bond capacity

Secrets of Bonding #110: Contract Additions – Is More Always Better?

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USUALLY more is better. 

  • “Would you like more ice cream?”
  • “Congratulations on your raise!”
  • “Honey, we’re pregnant!”more2

The same is true when it comes to construction contracts.  It is not uncommon for the scope of work to be modified. The project engineer may have discovered a problem and they will pay the contractor to fix it.

There could be a desire to expand or enhance the project, resulting in an increased contract price.  These additions occur routinely. Sometimes there are also “deducts” meaning an amendment that reduces the contract amount.

Additions to the contract mean more revenues for the contractor – it’s a good thing, unless unexpected problems pop up.

In this discussion, we are talking specifically about bonded contracts.  Whether public or private, prime or subcontract, our comments herein apply.

more3Bond Amount vs. Contract Amount

Surety bonds, Performance and Payment Bonds on contracts, are all similar but may have important variations.  It is common for the bond to adjust upward to follow an addition in the contract amount.  This means if the $1,000,000 contract is increased by amendment to $1,200,000, the bond is increased so that 100% coverage is maintained.

Not only does the bond increase, the adjustment is usually automatic.  Most bonds say there is an automatic increase with no obligation to inform the surety of the change.

When the surety is required to accept the additional exposure, they are entitled to be paid for it.

The Downside of Contract Additions

What could possibly go wrong to spoil this perfect picture? You have a contract and “Poof!” it just got bigger!  You provided a surety bond and “Wham!” it automatically adjusted to the new amount!  All good!

  1. One problem that can occur involves the additional bond premium. The subject is sometimes complicated, but the short version is that the surety will charge for the increase.  If the contractor fails to include the additional bond fee in the negotiation for the amendment, the bond fee will come out of their profits instead of being passed on to the project owner as is normal.
  2. A second issue can arise in connection with the automatic bond increase. Sometimes it doesn’t happen.  Some bond forms state that contract increases in excess of a stated percentage (e.g. 20%) must be pre-approved by the surety.  This is to prevent the surety from being pulled into a contract amount far above the original support level. If the surety refuses to accept the increase, the contractor will have the difficult / unpleasant task of seeking a new surety and possibly paying twice to bond the project!  Doesn’t get much uglier than that…

Subtletiesmore1

On the subject of the bond fee, some sureties demand payment when the contract increase occurs.  The thinking is, “We have the exposure now, why not get paid?”

Other companies may wait until the contract ends and net out additions and deducts, then charge for the net increase over the original bond amount.

You may also run into companies that charge for increases, but do not net out or give refunds for contract deductions.

If you want to know what to expect in these situations, you must ask for written answers from the surety.  These fine points are usually not stated in writing in advance – but are worth knowing.  With contract additions, it’s what you don’t know that can hurt you.

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 #109: Surety Letters – You Get What You Pay For

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A Surety Letter can be used like a bid bond.  It may be required by private owners (and General Contractors in connection with subcontracts) as a means of assuring the contractor / bidder can provide a Performance and Payment Bond upon award of the project.  Private owners are not the only ones who use this procedure.  You may even run into this requirement on public jobs.

The Surety Letter is a statement of the principal’s (contractor’s) ability to provide a surety bond.  They may seem like an easy and useful alternative to a bid bond.  After all, it’s a letter. That has to be easier than a bid bond!

Cost

Theoretically, bonding companies are entitled to charge for bid bonds.  They are binding financial obligations and sureties occasionally pay out claims on these.  The industry practice, however, is to waive such charges.

When it comes to the surety letter, there is no financial obligation.  They are usually issued for no charge.  You can’t make a claim on one, and they are not a guarantee that a P&P bond will be provided.

So when a surety letter accompanies a proposal, exactly what does the project owner get?

