the checks.  By limiting the GC’s money handling, misapplication of funds to another project is prevented.

The funds administrator charges a fee, which is paid by the GC.  For this procedure to be successfully implemented, the owner must officially agree to pay the funds administrator instead of the GC.

Conclusion

When it comes to money handling on construction projects, many people have a stake in the process.  The GC’s obligation is more than to simply complete the work.  They have a fiduciary responsibility to handle funds properly and assure that deserving parties are paid.  That’s what the bonding company expects, and it’s simply the right thing to do.

FIA Surety is a NJ based bonding company (carrier) that has specialized in Site, Subdivision and Contract Surety 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.)