bond capacity

Secrets of Bonding #164: The Phantom of the Underwriting Department

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When it comes to surety bonds, you know your underwriter. You know the process.  There are questions and answers, then a decision.  Simple, right?

You rely on your rapport with the surety and know how to monitor the status of the underwriting.  Maybe you understand the underwriter you see.  But what about the invisible surety underwriter, a shadowy phantom who exists in every transaction, and whose opinion always affects the outcome. Call this mysterious one “The Phantom of the Underwriting Department.” 

For mood music, Click!

You cannot talk to the Phantom…  Invisible.

There are no emails, no Q. and A. 

And yet, the Phantom analyzes, reviews and influences every bonding decision.  Let’s pull back the curtain on this ethereal being.

Contractors Questionnaire

It all starts here.  Your underwriter looks at the basic info: How long in business?  Largest prior jobs? What do they do, what do they sub?

But the phantom yearns for more. What company ownership structure was chosen?  Is it a proprietorship, corporation or LLC?  Did the founders make prudent decisions? These choices affect taxes, profits and future liabilities.  They can help or hurt the company… and its surety.

If criminal history, litigation, tax problems or surety bond claims / losses are indicated, these may require further investigation.  The Phantom will make a deeper review.

Continuity of Ownership: Who succeeds the current stockholder in the event of death? Will the company maintain operations and complete its projects? These arrangements show that management has an eye toward the future.

The Work In Process Schedule

These are requested often.  They show the contracts in progress, their billing status and costs. The underwriter wants to know how much “work on hand.” Then, silently, the Phantom digs deeper.

The current expected profit is compared to the original estimate. What does this show? Is the profit expectation as predicted or better? Is the estimating department in sync with the field organization?  Is job site supervision highly efficient? Can an undeclared underbilling asset be added to Working Capital?

Is the expected profit sufficient to produce a net profit at year end?  The Phantom will compare the projected job profit percentage to the company Profit and Loss Statement. Based on historical expense trends, the likelihood of an upcoming profitable fiscal year-end can be verified.

Company Financial Statements

He loves these.  There is so much.  They talk to him. The Phantom takes full advantage of this document to determine more than just “the numbers.”

Beginning with the accountants cover letter, who has the contractor chosen for this important assignment? Are they using a construction expert? Did they pay for a quality presentation?  Is the best accounting method in use? Is the fiscal date at an advantageous point in their business cycle?

Obviously, underwriters look at working capital, net worth, ratios, profitability. But there is so much more.  The financial statements show how the stockholders / managers treat the company.  What does it mean to them? Do they nurture and respect it, growing the tiny acorn into a mighty oak?

Past borrowing practices are revealed.  Also, the relationship between financial performance and the ambitions of management.

Growth of the revenue stream is observed and management’s success in monitoring / controlling expense levels.

The Phantom reviews financial statements and tax returns to appreciate the owner’s commitment to the bonded company.  This commitment is a cornerstone of the underwriter’s confidence.

Banking Relations

Very important! There are similarities between banking and surety bonds.  The banker’s opinions help reaffirm the underwriting position.

The banking history can reveal good cash flow and prudent business practices.  It can indicate stability, reliability and good management skills.

Credit Reports

The pay record is just the tip of the iceberg.

Now there is a historical review which indicates the adequacy of cash flow, the quality of money management, planning and the applicant’s good moral character.

The Phantom is always there, making this deeper analysis that may never be discussed, but can always make a difference.

Meet Our Phantom

Now, Remove the Mask!

Sorry, we don’t actually have any Phantoms.  All our underwriters are regular people, with real experience and know-how when it comes to bid and performance bonds. Our surety professionals review the facts promptly and efficiently. 

Their deep analysis enables us to support opportunities that may have been declined elsewhere.

We hope you found this article entertaining, but more importantly, informative!  With us, the underwriting is deep and detailed, giving the applicant the highest likelihood of approval.

Call us with your next bid or performance bond, and speak to a real person. 856-304-7348 

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

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

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

First Indemnity of America Ins. Co.

Bucket List: Update

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Great news!!  Today you can check off one more item from your Bucket List!

Current Bucket List:

  1. Learn to bartend like Tom Cruise in “Cocktail”
  2. Visit Abbey Road in London and re-create The Beatles’ cover
  3. Hug Mickey Mouse
  4. Write my name in wet cement
  5. Bury a time capsule
  6. Ride a Vespa
  7. Find a Bonding Company as Good as I Want
  8. Make a tie dye shirt
  9. Be the house on the block with the most Christmas lights
  10. Try every cheesecake at The Cheesecake Factory

Today you can finally check off #7: “Find a Bonding Company as Good as I Want” There are two big questions and we will answer them now.

