bid bonds

Secret #87: Payment Bonds – You Like It Hard or Easy?

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If you like to do things the hard way, stop reading. You’ll hate this article.

On unbonded construction projects, it is not uncommon for high dollar vendors to specifically ask for the protection of a Payment bond. When this is presented to surety underwriters, they quickly recognize that the purchase order is the subject of the bond guarantee, not the construction contract. This is a much more difficult underwriting scenario.

Why?

When a Performance and Payment Bond (P&P bond) is written on a project, the principal (contractor) is being paid to perform the work. If they fail and the surety is called in to complete the job, the unpaid balance of the contract price is a financial resource that remains available. Even if the principal has no financial capabilities, the surety still has a source of money that may be adequate to complete the obligation without having to add funds.

easy-hard

Now let’s go back to the vendor scenario. We are assuming there is no P&P bond on the project. When the vendor demands the protection of a payment bond, it will be a guarantee of the purchase order not the construction contract. It is purely a guarantee that the principal will pay the vendor. It is not a promise that incoming contract funds will be used appropriately to pay bills. Big difference!

The point is that in the vendor example, it is considered a financial guarantee – a promise that the principal will pay money when appropriate. The reason these obligations are more difficult may be obvious. If the customer is unable to pay the vendor because they’re out of money, only the surety remains to pay the bill. Solving the bond need of the vendor by issuing a financial guarantee bond on the purchase order is the hard way to solve this problem.

The Easy Way
If a 100% performance and payment bond had been required on the contract, it would have guaranteed (among other things) the payment of all bills for labor and material, including the one in question. Even if the project owner did not stipulate a P&P bond, it does not mean one cannot be used to solve the problem.

The easy solution, the alternative we always suggest, is to order a traditional 100% P&P bond and then simply file a copy of the payment bond with the vendor. It does not name the vendor as obligee the way a financial guarantee bond would. However, it is issued literally for the protection of such vendors and solves the need perfectly, and with less underwriting stress and probably a lower premium!

This can be a great solution that converts very challenging underwriting into plain vanilla.

Consider using this technique when the purchase order is a major portion of the overall contract. If it is not, it may not be economical to bond the entire job, just to cover one vendor. Then it could be necessary to pursue the financial guarantee bond instead.

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.

Secret #80: Substitute Final Bonds

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Secret # 22 covered the bonding of started projects.  Secret # 73 is about Substitute Bid Bonds. In this article we will look at cases where the contract was already secured with a surety or cash bond, but a new bond is under consideration.

Consider a number of scenarios:

  1. We are currently working on a case where a client put up full collateral (cash bond) because they did not have a bonding relationship. They contacted us to provide a surety bond that will enable them to recover their cash.
  2. A bonded project could unexpectedly require a replacement bond if the original is nullified by legal or administrative action. (This has happened!)
  3. Similarly, an otherwise valid bond may be deemed unacceptable if the surety’s A. M. Best rating drops below the obligee’s requirement.
  4. We have seen cases where a contractor wishes to voluntarily replace a bond because their new surety offers significantly better terms. (Only advantageous under certain circumstances, such as? Answer below. *)

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These are all legitimate reasons to issue a performance and payment bond on a project that is underway – and already bonded. So how does the underwriter approach these opportunities?  How can the contractor and agent prepare for this process?

The first question for the underwriters is whether they are subjected to adverse selection.  There could be physical or financial problems on the project that make a bond claim likely.  A thorough investigation will ensue.

Assuming there is no adverse selection, the underwriter’s first task is to determine the status of the project.

  1. How far along is the work?
  2. Has it been performed correctly and to the obligee’s satisfaction?
  3. Is the contractor up to date paying for labor and materials?
  4. Is the job on schedule?
  5. Does the project owner know of any disputes, delays or problems of any kind?

Will the obligee go on record stating that so far, everything is OK? The underwriter will require such a letter in order to proceed.

Typically, when the new bond is issued, it will cover the entire project back to inception.  If the original contract is the subject of the new bond, it will cover the entire dollar amount of the project including the completed portion.  As a result, the contractor may have to pay two bond fees.

The only way to avoid this is to draw up a new contract for just the remaining work.  In most cases, this is not an option.

It may seem that bonding a partially completed project is attractive. After all, part of the risk has been eliminated! In reality, due to the fact that all aspects of the completed work are guaranteed by the new bond including the prior materials and workmanship, the new underwriter faces nearly the entire risk.