The key points are:

  1. Sufficient Authority  Who wrote the letter? The best letters are written directly by bonding companies on their letterhead.  This is important because the author can bind the surety company. If they say they will provide a P&P bond, you can take that to the bank.  Less effective letters may be written by individuals who are not direct employees of the bonding company and who may not be able to legally bind them. Hint: The letter is stronger if a power of attorney is attached.
  2. Escape Hatch Typically these letters have a disclaimer that says there is no promise to provide a P&P bond. It may say the underwriter reserves the right to approve or disapprove performance bonds based on the client’s circumstances at the time the bond is requested. (Question: Do bid bonds have an escape hatch?  See below *)

What does all this mean? When a surety letter is used, it always proves one thing: The contractor has some form of a bonding relationship.

However, depending on the content of the letter, it may not include any form of commitment.  Such letters are an “indication of bondability” leaving the reader to speculate whether a P&P bond will follow.

dependability

To what extent can the project owner rely on a surety letter?  Considering most are only an “indication,” not much!  Bid bonds are binding obligations assumed by sureties, and claims can be filed against them.  If they both are available for little or no charge, which would you rather have?

* Answer: Bid bonds never contain an escape hatch.  If, upon award, an acceptable P&P bond is not provided, the surety will likely face a bid bond claim.

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 #86: Exoneration Nation – Why Get Off Performance Bonds?

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When it comes to performance bonds for contractors, the emphasis is always on getting them. They are normally required on public work. If you cannot bond the job, being a well-qualified low bidder is not enough. Once a contractor gets the performance bond, work commences and they may think they are done with the bonding company.  Actually, every bond has its own life cycle.  Issuance is the birth – but when and how does it end, and why should the contractor care? 

After a project is bonded, the surety may not require any further paperwork from the contractor. Sometimes the obligee wants the surety to provide a Consent to Final Payment or Consent to Release of Retainage. In such case the underwriter may ask for documentation regarding the health and status of the project. But absent that, the contractor may not think it is necessary to communicate with surety at the conclusion of the job. Why is doing so beneficial?

  1. Each bonded contract represents partial use of the contractors’ aggregate capacity. By officially closing out the project the surety capacity is restored. This is obviously important to enable the pursuit of new work.
  2. From the surety’s standpoint, any coverage for the warranty does not commence until the work is accepted and the performance bond is released. It is beneficial for both the contractor and the surety to start, and promptly conclude, the warranty obligation. While outstanding, the warranty is a risk for both.
  3. The third reason involves the payment bond. The recognition claims by suppliers of labor and material is affected by the last date of their supply or performance on the project. Officially closing the contract and performance bond creates one point of reference for evaluation of such claims.

Closing out the bond file is also important for the surety. It enables them to book any remaining unearned premium and concludes their liability. Both the contractor and surety are exonerated from the risk/obligation.

ex·on·er·ate   verb
past tense: exonerated; past participle: exonerated
– to relieve of a responsibility, obligation, or hardship
– to clear from accusation or blame

“The results of the DNA fingerprinting finally exonerated the man, but only after he had wasted 10 years of his life in prison.”

How to Close the Bond File

At the end of the project, whether requested by the surety or not, the contractor should obtain a letter from the obligee stating that the contract has been completed / accepted and the surety bond is released. The contractor retains a copy and sends this evidence to the bonding company. It’s just that simple.

Contractors should assume the responsibility for this action because not all sureties are diligent in requesting closure evidence for their files. It is true that in every case, it is beneficial for the contractor to submit this information to the bonding company.

Exoneration Nation: Be part of it!

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 #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 #71: The Best Way to Avoid Low Profits

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In this edition of Secrets we will continue a discussion that began in #70 which covered “Labor, Contracts, and Labor Contracts.”  Last time we concluded by describing a project with unusual characteristics:

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

These percentages describe a job that is predicted to yeild no profit. Why would a contractor bid this way? Some possible reasons:

  • Maintain labor force – The project will enable them to keep their valuable / long term employees working
  • The revenues and cash flow will help with creditors
  • There are design deficiencies that will result in profitable addendums to the contract
  • Protect their relationship with a repeat customer (keep out competition)
  • With the job in hand, additional profits can be squeezed out of the subcontractors and vendors

While these strategies (or others) could make sense to the contractor, it is likely the bond underwriters will be reluctant to support the project.  Why?

