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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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Secrets of Bonding #68: Get Your Surety Bond for Free!

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There’s no question about it.  The only reason bonding companies issue surety bonds is because they want your money. But how, when, and if you pay are all up for grabs!

Let’s look at some of the realities and options when it comes to paying for surety bonds.

Payment Practices

 INSURANCE – You may know that you can pay for insurance with installments.  You may also finance the premiums. Eventually, if you fail to pay the installments, the coverage is cancelled. It is this ability to terminate the exposure that enables the insurer to offer payment terms and the finance company to assume the risk.

 COMMERCIAL BONDS – These common types of bonds are usually issued for low amounts.  For example, the face amount on license and permit bonds may be $5,000 or less.  The premium on them is low and may be a minimum charge. Such bonds may contain a cancellation clause.

 These facts may seem to make installments possible, but the practice is often to require payment in advance. It could be that for a small premium or commission, the issuer is not willing to face any collection problems or related expenses.

 CONTRACT SURETY: BID BONDS – Bid bonds are not issued until the underwriting is completed, so the surety always incurs expenses.

Another fact: You can have a claim on a bid bond and the surety could suffer a net loss.  So there are costs and exposures attached to these instruments.  Bonding companies normally have filed rates that entitle them to make a charge for every bid bond. But do they? No! The majority of sureties do not charge for them. “Free bonds!” Their motivation could be that the fee is so small; it is unprofitable to bill it.

 PERFORMANCE AND PAYMENT BONDS – These obligations are typically irrevocable. Put simply, if the surety issues the bond and bills later, they cannot terminate the obligation for failure to pay. Even a casual observer would be forced to conclude that P&P bonds MUST be paid for in advance. It’s logical, but the industry practice is often to wait 45 to 60 days until the client has collected their first payment on the contract.  This gives the contractor the luxury of not having to “front” the bond fee.

 A portion of the industry does charge in advance for P&P bonds.  You’ can’t argue with their logic!

 COURT & PROBATE – These bonds are normally paid for in advance, and may be fully earned upon issuance.  In a legal action, the mere ability to issue the bond can have a beneficial effect for the applicant.  Knowing this, sureties would be foolish to offer any form of return premium.

 PREMIUM FINANCING – This would seem to be the client’s solution to the pre-payment requirement, but most finance companies will not support bonds due to their non-cancellable nature.

 Conclusion

If you’ve been looking for the thread of logic, there is none!

Billing practices are traditional, and may not make much sense.  We should charge for bid bonds but often don’t. A bid bond for a large project could cost more than a small one.

P&P bonds should be paid in advance but we often collect payment later.

Since the methodology defies logic, you must ask the underwriters in every case.  Don’t assume you can predict when to pay or if you have to pay for it at all!

There’s no question about it.  The only reason bonding companies issue surety bonds is because they want your money. But how, when, and if you pay are all up for grabs!

Let’s look at some of the realities and options when it comes to paying for surety bonds.

Payment Practices

INSURANCE – You may know that you can pay for insurance with installments.  You may also finance the premiums. Eventually, if you fail to pay the installments, the coverage is cancelled. It is this ability to terminate the exposure that enables the insurer to offer payment terms and the finance company to assume the risk.

COMMERCIAL BONDS – These common types of bonds are usually issued for low amounts.  For example, the face amount on license and permit bonds may be $5,000 or less.  The premium on them is low and may be a minimum charge. Such bonds may contain a cancellation clause.

These facts may seem to make installments possible, but the practice is often to require payment in advance. It could be that for a small premium or commission, the issuer is not willing to face any collection problems or related expenses.

CONTRACT SURETY: BID BONDS – Bid bonds are not issued until the underwriting is completed, so the surety always incurs expenses.

Another fact: You can have a claim on a bid bond and the surety could suffer a net loss.  So there are costs and exposures attached to these instruments.  Bonding companies normally have filed rates that entitle them to make a charge for every bid bond. But do they? No! The majority of sureties do not charge for them. “Free bonds!” Their motivation could be that the fee is so small; it is unprofitable to bill it.

