Our agent asked this question. How would YOU respond? (Our answer at the end.)
“Hi Steve, my client got a call from a township that is one of his past customers. There’s a project they want him to finish. The other contractor ran out of money and couldn’t complete the job.
The defaulted contractor thinks he is 95% complete, but it looks like there is more than 5% left to finish this up. There is also subcontract work that the township cannot evaluate. They are not sure what remains to be done.”
Your answer: __________________________________
This is a bit thorny. There are red flags and we don’t even know the size of the contract yet!
The first point is that this is a completion contract for the defaulted contractor’s surety. It’s not a normal township bonded project – like the client is used to doing. Does he have prior experience working for a bonding company? I don’t think so.
“Abbey Normal”
Secondly, if there is some question regarding the remaining work, how can he price it correctly? “Lump Sum” contracts are common in the industry. There is a set dollar amount to be paid. If it turns out to be insufficient to complete the work, the contractor faces a loss on the project.
Obviously there is much more to know about this, but here was our response:
Generally, sureties are reluctant to issue bonds with another surety as obligee, can get too messy. This is an “abbey normal” situation. He could only offer to proceed with no bond on his completion contract.
The client should avoid a lump sum contract because the scope of work is not clearly defined. A better choice would be a Cost Plus contract. It would prevent an unprofitable outcome.
No premium on that one, but at least we helped our agent and contractor.
Tip #1: The Contractors Questionnaire should be filled out completely, signed and dated.
Explanation: It is better to answer every question and provide additional explanations than to leave answers blank. They make the reader suspicion that critical info is being withheld. It gets the relationship off on the wrong foot.
Tip #2: Owners spouses’ info must be included in all areas including the Contractors Questionnaire and personal financial statements.
Explanation: Bonding companies expect to have personal financial info and the indemnity of all owners and spouses. The underwriters will ultimately determine if the owners are married. If the spouse info has been omitted it is an immediate red flag.
Tip #3: If there is a default or bankruptcy in the company or personal history, provide full disclosure with an explanation and offer documentation (even if it occurred more than 7 years ago.)
Explanation: There are often legitimate reasons for such events. It is important to explain why it happened and the events/actions that followed. There are bonding companies that will be understanding and welcome the business.
Such historical details cannot be concealed. They will be seen in the credit reports and background checks.
Tip #4: Tax disputes – if they result in a Tax Lien, you may lose more money by fighting it than by paying it off.
Explanation: Tax Liens are viewed as a possible indication of poor management, insufficient cash flow and/or bad accounting practices. This can hold back your bonding and keep you from acquiring new projects. Weigh the advantages. It may be better to pay the tax bill and keep your credit report clear.
NOTE: Unpaid taxes can result in a tax lien even if you have been told to not make payments while the matter is under appeal.
Explanation: During an appeal, the government may file a tax lien to perfect it’s rights. They do this with no regard for the effects a lien may have on your credit rating, your banking or your bonding relationship.
Talk to your attorney about paying the disputed amount during the appeal process.
Tip #5: Don’t borrow money from the company.
Explanation: This creates an asset on the company balance sheet called “Stockholder’s Loan Receivable.” Bond underwriters typically disallow this asset by deducting it from Working Capital and Net Worth (bad for your bonding). Avoid such transactions!
Extra Tip: If you have already borrowed from your company, start paying it back now.
Tip #6: Litigation – open suits must be disclosed on the Contractor Questionnaire.
Explanation: Such facts will become known to the surety from a variety of sources. For example, your CPA may be required to disclose open litigation in the financial statement notes.
If you are a defendant, the surety will want to know the cause of the action and the financial implications. It can help if your attorney writes a letter of explanation and predicts the likely outcome.
It is better to volunteer this info on the application, and offer the explanation YOU feel is appropriate.
Tip #7: Young companies can supplement their history by providing resumes of key people.
Explanation: Many sureties will not accept applicants with less than 3-5 years of operating history under the current name and ownership structure. When experienced construction professionals start their own companies, their resumes will be a key element explaining skills and capabilities demonstrated on prior projects. Be sure to include contract details such as work description, year completed, $ amount and your personal responsibilities.
Tip #8: Hopping around – multiple sureties over a short period of time will raise concerns.
Explanation: Setting up a bond account is an expensive proposition for the surety. They are looking for customer loyalty and stability.
Long term relationships tend to produce more capacity and better terms for the contractor. If you like to hop around on your insurance every year, try not to do so on your bonds.
Tip #9: Maximizing bank credit can help your bonding.