Remember, if a default occurs, the surety may be required to step in and complete the project.  Their primary financial resource will be the remaining (not yet paid out) contract funds. If the project was estimated with a 0% profit, it would be easy for increased costs or inefficiencies to result in a losing job – which means the surety would be forced to add funds in order to reach completion of the project.

Contract estimates are just that: Estimates or Guestimates.  A job projected to produce a 10% profit may actually end up at 11% or 9% or Zero! Faced with this uncertainty, and the unavoidable responsibility to finish the work, a 0% profit projection may be too much risk for the surety.

The best way for contractors to avoid low profits is to not accept underpriced work.  Whatever benefits they might perceive, the risks are a huge burden. Construction work is a challenge under the best of circumstances.

Starting with the expectation that you are on the verge of a loss only adds to the exposure faced by contractors and their bonding companies.

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 #66: Timing, the Cart, the Horse

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Being in the right place, or the wrong place, can make all the difference. In the world of surety bonding, particularly contract bonds, timing plays an important role.

Here is a typical scenario.  It is a question of timing:

The client comes to us to get their bond account set up for the first time.  We send over the “laundry list” of documentation that is normally required.  It’s a bit daunting.  For companies that have never been bonded, they probably do not have all the info readily available.  They must gather documents, others must be filled out, they must be scanned and shipped. There are better ways to spend a Friday evening!

The cause of this activity is usually that the first bonded project has popped up.  We had a case like this recently where the project was being negotiated.  No bid bond was required. If the effort was successful, the contractor would need a bond.  If not, the bond monster goes back to sleep.

Our new client seemed unconcerned about the bond.  They didn’t want to take the time to develop their file unless they won the project.  Only then would they find out if it is easy, hard, or impossible to get the bond!

For this applicant, the project comes first – then the bond. Is this a smart approach?  Maybe not, because sometimes the first bond is a harder, slower process than expected!

Let’s look at some aspects that could cause unexpected delays (assume this is not for a small contract):

  1. Financial Information – The underwriters will request business financial statements, not just tax returns. Not all companies automatically prepare these. If the year-end date is not close, it can be very inconvenient to go back and reconstruct the financial picture.
  2. Accounting Methods – Companies that have been using Cash Method statements will find they need to re-issue the document using a different accounting method.  To accomplish this, the accountant will require an additional body of financial information, then they commence with their processing.
  3. CPA – Don’t have one? You will need to choose/engage a firm then allow time for their due diligence and procedures.
  4. Accounting Presentation – If a CPA Compilation has been the norm, it may be necessary to upgrade and re-issued as a Review. The CPA will need time to perform the additional services.
  5. Outside References – These are sent to creditors and vendors for handling, then you wait for their response.
  6. Historical Data – The project history of the company and its key people, including contract details, will be required. Prior financial data is needed. Three years of complete tax returns are often requested.
  7. Work In Process Schedules – Many contractors do not employ a sophisticated method of analysis. All sureties do! It may be necessary to upgrade the reporting with highly detailed individual project cost records and profit projections.
  8. Credit Reports – Erroneous or incomplete reports can have a devastating effect on the underwriting, and such problems are slow to correct. Adjustments to the credit report are only accomplished after a time consuming process with the rating bureau.

Issues like these can throw the timing off, and delay the bond issuance, but they are all correctable.

There may be other unexpected problems that cannot be easily fixed.  For example, unacceptable financial ratios.  The company could be solvent and profitable, but with poor ratios, some underwriters will say “Come back and see us next year.”  An unacceptable company or personal credit report can have the same effect.

Contractors often dread the bond underwriting process.  We’re not trying to foment anxiety by describing these pitfalls – actually just the opposite!  By allowing enough time, we often can help the client through them.

Summary: Get your bonding set up in advance. Then you have it when you need it with no last minute surprises or disappointments.

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 #13: Release of Lien Bonds

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“For the want of a nail…”

This often quoted proverb reminds us that if left unresolved, small problems may become catastrophes.  Construction liens fall into this category.

If you are a contractor or insurance agent with construction clients, this is a subject worth knowing about.