PERFORMANCE AND PAYMENT BONDS – These obligations are typically irrevocable. Put simply, if the surety issues the bond and bills later, they cannot terminate the obligation for failure to pay. Even a casual observer would be forced to conclude that P&P bonds MUST be paid for in advance. It’s logical, but the industry practice is often to wait 45 to 60 days until the client has collected their first payment on the contract.  This gives the contractor the luxury of not having to “front” the bond fee.

A portion of the industry does charge in advance for P&P bonds.  You’ can’t argue with their logic!

COURT & PROBATE – These bonds are normally paid for in advance, and may be fully earned upon issuance.  In a legal action, the mere ability to issue the bond can have a beneficial effect for the applicant.  Knowing this, sureties would be foolish to offer any form of return premium.

PREMIUM FINANCING – This would seem to be the client’s solution to the pre-payment requirement, but most finance companies will not support bonds due to their non-cancellable nature.

Conclusion

If you’ve been looking for the thread of logic, there is none!

Billing practices are traditional, and may not make much sense.  We should charge for bid bonds but often don’t. A bid bond for a large project could cost more than a small one.

P&P bonds should be paid in advance but we often collect payment later.

Since the methodology defies logic, you must ask the underwriters in every case.  Don’t assume you can predict when to pay or if you have to pay for it at all!

Steve Golia
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 #67: Get to Know FedBizOpps

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“FedBizOpps” or www.FBO.gov, is a federal website presented by the General Services administration. It is officially described as a “web-based portal which allows vendors to review Federal Business Opportunities.”

This site can be a great help to bonding agents and is a critical resource for contractors pursuing federal work.  Open another browser while you read this and and connect to the site.  We’ll go through the highlights.

The main purpose of this site is to connect contractors with upcoming federal projects.  Let’s try the Quick Search on the front page.  For Type select Presolicitation. For Keyword enter Janitorial, then press Search. A list of upcoming janitorial projects appears. They are all available for bidding!

Do another search using Place of Performance: Alaska. For Keyword, enter “snowmachines” then click Search.  This should take you to a page showing an Air force contract award for $35,500. Here you see the details of a company that successfully acquired a contract.

FedBizOpps provides all the federal contract activity centralized in one web site.  What a great resource!

How to get involved

Contractors are considered “vendors” to the government, so step one is to follow the Vendor / Citizen registration link near the bottom of the front page.

After you register and classify your business, you are ready to perform a contract search. Log in to the site if necessary, and do a Quick Search under My FBO. Use Presolicitation and Janitorial again.

My search resulted in a list of 25 contracts. If you click on the first one it immediately shows you the nature and location of the work, the response date and other key details.  If you wish to pursue this contract, additional information is provided.  When you click Add Me To Interested Vendors, your company info is immediately included under the third tab “Interested Vendor List.”  This entitles you to automatic updates that will arrive in your email.  You will be advised as this opportunity moves through various stages resulting in an award.

When listed as an Interested Vendor, you may find that suppliers and other companies will contact you.  They may offer to assist in your solicitation effort or be your supplier if you win.

As a prospective bidder, you will also see who you are bidding against.  Good stuff!

Saved Searches

Here is an excellent feature of the site. Under My FBO, follow Search and Create Saved Searches. You can use very specific parameters.  After you run the search, choose Save Search Agent. At the bottom follow Save and Schedule Search Agent.  You can instruct the site to run this search every day and email you the results!  You can also set up any number of additional searches you may desire.

There is always a button near the top for the User Guide, which is a very helpful “FedBizOpps for Dummies” type resource.

For Bond Agents, the site provides the names and contact info of federal contractors.  Other vendors and suppliers use the site for the same purpose.

If you have an interest in federal contracts, get to know FedBizOpps!  Make it work for you every day.

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.