When you add the possibility that the underwriter may be subjected to adverse selection, most sureties are cautious when issuing a substitute final bond.

* The timing must be right. If the purpose of filing a replacement bond is to pay a lower bond fee, the greatest advantage is at the beginning of the contract when a full refund may be provided by the incumbent carrier.

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 #77: Fire, the Wheel, Surety Bond Rates

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These were among caveman’s greatest inventions.  But unfortunately, bond rates have changed little since the Paleolithic Era!

That may be a slight exaggeration, but it is true that bond rates and rating methods are not revised often.  Here are some of the peculiarities worth knowing, primarily in the area of contract surety:

  1. All sureties are entitled to charge for bid bonds, but most do not.
  2. They may charge for performance bonds in advance, but many wait 45 days for payment even though the instrument is uncancellable.
  3. A performance and payment bond costs the same as just a performance bond.
  4. A 100% performance and 100% payment bond costs the same as a 100% performance and 50% payment bond.
  5. A maintenance bond may be cheaper if the same surety preceded it with a performance bond.
  6. A 20% performance bond may cost the same as a 100% bond even though the surety has 1/5th as much exposure.
  7. In cases where a bid bond or surety consent letter is required, but then the work is awarded without requiring a final bond, the surety is entitled to make a charge for the unissued performance bond.

Now here is my favorite crazy bond rule.

Situation: You have a $1,000,000 private contract on which a P&P bond is optional.  The project owner asks the contractor to price an “alternate” to include a bond.

Let’s say the bond rate is 2% of the contract amount. So what is the bond price?

  1. $20,000
  2. $40,000
  3. $20,400
  4. $40,200

I know you love #1. It just looks so right.

But alas, that is not the answer, which is why this wins the wacky award!

#3. is the correct answer. The reason is that the bond fee is actually calculated on itself.  When determining the bond fee, it is not correct to remove the bond cost from the contract amount.  Like the cost of insurance and all costs related to the project, the bond cost is included in the contract amount.

Therefore, the correct basis for the calculation is $1,020,000 x 2% = $20,400.

Q. So what about the additional $400? Should the calculation actually be $1,020,400 x 2%? (Then, wouldn’t you have to recalculate it again, and again, and again…)

Q. And who pays the extra $400? It’s not in the $1,020,000 contract amount.

A. Beats me. You better ask that Neanderthal in the corner office!

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.

Bonding Pros Success Story

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November 12, 2014 to Bonding Pros:

“Steve, Good to see it came thru OK. We would like to offer our sincere appreciation and gratitude for your efforts. Thanks so much! Talk soon, (Contractor)”

Frankly, we even impressed ourselves on this one!

The client had a series of obstacles in their file, any one of which could have caused a declination.  With their good cooperation we crafted a file that brought out the key elements of their strength, and effectively addressed issues we knew could be deal killers.

We got them capacity with a highly rated, T-listed surety… with NO COLLATERAL.

This is where our long experience as bonding specialists pays off.

You know insurance, but we know bonds.  Use us as you agency bond department.  We’re problem solvers and our markets are the best.  When you need a bond, talk to the Pros!

We protect our brokers, pay a commission on every bond fee and keep you in the loop.  Try us!

Secrets of Bonding is brought to you by Bonding Pros

856-304-7348  www.BondingPros.com

Secrets of Bonding #76: The Second Bidder’s Second Chance

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In this article we will talk about some opportunities that may exist for second bidders.  These are the contractors who have come in 2nd on a competitively bid project, such as a federal or state contract.  These projects are typically awarded to the “lowest responsible bidder” (meaning they must have the proper credentials and meet other requirements.)  As for the 2nd bidder, they get nothing.  They were close, but did not win.  It’s a 100% waste of time and money – unless they DO ultimately acquire the project.  A contract may be awarded to the second bidder under certain circumstances – such as a defect in the low bidder’s paperwork.

There are many documents required in a typical bid proposal: Licenses, certifications, references, non-collusion affidavits, business registration, consent of surety, bid guarantees, etc.  If documents are missing, or issued with defects, the low bid can be declared “non-responsive” at the discretion of the project owner.  The 2nd bidder then becomes the lowest responsible bidder and may receive the contract award.