Question

What do you want from a bonding company? They must have capacity.  If the company is too small, they can only write tiny bonds.  They are of little use to Surety Bond Agents and their Contractor clients.

Good credentials.  The bonds must be widely accepted so contractors can use them on various contracts, in any state.

Flexible underwriting.  The process of getting the bond approved must be willing and aggressive, like the underwriters actually want to write the bond.

Speed.  You can’t wait forever for an answer.  How long should it take the underwriter to respond?  Basically, your Bucket List surety will give you a same day response.

What about speed? Our underwriting expertise originated in the early 70’s!  We have lots of experience solving problems for our clients efficiently and with a same day response.

Hooray!  You nailed #7.  When you need the next bid or performance bond call us: 856-304-7348.

Now, here is a link to help you with #1: Click!

Secrets of Bonding: #163: Financial Statement Fraud!

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You know the old adage, “Financial statements don’t kill people, people kill people.”

While it’s true there can be misrepresentation and deception in a financial statement (FS), the document is not inherently bad, it is the poor intentions of the preparer or company that is to blame.

As credit analysts, we always review and rely on FSs when underwriting surety bonds. We know there may be attempts to mislead our judgement or even downright deception. But the need to evaluate the financial report is unavoidable. It is considered a valuable “report card on the quality of management.”

There are three levels of financial presentation by Certified Public Accounts (CPAs):

Compilation – a properly organized report where the numbers have not been verified or evaluated by the CPA

Review – includes some checking “Review” of key elements

Audit – is the highest level and includes the CPA’s statement that they have checked and believe the numbers are correct

The reader of the FS is entitled to certain expectations: A candid and complete presentation that informs the reader. Are they entitled to more than that? Does the reader sometimes expect too much?

Let’s consider what the FS actually says, and what it doesn’t… 

The Balance Sheet

This shows assets and liabilities. It describes the dollars in the company (assets) and who owns them (liabilities and stockholder’s equity). You know many of the normal entries: Cash, accounts receivable, accounts payable, inventory, bank debt, the net worth / stockholder’s equity section, etc.

The balance sheet always has a date, such as 12/31/2017. It shows the status of these accounts on the one day. Credit analysts calculate the Working Capital aka Net Quick (NQ) which is considered a measure of short term financial strength. You find the NQ by subtracting current liabilities from current assets. When the bond underwriter has the NQ number, it can then be incorporated in the decision making.

“What size bonds will be approved for this applicant?”  “How much total capacity can they be allocated?” The NQ figure becomes a benchmark that is used for the remainder of the year.

For many analysts, this one number carries a huge importance for the following 12-15 months.

Let’s move forward one day in time, to 1/1/2018. “Happy New Year!” and let’s check the bank account. Some money has come in! The accounts receivable and cash have changed. Other elements are also different and so, if we calculate the NQ based on the 1/1 balance sheet, the NQ will probably be different from 12/31. Again, that’s because the balance sheet shows the state of these accounts on ONE DAY. It is always changing!

The reality is that the working capital number is only correct for one day, then it is subject to revision. This is not to say the number is not important or relevant. And certainly decision-makers must have annual benchmarks and a method for their determinations. It is very important, but so are other elements.

Financial Statement Fraud

The most common FS fraud is not committed against us by others. It is the self-deception we commit by over relying on these “one-day numbers.” To do so is to miss the big picture!

Underwriters love to see a big cash account sitting on that top line (of the balance sheet). But that’s a one-day number. Isn’t it even more important to determine the average funds on deposit for the prior six months or year? Many analysts fail to ask for this.

Accounts Receivable and Payable – here is another key area where the “one-day number” can easily be given a historical perspective. Aged schedules of A/R and A/P are easy to obtain and they give a view over more than one day. These documents are not automatically included in FSs, and underwriters may fail to ask for them.

Another example: A broader understanding of the banking relationship is accomplished by looking beyond the balance sheet bank debt.  A reference letter can reveal if the client has bounced checks, broken loan covenants or defaulted.

Conclusion

As readers of these documents and analysts, let’s not cheat ourselves by over relying on the balance sheet or thinking it is more than a one-day snapshot. It should be scrutinized and viewed in harmony with other key underwriting factors such as mid-year financial reports and supporting documents.

