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.
Steve Golia, Surety School Director
FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
An “A Rated” Carrier