Explanation: Even if you don’t expect to need it, maximizing your bank credit will help support your bonding. Bond underwriting includes a credit analysis. If the bank supports you, it proves to the surety that you are credit worthy and therefore deserving of bonds.
In addition, bank credit is a financial resource that could be the key to completing a bonded project and avoiding a bond claim or default.
Tip #10: Make bid estimates sufficiently high.
Explanation: When submitting a bid bond request, make the “estimated contract amount” high enough to allow for last minute increases. There is no harm in bidding less than indicated.
What fun! But before the music starts you pick your partner: Somebody who has all the moves and can keep up with you.
In bonding, how do you choose your surety partner? What are the “moves” you want from your bonding company?
Speed – You need answers promptly. Today business is moving faster than ever!
Ambition – Look for underwriters that are hungry, willing to work for the business.
Capability – Search for the appropriate skills and credentials. Do you need a surety that loves pavers, or roofers, trash haulers or remediation*?
Consistency – The surety reviews the history of bond applicants. You can review the history of the surety. Steady? Committed? Long-established?
There’s nothing more important than picking the right partner. Otherwise you’re doomed to disappointment and awkward missteps.
There is a spot for you on the FIA Surety dance card. We are steady, long-established and successful. We have all the right moves for contract surety, site and subdivision bonds. Call us with your next one.
* Yes, we write all of those and more.
FIA Surety / First Indemnity of America Insurance Company 2740 Rt. 10 West, Suite 205 Morris Plains, NJ 07950 Office: 973-541-3417
An “A Rated” Carrier
We are currently licensed in: NJ, PA, DE, MD, VA, NC, SC, WV, TN, FL, GA, AL, OK, TX
Remember when you had to take bad tasting medicine as a kid? “OK honey, this will be good for you!!!“
Collateral is a little like that. Here’s the situation:
When contractors apply for bid and performance bonds, sometimes the surety underwriters are reluctant to provide them. They view the risk as excessive. A way to sweeten the deal, reduce the perceived risk, is for the contractor to give the surety funds to hold “collateral” until the bond is released.
That’s all good. It gets the deal done. The contractor gets the bond, starts the contract and can (hopefully) make some money. When everything is done, they get the collateral back. Simple.
However, it’s not THAT simple. The collateral is cash, cash the contractor no longer has to help finance and complete the project. So the very thing they need to be successful is taken away from them in order to get the bond. Yipes!! That’s a heavy price to pay.
It’s a double edge sword for the surety, too. They were somewhat reluctant to provide the bond, now they have taken an important resource (cash) away from the client – possibly creating a situation where a bond claim is more likely. This is the main thing they want to avoid… That’s no bargain.
Guess what, we haven’t even gotten to the nasty part yet. The first nasty is when the job is half done. The client asks for half of the collateral back and are told they can’t have it until the end: “We have no way of knowing how large a bond claim might be.” When they DO get to the end of the job, they STILL can’t have it back because the funds are typically held until the end of the lien period (when payment bond claims may surface). Some sureties hold it until the maintenance period ends (one or two YEARS?!) Torture…
Biggest Nasty: There have been cases where the client is having trouble completing the project. So they contact the surety, “We have a cash flow problem but want to finish this project. If we get the collateral back now, it will get us through and everyone will be happy – no chance of a bond claim.”
What do you think the answer is? The collateral is for the protection of the surety. So they will hold it and if there is a default, the funds are used to finish the project with the new completion contractor. It sounds brutal but it’s true.
So there’s your bitter medicine. It makes sense in some cases, but it is important to understand the rules of the game before you play.
Here are actual student comments from our recent Free CE webinar “Understanding Financial Statements.“
"This was a good class Steve. Really helped explain the financial statement and if a company is making money, keeping money in the business, or losing money. Thanks"
"I thought this was a really great class. I don't have any prior knowledge about financial statements and I learned so much. Thank you!"
"Steve, I am a CPA and you did a terrific job. Great job, really."
"Fun"
"I found the high level analysis very helpful and you kept the explanations interesting, thanks!"
"This was a great review of financial statements which I have not really examined before. Thanks so much for the in-depth review."
"Thanks Steve, well done. I will attend almost any CE Bond class you do. I like knowing what I should be picking out of a F.S. that underwriters will think is good or bad. Zoom makes this so convenient. Thanks again."
Well, there you have it. Why pay for a boring CE class when you can attend an interesting, Free CE webinar? Check out our upcoming schedule here: Free CE
Secrets of Bonding 