In this manner underwriters can make realistic, well-informed decisions.

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.

Secrets of Bonding #162: Burn Baby, Burn!

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In the surety underwriting business, we are forward looking.  Bond decisions are based on a variety of factors including “The Four C’s of Bonding” (read our article #5).  Underwriters make a detailed analysis, then set surety capacity levels to administer the account. That all makes sense.

However, the forward looking analysis makes assumptions – that may or may not be correct.  If incorrect, the outcome could be devastating for the contractor and surety.

In this article we will delve into an aspect of evaluation used extensively by investors, but not so much by bond underwriters.  It is called the Burn Rate.  Mood Music: Click!

 

Here is the internet definition:  

Burn Rate is the rate at which a company is losing money.  It is typically expressed in monthly terms; “the company’s burn rate is currently $65,000 per month.” In this sense, the word “burn” is a synonymous term for negative cash flow.

It is also a measure for how fast a company will use up its shareholder capital.  If the shareholder capital is exhausted, the company will either have to start making a profit, find additional funding, or close down.

Very interesting. The reason our underwriters use the Burn Rate is because of the assumption it does not make…

Think of the typical decision-making process.  Working Capital (WC) and Net Worth are calculated then compared to the requested bonding limits. The underwriter wants to predict if the company’s financial strength is sufficient to support the amount of surety capacity.  (A 10% case?) This evaluation is important, but it assumes the client will have enough future work to fill the bonding capacity limits. But what if they don’t? Can we predict the company’s ability to survive with inadequate revenues and in the absence of profits?  Would this not be an important measure of financial strength and staying power?

The Burn Rate enables us to determine:

Runway

 A company’s “Runway” is the time it can survive on existing capital without new funds coming in.

Here’s how to calculate a company’s financial Runway. This is a hard core analysis that eliminates all expectation of new revenues. The formula requires two elements:

  1. Working Capital “As Allowed” by the underwriter’s analysis
  2. Average monthly fixed expenses

Working Capital (WC), as you may recall in Secret #4, is a measure of the company’s short term financial strength.  It calculates the assets readily convertible to cash in the next fiscal period.  Every underwriter identifies this number during their financial statement review.

If future revenues are inadequate, what is the company’s survivability?  The Fixed Expenses help us determine this fact.  These are the expenses that don’t go away, even if there are no new revenues.  Every month, you pay the rent, utilities, administrative staff, telephone, maintenance, insurance, etc.  These expenses are coming regardless of how much or how little sales are achieved.  In the absence of future revenues, it is Working Capital that must pay these monthly bills.  The Runway is how long the company can operate in this mode.  The Burn Rate reveals this survivability.

An actual client:

12/31 Working Capital As Allowed from the Balance Sheet = $1,099,000

1/31-12/31 Total Expenses from the Profit and Loss Statement (not including Cost of Goods Sold, aka Direct Expenses) = $1,243,000

Burn Rate: Average Monthly Expenses = $1,243,000 / 12 = $104,000 per month

Runway: WC Divided by Average Monthly Fixed Expenses

$1,099,000 / $104,000 = 10.6 months

Based on current expected cash flow, the company can cover it’s fixed (unavoidable) operating expenses for 10.6 months even if it has no income/ profits from new revenues.  The Runway is 10.6 months. This measure of survivability can be compared from period to period, by year, or from one company to another.

Don’t forget, when the mood music stops, the party is not over.  Our national underwriting department brings this high level of expertise and willingness to all your bid and performance bonds. 

Call us when you need a corporate surety with excellent credentials and capacity on surety bonds up to $10,000,000.  Excellence in underwriting, aggressive, creative, fast. Underwriting the way you wished it would be.

Steve Golia is a long established surety bond provider and expert. Call us with your next bid or performance bond.

856-304-7348 

Secrets of Bonding #159: Beware the False Asker

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Surety Bond Producers have one main goal: produce the business and move on.

You know there is a process when submitting a surety bond for approval but hate that sick feeling when the underwriter comes back with a ton of questions.  Let’s face it, customers just want to complete the transaction and get on with their lives.  They have more important things to do than fill out forms, scan documents and complete applications.  You know you’ll get push back if you bug them.  

What’s more, the questions may result in a dead end, a declination!  Did the underwriter already form an opinion?  Did they already decide the account is not for them, but just want to complete the file… to have a complete file?