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Secrets of Bonding #61: Solve This Problem

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A key vendor / supplier is demanding that a GC provide protection for their purchase agreement. However, the project owner did not stipulate a Performance and Payment bond on the contract and none was provided. The work has started and the contractor needs to get materials delivered from the reluctant vendor.

What are the possible solutions that may satisfy the vendor?

Q. Can we issue a Payment Bond on the Purchase Agreement?
A. A vendors purchase agreement is not the same type obligation as a construction contract. A bond guaranteeing payment of the purchase agreement would be considered a Financial Guarantee Bond (Why?  See below *) They are more difficult to obtain than a Payment Bond, so that may not be the best solution.

Q. So what about issuing a Performance & Payment Bond on the Purchase Agreement?
A. This is also not an option due to the differences between the nature of a purchase agreement and a construction contract.  (Details below *).

Q. Can we bond the contract in a normal way (100% Performance & Payment)? That Payment bond would cover all vendors, so it would cover the one in question.
A. Bonding a started project is always a red flag. The underwriters initial question is “Why do they want a bond now?” It does seem suspicious, like there may be a problem with the performance of the construction work or the owner received some negative info on the contractor. The contractor could have a problem and the work may be in jeopardy.

Another issue is the cost. If a bond was not originally required, the bond cost was not included in the contract price. This means a bond purchased subsequent to the execution of the contract will be paid for out of the contractor’s profit margin. The Principal / GC will be looking for the most inexpensive solution possible.

Keep in mind that the purchase order amount is less than the contract price, so bonding the contract would result in a bond higher (and more expensive) than actually needed.

Q. Can we issue just a payment bond on the contract?
A. This too will be viewed as a red flag by the underwriters. Who asks for a payment bond but doesn’t want a Performance Bond? That would be unusual.

Summary
We have concluded that it will be difficult to retroactively bond the contract, the amount of the contract is more than the purchase order and only a financial guarantee bond can be issued on the purchase agreement, so a bond may not be the solution at all!

Our Solution

In this case, we offered Funds Administration instead of a bond. This was an inexpensive alternative, and provided an assurance for the vendor that bills would be paid in a routine manner. (The project owner pays the Funds Administrator who directly pays the vendor.)

Keep in mind, however, that the Funds Administrator has no obligation to the vendor. If there is an unexpected event, such as termination of the contract, the Funds Administrator does not guarantee to the vendor that they will be paid appropriately.  A bond would, if one had been written.

*The nature of purchase orders is different from construction contracts. When issuing a P&P bond on a contract, the surety depends on the fact that the obligee / beneficiary is paying for the work, and that money may be the key to solving any claim or default.

When bonding a purchase order, the obligee / beneficiary (vendor), is not paying – they are receiving payment. That is why a Financial Guarantee Bond must be used, and is why they are harder to obtain.

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 # 59: Bonding Specifications, Boilerplate That Bites

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Does anybody really read this stuff? YEP, WE DO!fine print

Just like on insurance, there are written specifications (specs) for bonds, and if you don’t know what they are in each case, you could be setting yourself up for a disaster.  There can be serious consequences if a bid bond is rejected and a contract is lost.

So how do agents protect themselves from such an outcome? Step one is to obtain the written bonding requirements in every case. You may find they are open or they may be very narrow and specific.

Here is an example of one spec we recently handled: “The surety company shall hold a current certificate of authority as acceptable surety on federal bonds in accordance with the United States Department of Treasury Circular 570, Current Revisions.” (Read Secret # 23 about the T-list). To determine if you are in compliance with such a requirement, find the name of the surety exactly as it appears on the bond, and look it up here: http://www.fms.treas.gov/c570/c570_a-z.html
If the requirement goes on to say the Circular 570 dollar amount must be sufficient, compare the “Underwriting Limitation” amount to the dollar value of the bond. It must be is equal to or larger than the penal sum of the bond.

“No modification or waiver of any of the terms of the contract to be performed will in any manner discharge any surety liability thereunder.” This is commonly accepted language meaning the bond follows the contract even if the amount or terms are subsequently changed.