Here are some of the technical areas to check that can cause bids to be rejected:

  1. Mandatory forms Failure to use mandatory forms, use of obsolete / expired forms, or not following a stipulated format.  Does the bid invitation contain a bid bond form described as mandatory? Bid bonds are all similar but the failure to use the right format or document is a potential cause for rejection.
  2. Bid bond details Check all the typed information for accuracy.
    1. Bidders name
    2. Obligee’s name
    3. Job description and project number
    4. Bid bond percentage or dollar amount
  3. Capped bid bonds If a “capped bid bond” is used, a proposal amount that exceeds the bid bond maximum would invalidate the instrument.  (More info in Secret #68)
  4. T-List requirement If a “Treasury Listed” surety is required, does the bonding company appear on the list, and for a sufficient amount?  http://www.publicdebt.treas.gov/fsreports/ref/suretyBnd/c570.htm
  5. Power of Attorney Is one attached, in the correct name, properly executed and for a sufficient amount?
  6. Notary Acknowledgment Needed for both the surety and the contractor, properly executed.  Is the notary’s commission for the correct state and not expired?
  7. Execution Signed and sealed with the correct seals?
  8. Financial Statement Attached for the surety?  Is it for the correct surety name? Is it as of an appropriate date (not obsolete)?
  9. Consent of Surety This is not always required. However, if stipulated, failure to provide it can cause a rejection. Are all the details on the consent accurate? Properly executed including correct seal?  If there are stated conditions, does the proposal comply? (Example: The Consent may only be valid up to a stated bid amount.)

On public bids (municipal, state and federal), the bid documents are normally available for public review.  Second bidders may be surprised to learn they have a second chance if the low bid is defective.

Another second chance may arise if the low bidder falters on the project after commencing work.  In the event of default, the bonding company must come to the rescue and they want an efficient (fast, economical) way to complete the job. Who better to call than the 2nd bidder?  The 2nd is the natural “completion contractor” to finish the job for the surety.  They already know the project and presumably offered a price close to the low bidder. The 2nd should contact the claims department of the surety that holds the Performance Bond if they see the project is in trouble.

Now a parting comment for LOW BIDDERS: Keep in mind that 2nd bidders don’t give up easily.  They, too, spent time and money pursuing the work, and want to win the contract.  Be sure your quality control prevents bid errors that cause bid bond claims and open the door for 2nd bidders.

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 #74: Twofers

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A Basic Question

 Talk to the experts, and you may get different answers to this extremely basic question: “What is the maximum potential loss for the surety on a Performance and Payment Bond?”

If you have experience producing surety bonds, you know that a 100% Performance Bond (equal in amount to the contract) is priced based on the contract amount. If the bond rate is 2.5% of the contract amount on a $100,000 project, the Performance Bond cost would be $2,500.

How much would it be for a Performance and Payment Bond? It seems logical that if you add to the exposure, you must charge more – but the cost is the same. Surety rules typically say that the Payment bond is provided at no additional charge. Is this because the surety is being generous, or is the exposure amount not actually increased?!

Surety Practices

We have established that bonding companies do not charge twice as much for a P&P bond.

When it comes to the use of the contractors bonding capacity, they use “1 x” here too.  For the contract in our example, $100,000 of capacity is consumed by the P&P bond, not $200,000.

Combined Bond Forms

Look up New Jersey law “N.J.S.A. 2A:44-147” and you will find it stipulates a combined Performance and Payment Bond form for public work in the Garden State. The penal sum (maximum dollar value of the bond) is stated once in support of a two-headed obligation. This may lead the reader to conclude that the single bond penalty is shared by the surety’s two legal obligations. That would justify not making an additional charge when including a Payment obligation with the Performance Bond.

Bond Specifications

On public work, such a federal, state and municipal contracts, the bonding requirement may indicate “100% Performance Bond and 100% Payment Bond” or “100% Performance and Payment Bond.” In the context of this article, the implications may be obvious, but it appears contract officers use them interchangeably.

Federal contract officers, on other other hand, can be quite specific on this point and expect the surety to assume a 200% exposure for the 1 x bond fee.

Federal bond forms require a separate instrument for Performance and another one for Payment, each with its own penal sum.  The Surety may attach them both as a single document and even give them one bond number.  But the government clearly is buying a guarantee with a combined value of 200%.

Twofers

The reality is that, despite the pricing methods and handling procedures used by sureties, the bonding company IS responsible for 200% if they issue two instruments each stating a 100%  obligation. This is the twofer that sureties willingly offer. You can have Performance only, or get Performance and Payment, twofer the price of one!