We will call such a person the “False Asker” – an underwriter who puts you through the paces, just to say no at the end.  They never really wanted to write the bond and are developing the file under false pretenses.  They send you on a fools mission.  It is 100% a waste of your time!

Or just maybe, questions are the opposite…  The bond underwriter thinks the account may be a fit, but just needs to check a few more points.  This could be the first step on a successful journey. Here’s more: There may be something wonderful about the questions good underwriters ask.  Let’s explore.

When reviewing the file, the analyst marks off elements of strength and weakness.  For example, the company is 10 years old, but current management has only been in place for a year (a plus and a minus).  Or maybe the net worth is strong, but debt is high resulting in too much leverage.  If there is more good than bad, an approval may be in order – after additional development. 

Now comes the gift: The key points, the underwriting questions, are an insight to the decision making process.  They are keys to the underwriter’s mind.  With favorable answers, authorization may ensue. The questions chart a course that the producer could imagine but not confirm.  In this manner, the underwriting questions are priceless, the keys to success.

Remember, there is room for frustration on the underwriter’s side, too.

Q. Which of the underwriting questions are optional? You know, the unimportant ones?

A. They are all important.

Sometimes we ask 5 Q’s and get back 3 A’s.  Then re-ask the 3 and get back only 2.  It’s like beating your head against the wall…

It all comes down to this:  Beware the False Asker.  You must avoid that person who churns the file and wastes your time.  Every producer has been through it.  You answer questions for two weeks and get a declination they could have figured on day one – and not wasted your time.

A good underwriter only develops an account they intend to support.  They like it and want to proceed, but must tidy up the file. Their Qs are a gift, the path forward, the key to your success if you follow through willingly and diligently.

Judge all of us by our performance:

  • Good underwriters are prompt. For example, our office provides a same day response on all submissions.
  • Are our responses concise and easy to understand?
  • Do we offer a prompt declination or clear path forward, defined by the underwriting questions that will get the deal done?

A good surety underwriter can be your important ally and business partner.  Choose us carefully based on performance, and always Beware the False Asker!

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 #155: The Double Bonding Conundrum

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This is America. Everyone is entitled to their opinion. Like on the subject of Double Bonding (Contract Surety) we will not all agree.

So here are the facts. You will decide if this is a great idea or just a waste.

What is Double Bonding?

Also called “back bonding” or “subcontract bonding” an example would be when both a subcontract and a prime (directly with the project owner) construction contract are bonded. The prime contractor is the General Contractor (GC).

The GC gives some of the work to trade contractors such as the plumbing, electrical and HVAC. These firms may be required to give a subcontract bond to the GC guaranteeing their work. In turn, the GC provides a bond that covers everything. In other words, it too covers the plumbing, electrical and HVAC. That’s the “double” part. Sounds pretty dopey so far, right? Why would anybody do that?

Turns out this occurs often. Depending on your viewpoint, it may seem helpful / essential, or just a waste of money. Let’s evaluate it and you decide.

Why Love It:

  • Owner: Subs that have been approved by a surety may perform better.
  • GCs: May have a policy to automatically bond subs over a certain dollar value. This is intended to prevent delays and unpaid bill problems.  In addition, the GC / prime contractor is the direct beneficiary, and the potential claimant against such bonds.
  • Subcontractors: With a surety backing them, they may have an advantage when pursuing new work. These are important credentials that prove they have passed the underwriters scrutiny and have the backing of a professional guarantor.
  • Sureties:  May find it easier to support the GC bond if major subs are bonded. A portion of the risk is then covered by *another bonding company.
  • Third tier subs and material suppliers: May not be protected by a payment bond unless double bonding is in place. The GC’s bond may not go down to the third tier (sub of a sub or third tier suppliers.)
  • The most important reason: It is possible that the GC’s surety may insist that major subs be bonded as a condition of supporting the GC. This can be the key to acquiring the contract.

Why Hate It:

  • Owner: Doesn’t need sub bonds because the GC’s bond already covers all the work.  They may be forced to bear the related premium costs if the sub bonds were anticipated. If they were not, the charges may come out of the GC’s profits.
  • GC: In a competitive situation, the related costs could cause them to lose the project. Sub bonds may help GC with their surety, but they do not reduce the cost or dollar value of the GC’s bond.

Bonus Conundrum

Love it or hate it, double bonding is sometimes done voluntarily, or it may be stipulated by the GC’s surety. There is no denying that the concept is important – so important that in some cases both the GC bond and the sub bonds are written by the *same surety. Why would they do that?!