Normally the specs require a Performance and Payment Bond equal to 100% of the contract amount. Occasionally you may see a request 110% bonds. This is troublesome for the surety and they will resist issuing on this basis.

The boilerplate may require a bonding capacity letter issued by an acceptable surety in lieu of a bid bond.

Also note, bid bond percentages vary. Federal is normally 20% of the bid amount. Others are often 10%, but some are 5%.

The bid could also require a surety consent letter, promising to issue the P&P bond if awarded the work.

Federal Projects
On all federal projects where the contractor has a direct (prime) contract with a federal agency, the surety must be on the T-List and for a sufficient amount. Other owners sometimes choose to use this as part their own requirements.

On a prime federal contract you are also required to use the government bid bond form (Standard Form 24) and performance (25) / payment (25A) bond forms. Get them here: http://www.gsa.gov/portal/forms/type/SF

A.M. Best Ratings
It is not unusual for the specifications to require a minimum A.M. Best rating.  To confirm that the surety has a sufficient Best rating, look up the exact surety name in the A.M Best site: http://www3.ambest.com/ratings/default.asp

State Licensing
Another common requirement is that the surety must be “authorized to do business in the state of…” This means the surety must hold a state insurance department issued license (an admitted carrier). To check this, go to the insurance department for the state where the work is located. In our home state of New Jersey, we go here: http://www.state.nj.us/dobi/data/inscomp.htm

Bond Forms and Documents
You may run into mandatory bond forms. These are more common on private contracts than on public work. However, mandatory means just that. So it is important to 1. know if mandatory forms are stipulated and 2. confirm that the forms are acceptable to the surety and contractor. Sometimes on private work, they are strongly slanted against them.

Summary
Referring again to Secret #30, there is a significant risk for bond issuers, especially on bid bonds. Important: Agents should not rely on the bond request form prepared by the contractor. We often find this information incomplete and/or incorrect. To be sure you are issuing a valid bid bond that the obligee will accept, you must directly review the written bonding requirements

All the fine points we discussed can lead to a bond rejection. So get the boilerplate and take a bite out of it, before it bites 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.

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

Secrets of Bonding #58: Bonus Edition

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Balance Sheet Bride + WIP Schedule Groom

In this article we will pull together some of the individual concepts that have been discussed and show how they are married in a contractor’s surety bond account.

In article #48 we talked about the different accounting methods that are utilized. We covered how to recognize the Percentage of Completion method and the Accrual method.  Accrual may be the one you see most often.

An important characteristic of the Accrual method is that it does not include Underbillings and Overbillings. Do you recall which method* does show these entries? Let’s consider the implications when these entries are not part of the underwriting.

In article #57 we reviewed how the Underbillings and Overbillings affect the Balance Sheet analysis.  Sometimes they help, sometimes they hurt.  Overbillings are a Current Liability.  Their effect on the Balance Sheet is that they reduce Working Capital. We all know that’s bad for bonding purposes.  It means less capacity for the client and maybe lower revenues.

Underbillings, on the other hand, are a Current Asset.  They increase the Working Capital calculation, and therefore the customer’s bondability. So you want them in the picture, but Accrual financial statements will not show either entry. Is there a solution?

With a correctly prepared WIP schedule in hand we can find the degree of completion, the correct billing amount, and then determine if the company is Under or Overbilled on each project. (If they were Underbilled $3 on one job and Overbilled $1 on another, the balance sheet adjustment would be the net effect: Underbilled $2.)

If a contractor has a Working Capital deficiency and the bonding capacity amount is inadequate, this calculation can help.  Bear in mind, it can also serve to reduce the bonding line if the net effect an Overbilled status.

The underlying reality is that, good or bad, these numbers must be known. Larger, more sophisticated contractors often use the Percentage of Completion method * which always includes Under and Overbillings – because they are relevant.  They are no less relevant for the Accrual method contractor.  On Accrual method financial statements, you should always analyze the WIP schedule to see if any significant Under or Overbillings could affect the Balance Sheet analysis.