It all starts with a small problem: A money dispute.  It could be a performance issue a general contractor (GC) has with their subcontractor or defective materials received from a supplier.  This could happen on ANY project. The sub or supplier files a lien against the property to protect their interests until the matter is decided.

A Release of Lien Bond removes effect of the lien and restores the property owner’s right to sell or deal with the property as they wish.  It does so by acting as the replacement security to assure the lien claimant will receive any payment that is eventually due them.

That’s all pretty simple.  There is a money dispute and the Release of Lien Bond becomes the replacement security for the claimant until there is an actual decision in the matter.

Here’s where it gets exciting. Assume the project is not bonded.  If there WAS, the claimant could have gone against the Payment Bond – then there would be no lien.  Also assume the GC’s contract requires that they protect the owner from liens, which is a common requirement.  Owners want to avoid having to pay twice if they pay the GC but the money doesn’t flow down to suppliers and subcontractors. So the GC (or prime contractor) may be charged with the task of removing the lien against the owner’s property.

From the surety’s side, a release of lien bond is difficult; it is a financial guarantee.  It promises that money will be paid at a future date.  Because of the immediacy of claim payment (if the matter is decided in favor of the plaintiff), the surety needs funds (collateral) in hand.  This means the GC (bond applicant) has to come up with cash for possibly twice the lien amount, because that’s how the bond amounts are set.

It gets worse: The GC faces three bad options.

  1. Pay the claimant just to settle the dispute (and thus release the lien)
  2. Put up collateral (2x?) and pay for a Release of Lien Bond for the privilege of fighting the claim in court
  3. Ignore the lien and risk being in default of their contract or at the minimum, have contract funds withheld by the owner

We think the P&P bond is just for the protection of the owner, but the GC would have benefited if the project was bonded.  There would have been a Payment Bond claim.  With their sureties support the GC would deal with the matter and not involve the owner.

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 #9: Capacity – Cure or Lure?

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Bonding Capacity is a key point for many contractors along with rate (the cost of the Performance & Payment Bonds) and the approval terms.   Capacity is the amount of bonding the surety will provide, both the “per job” limit, and the total amount.  Let’s look at how all this works. 

Traditionally, the capacity amount is defined as Single and Aggregate.  The Single is the per job amount for any one contract and bond, which is the way bonds are actually issued.

The Aggregate is the maximum at any one time, comprised of:

  • The remaining “costs to complete” on started projects
  • The full amount of all awarded, signed but unstarted contracts
  • The full contract amount for low (winning) and undecided bids

Typically, the Single is no more than half the Aggregate. It is also common for the Aggregate to include all contracts, both bonded and unbonded.  The Aggregate is not just an expression of how much the surety will provide.  It is also an indication of how much work they feel the contractor can undertake without being overextended.

Here are some underwriting elements surety underwriters may review when making a capacity determination:

  • Working Capital (WC) and Net Worth (NW) of the company – The benchmark is for each of these to not be less than 10% of the Aggregate.  i.e. $100,000 WC could support $1 million Agg.
  • Secondary Financial Resources – Available bank credit, personal financial strength, affiliate companies and strong credit reports could help justify support.
  • Prior Experience – The Single is normally not more than 100% greater than the largest similar single contract successfully completed. Company longevity and expertise of key individuals is also considered.
  • Current Work On Hand – Even if the applicant has a good financial condition, underwriters may be unwilling to add to their workload if company resources appear to be fully utilized or if exisiting contracts have problems.

There needs to be balance between the elements.  For example, support will be withheld from an applicant who has good prior experience but no financial resources.

Bottom line is that bonding capacity is important.  It influences which projects the contractor will pursue and directly affects their annual revenues and profits.  Having adequate capacity can be the Cure for construction companies seeking better financial performance and market penetration.  It also Cures the bond agents need for increased commission income.

Capacity can also be a Lure. The promise of increased capacity can be a hook to draw in a contractor’s account.  Lines of bond capacity are always conditional.  Any bond can be declined for various reasons – meaning: “We’ll actually give you the capacity if we feel like it.”

It’s best to look at the credibility, reputation and stability of the provider of the line. Make sure the capacity you rely on is a Cure, not a Lure.

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.

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