~ ~ ~

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.)

* This procedure adds more premium and more assets / indemnity to the project, however it does not lay off any risk.

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.

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

Secrets of Bonding #126: Surety Bonds in the Bizarro World

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There have been 24 movies about Superman, but I loved the original TV series starring George Reeves (the real Superman). Even before that, there were Superman comic books published by DC Comics.

BizarroThe character, “Bizarro #1,” first appeared in 1958 – a mirror image of Superman but from a world where everything was opposite from that of humans. That was over 50 years ago, but strangely, there is a little piece of Bizarro World that still survives today. It is alive in our surety rate system. See if you agree…

Example #1

A contractor won a $1 million contract. The specification calls for a 50% performance bond: $500,000. The surety’s maximum exposure is $500,000.

Bizarro Fact: The bond rate is based on the contract amount, the full $1 million!

Example #2

Sureties often issue a Performance and Payment Bond in a single combined instrument that states the bond amount once (the penal sum). However, if required, they will issue two separate instruments, one Performance and the other Payment, each with it’s own penal sum (double the amount in the combined bond form.)

Bizarro Fact: When required to issue this double bond amount, the bond premium remains the same as for the combined bond form!

Example #3

The contractor has already started the project. Now it has been verified that 50% of the work is completed and accepted by the project owner. It is confirmed that all related bills have been paid. It is apparent that 50% of the exposure has been eliminated.

Bizarro Fact: The bond costs the same as if it had been issued at the start of the work. There is no reduction or recognition for the portion of the exposure that has been eliminated.

Example #4

The contractor has negotiated a $1 million contract. Now the project owner has indicated that a P&P bond must be provided. The surety states that the cost of the bond will be 2% of the contract amount. Is the cost 2% of $1 million ($20,000)?

Bizarro Fact: No! The correct calculation is 2% of $1,020,000 or $20,400. The bond premium is calculated on itself, even though it cannot be classified as part of the contract exposure.

There you have it: The upside-down world we actually live in. Naturally there are justifications for all the procedures sureties use, but still, they are Bizarro!

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.

Secrets of Bonding #125: When to Call It Quits

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Construction contracts can be terminated by either party under certain circumstances.  Let’s take a look at it from the Contractors point of view.

Federal contracts make it easy for the government to end a project.  The “termination for convenience” clause spells out how the project can be ended (with no fault on the part of the contractor) and provides a method of payment for the work in place. Other public and private contracts may also contain this clause.

Sometimes it is the contractor who is motivated to end the project early. In these situations, it is important to know how and when to proceed.no-work

The Disputes Clause

“The Contractor shall proceed diligently with performance of this contract, pending final resolution of any request for relief, claim, appeal, or action arising under the contract, and comply with any decision of the Contracting Officer.”

Found in federal contracts, this clause means you must continue to work when facing a dispute. This assures that the contractor doesn’t hold the project hostage while the dispute is under review. 

Other public and private contracts may include language regarding unresolvable disagreements, so it is important to…

Read the Contract

Contractors should only quit a project when they have a legal right to do so.  You need to read the contract and, with the help of your attorney, choose a course of action.

An Unresolvable Disagreements clause may allow the contractor to stop work.  An example could be engineering issues that make it impossible to proceed.

Stop Work for Nonpayment

In these cases, the contractor should send written notification of the overdue payment and allow a time period to collect the funds.  Some contracts require that a second notification be sent before work may be suspended.

Because nonpayment may be a material breach of the contract, it can justify stopping work.  However, state laws vary on this subject.  An attorney can help determine if such action is advisable.

Surety Bonds

If a Performance and Payment Bond covers the contract, it can play an important role.

General Contractors should alert their surety regarding any disputes.  They should also remember that stopping work can result in a Performance Bond claim.  This can hamper the availability of bonds for other projects. The surety will want to understand the dispute and may offer guidance to the contractor and attorney.

Subcontractors have these same issues if they have bonded their subcontract.  In addition, contracts with “pay when paid” wording may justify the GCs nonpayment – another reason to read the contract.

An advantage for subcontractors may be a P&P bond above them, filed by the general contractor.  This Payment Bond is available for claims by subs and suppliers.  It can be a powerful tool to protect subcontractors.  Even a letter to the GC threatening to file a payment claim can shake the money loose in some cases.

Conclusion

Stopping work can be an important remedy for the contractor, providing the action is legally permitted.  When a contractor considers suspending work they must weigh the risk that they may ultimately be found in breach of contract themselves.  On the other hand, the larger situation of the nonpaying party may demand action, such as an impending bankruptcy.