The Irony

Surprisingly, obligees may not position themselves to obtain maximum value and protection from the bonds they buy, and sureties may give away coverage rather than charge for it. fia_surety_logo

 

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417
Visit us: www.fiagroup.com
We are currently licensed in: NJ, PA, DE, MD, VA, NC, SC, WV, TN, FL, GA, AL, OK, TX

Secrets of Bonding #73: Substitute Bid Bonds

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substitute teacher

Remember how much fun it was to have a substitute teacher? Well, this is a little less exciting…

In Secret #49 we talked about bidding with a check.  This is a related topic. Substitute bid bonds are an odd part of what we do as surety professionals.  Here’s how you may run into one.

It is common for project specifications to offer a number of methods to provide the bid security that accompanies a contractors project proposal.  The options may include a check made out to the obligee, or a bid bond.

A substitute bid bond may be issued after bid security has already been given with the contractor’s proposal.  This bid bond will replace, or be substituted for the existing security – thus the name.

This may arise when the contractor has no surety at the time of the bid.  They bid with a check.  Now, with a surety in place, their first request is “How about helping us get our cash back?  It’s tied up with that bid.”

What a great way to start off by helping the new client. However, sureties are not always in favor of issuing these, and some refuse to do so under any circumstances.  Why?!

1. Bid Spread: In this case, the contractor is the low bidder, but they are too low. (Read Secret #16 to learn about unacceptable bid spreads.) The contractor may be in line for the project, but the surety does not want to issue the performance bond (aka final bond).  If the bonding company provides the substitute bid bond, they become obligated to issue the final bond or face a bid bond claim (two bad options!) “Sorry, we are not able to provide a substitute bid bond for that project.”

The fallout is that the contractor may blame the surety when they lose their bid security for failing to deliver the final bond. They will also lose the expected income from the project – pretty ugly.

2. Final Bond Optional: The specs may indicate that a Performance & Payment bond is not mandatory. It is optional at the obligee’s discretion. This amounts to adverse selection against the surety.  If the obligee thinks the contractor looks capable: No bond.  If there is some doubt about their ability to perform or the adequacy of the price, better pass the risk over to the bonding company.

For this reason, substitute bid bonds may be declined if a final bond is not mandatory.  Remember, final bonds are where sureties make their money.  Bid bonds are usually free.  The contractor will not lose anything as a result of the refusal to issue the substitute and they are already eligible to win the contract.

3. Not Low Bidder: This is similar to Number 2. Here the contractor is second or third bidder. The common practice is for obligees to hold the bid security of the second and third bidders in case they need to give them the project (maybe the low bidder can’t get their final bond issued?) The bid checks could be held for months!

From the surety’s perspective there is no question about the adequacy of the second or third bidder’s number.  This may be a well-priced contract. The problem is that they are unlikely to issue a final bond.  (Projects are rarely awarded to the second or third bidders.) This has even less chance of making money for them than a normal bid bond request.

To the contractor, a substitute bid bond may seem like a great idea. For the surety, the only desirable situation is when their client is low bidder with an acceptable bid spread and a mandatory final bond. Absent that, don’t be surprised if the surety only wants to get involved after the contract award takes place and the final bond is needed.

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FIA Surety is your go-to market for Site & Subdivision bonds.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417
Visit us: www.fiasurety.com
We are currently licensed in: NJ, PA, DE, MD, VA, NC, SC, WV, TN,  FL, GA, AL, OK, TX

Secrets of Bonding #72: Surety Consents 1, 2, 3.

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Sorry OCD, we are starting with Consent #3!

#3: Surety Consent to Release of Final Payment

This may be one of the final steps in the life of a bonded contract. The obligee (party protected by the bond) may give the surety the opportunity of providing a “consent to release final payment” before the last money is paid out.

 It is common for contractors to be paid on a monthly basis.  When it is time for the final payment, it may be the obligee’s last opportunity to influence the contractor to resolve deficiencies in the work product.  The contractor may be more likely to make corrections before the last money is paid out than after.  Un-resolved problems can eventually become bond claims.

 The bonding company should determine if the obligee is satisfied with the work (Status Inquiry form) before issuing the consent. In this manner, they may spur the contractor to action and  eliminate a potential bond claim.

 This procedure benefits the obligee in two ways:

  1. The surety will require responsiveness to the obligees reasonable performance demands before consenting to the payment
  2. It reduces the surety’s ability to refuse a future bond claim on the basis that funds were improperly released by the obligee

View sample: http://74.218.115.26/wp-content/uploads/2010/07/4D-AIA-CONSENT-OF-SURETY-FINAL-PAYMENT.pdf

 #2 Consent to Release / Reduce Retainage

This is similar to the Final Payment, but it can occur during the life of the contract.