The best approach is to review contracts in advance and negotiate the addition of language that allows work stoppage under appropriate circumstances.  The goal is to acquire the contract while limiting the risks.

Note: we are not attorneys and are not giving legal advice.  If you have a project dispute, call your attorney for help.

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.

Secrets of Bonding #111: WIP Quiz

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 When it comes to Bid and Performance Bonds, nothing may be required more often than financial statements and WIP schedules (Work In Process aka Work On Hand).  For mood music, click here.australian-whip

The WIP schedule could be required monthly for active bidders.  Certainly, the construction company management team monitors this critical info.  It tells the tale of how things are going, and where they’re headed. Profitability is revealed.  It is a preview of the upcoming Profit and Loss section in the next financial statement.  Poor results on the WIP schedule equal low Gross Profits on the next P&L – and maybe a net loss.

Let’s look at a couple of examples and see if you can spot what’s going on.  For the sake of illustration, we’ll use an abbreviated format.

On each of the following WIP schedules, compare the expected profit upon completion to the original profit estimate.

Joe Shmoe Construction

Project

Current/Revised Contract Amount

Original Gross Profit Percentage

Billed to Date

Costs to Date (Including change orders)

Revised Remaining Costs to Complete

1001

$1,000,000

10%

$700,000

$602,000

$202,000

Is the current profit projection more or less than originally expected?

  1. More
  2. Less
  3. Exactly right

 

Global Construction and Gutter Cleaning

Project

Current/Revised Contract Amount

Original Gross Profit Percentage

Billed to Date

Costs to Date (Including change orders)

Revised Remaining Costs to Complete

4321

$1,000,000

10%

$700,000

$602,000

$410,000

Is the current profit projection more or less than originally expected?

  1. More
  2. Less
  3. Exactly right

 

Dummenhappie Contracting

Project

Current/Revised Contract Amount

Original Gross Profit Percentage

Billed to Date

Costs to Date (Including change orders)

Revised Remaining Costs to Complete

007

$1,000,000

10%

$700,000

$630,000

$270,000

Is the current profit projection more or less than originally expected?

  1. More
  2. Less
  3. Exactly right

 

Got your answers?  Let’s go over these:

Joe Shmoe originally projected $100,000 profit (10% of $1,000,000).  Now it has nearly doubled! (602,000+202,000=804,000.   1,000,000-804,000=196,000)  “a. More”

Global starts with the same numbers (to help illustrate our point), but the costs are different.

(602,000+410,000=1,012,000   1,000,000-1,012,000= -12,000)  Not only has the profit margin slipped, it exceeds the contract amount resulting in a projected overall loss. “b. Less”

And finally Dummenhappie.  This one is amazing!  They are about ¾ of the way through the project (actually 70%), and right on target profit wise. The expected profits and total costs are exactly as predicted before they started the work.

(630,000+270,000=900,000   1,000,000-900,000=100,000)  “c. Exactly right”

Think about that. This answer “Exactly right” means prior to actually starting the project, they accurately predicted the exact number of labor hours.  Do you think the reality of the project might be somewhat different from the prediction?  Maybe they will hit unexpected obstacles and things will go slower (higher labor costs).  Or they may find more efficient ways to perform the work as it progresses (lower labor costs).  The cost of material purchases can also vary.  Get the point? It’s hard it imagine any project in which the costs can be perfectly predicted in advance.

indy-whipSo what’s going on here if Dummenhappie isn’t brilliantenluckie?  Our assumption is that the contractor has failed to RE-estimate the remaining costs to complete.  They are still relying on the original estimate – not analyzing the actual “costs to complete” during the life of the project.

Relying solely on the original cost estimate is a dangerous and weak practice.  The contractor may be unpleasantly surprised if unanticipated costs (such as labor inefficiency) have eroded the profit margin.  The worst part: They won’t know about it until the end, when it’s too late to make a correction!

Surety underwriters will detect if the remaining costs are not being reevaluated.  It reflects poorly on the contractor’s management practices.  It also means their profit projections may be totally unreliable.

The solution is to keep accurate records of the labor and material costs that go into each job, and periodically reevaluate (re-estimate) the remaining costs to complete. 

You can have a lot of fun with WIPS!  We’ve just touched on one part in this article. The analyst must not only review the profit trend, but also the method of calculation to confirm that accounting procedures are appropriate.

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.