The obligee may ask the surety for consent to release or reduce the retainage funds.  This money is a portion of each monthly payment (called a requisition) that is held back (retained) by the obligee.  For example, in a contract with a 10% retainage, the obligee will pay $9,000 on a monthly requisition for $10,000.  The retainage is accumulated in the hands of the obligee and used as motivation to assure acceptability of the work as the project concludes.

The retainage percentage may also be reduced during the contract.  There could be 10% retained during the first half of the project, then 0% for the balance.  This enables the obligee to gather some protective money in the early stages, while allowing the contractor to have better cash flow toward the end. View sample: http://www.state.nj.us/treasury/dpmc/Assets/Files/Contractor%20Award%20Doucuments/DPMC-20r(1),%20Consent%20of%20Surety%20to%20Reduction%20in%20Retainage.pdf

Now we come to #1.  Why did we cover these in reverse?

#1 Surety Consent to Issue Final Bond

This consent, which concerns the Final or Performance bond,  is commonly used on all public construction contracts in NJ, and may be used by obligees on private work anywhere (such as a GC soliciting for subcontractors).  View sample: http://www.njsbga.org/yelbook_sec_c-all.pdf

We saved this one for last, because without it, there is no contract!

Important points:

  1. If required in the bidding specifications, the contractors proposal could be rejected for failure to include a consent or if the document is defective.
  2. The surety may issue a “capped consent.” It includes a condition that voids the surety’s obligation above a stipulated amount: “…however, such contract/performance bond amount shall in no event exceed $___.” This language protects the surety from having to support a contract higher than the approved amount. If the contractor does bid above the approved figure, it is likely the bid will be rejected by the obligee based on such language. The contractor must be mindful of this limitation.
  3. Sureties do not automatically issue these consents. They must be specifically requested when ordering the bid bond.
  4. Bonding companies issue this form of consent reluctantly. It deprives them of the discretion to not issue the performance bond if the contractor’s condition has deteriorated, or if there is an unacceptable bid spread. (Read Secret #16: Bid Spreads)
  5. The consent does not require that the same surety be used for the bid and performance bonds. However, if the bid surety balks on the final bond, the contractor and obligee may remind them they are obligated to provide it.

Consents of Surety: They are one more intricate piece in the surety puzzle.

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.)

Secrets of Bonding #70: Labor, Contracts, and Labor Contracts

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On the subject of Bid and Performance / Payment Bonds, the process of obtaining one always includes a Bond Request Form.  This document is required by surety company decision makers (bond underwriters), who need to view a summary of the relevant details.

They also use this form to document the approval of the bond, and may make note of special conditions they are requiring, the bond rate and execution / shipping instructions.

The bond request form contains general info identifying the client and the beneficiary of the new bond (the obligee), plus specific details about the project.

For example, it will ask for the description and location of the work, the start and end date, and details about the performance. Subcontractors will be described. There will be a question about other projects the contractor is performing.  There will also be a question about labor on the project.

The labor question is usually part of a group like this:

Est. Materials:___%     Est. Labor___%     Est Overhead / Profit___%

(It’s worth noting that the sum of the three should equal 100%!)

The answer to the labor question has certain implications for the underwriter. There is no “normal” scenario, but let’s use this for illustration:

Materials: 30%     Labor: 60%     Overhead/Profit: 10%

If 30-60-10 is a response within the range of normal, how would you interpret this?

Materials: 90%     Labor: 0%     Overhead/Profit: 10%

This looks like a material supply contract.  The client has a product they are selling.  They have no “on-site labor.”  They are not assembling or incurring any labor costs at the project location.  When evaluating the relative degree of risk associated with bonding this contract, is there more or less risk than normal?

You may run into the opposite situation:

Materials: 0%     Labor: 90%     Overhead/Profit: 10%

This is a “labor contract.” Maybe a general contractor needs carpenters on a project so they give out a labor only subcontract. Would underwriters consider this factor a plus?

The answer is that labor is considered more unpredictable than materials.  You know the exact cost of materials, but how much for installation? There are variable factors that can influence the ultimate cost of project labor (human productivity, worker morale, quality of supervision, design deficiencies, weather, other contractors, etc.)

Conclusion:

A material “supply contract” is easier to bond than a labor and material contract or a labor contract.

What about this?

Materials: 40%     Labor: 60%     Overhead/Profit: 0%

Sounds like the subject of a future “Secret!”

FIA Surety / 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 #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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