The procedure we described is helpful for contractors when managing their projects, and for their underwriters.  It provides a sharper analysis and results in better management decisions for all parties.

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 #57: (4 of 4) Work In Process Schedules – Own Them!

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WIP Schedule, Effect on Balance Sheet Analysis

Now we pull it all together.

Here again is our sample contract.

Contract Price / Original % GP  /   Billed    /     Costs to Date  / Remaining Costs

$1,100,000     /        10%            /$550,000 /    $350,000      /  $700,000

What did we determine so far?

  1. We found that the job is 33% complete.
  2. The profit % has slipped from 10% to 4.5%
  3. The contract is Overbilled by $187,000

In addition to generating some discussion (What’s going on with this project?), these facts have an effect on the financial analysis and bond worthiness of the account. They could result in the bonding line being reduced and future bonds being declined.

How does this happen?

Remember the Overbillings are dollars the contractor has in hand, but at this stage of the project they are undeserved.  The dollars are comprised of costs and profits, and the profits are unearned at this point.

So where are these “undeserved funds” on the balance sheet?  There is no entry by that name on the Balance Sheet.  These dollars are sitting in the cash account, along with other cash owned by the company.  These dollars are not yet earned or deserved, yet they are sitting in the account looking normal.

The solution is to reconcile (recognize) the undeserved funds by creating a corresponding liability that offsets the Overbilling cash asset. This Current Liability will be called Billings in Excess of Costs and Estimated Earnings. In short, this is referred to as Overbillings.

In this case, there will be a $187,000 Overbilling Current Liability to offset the undeserved funds in the cash account (Current Asset).  This removes the extent to which the Overbillings inflated the Working Capital calculation (Current Assets minus Current Liabilities).

In an Underbilled situation, a Current Asset called “Costs and Estimated Earnings in Excess of Billings” would appear.  (Notice that it sounds like the opposite of the Overbilling title.) This adds to Working Capital by reflecting the earned funds that have not been collected because the billings are not current.

Here are some CPA comments regarding WIP schedules and their importance:

http://www.reacpa.com/the-contract-schedule

Conclusion: The analysis described in this series is critically important for contractors and their surety.  However, the analysis is impossible if the contractor does not keep valid records of the costs attributed to each individual project and then periodically re-estimate the Remaining Costs to Complete based on the actual realities experienced.

Watch for #58 – a Bonus Edition!

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 #56: (3 of 4) Work In Process Schedules – Own Them!

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Profit Analysis

Every project starts with an estimate that attempts to predict the total Cost of labor and material needed to perform the work.  With this number and the contract price, we can find the Original Estimate of Gross Profit.  (Contract profits are always “gross” because overhead and other expenses have not yet been deducted.)

The same analysis can be performed during the life of the project to determine:

  1. if the contract is expected to produce a profit
  2. if the original project estimate was reasonably accurate in predicting the costs that are being incurred (and therefore the profit prediction is dependable)
  3. if field supervision and the labor force is as productive and efficient as expected
  4. if material costs are coming in as predicted

We use the original percentage of gross profit instead of the dollar amount so the contract performance can be compared over time, even if the contract dollar amount has changed by amendment.bookkeeper3

A short form WIP may not state the Current Estimate of Total Costs, or the Current Estimated Profit, but you can calculate them.

Formula to find Current Estimated Percentage of Profit:

On the WIP schedule, do you see, or can you calculate, the Current Estimate of Total Costs to Complete? (Discussed in “2 of 4”)

Find it by adding the Costs Incurred to Date to the Current Estimate of Remaining Costs to Complete.

To calculate the current estimated profit %, subtract the Current Estimated Total Costs from the Current Contract Amount (gives you the expected profit in dollars), then divide the profit dollars into the contract amount to find the profit %.  Try it on our sample contract.

Contract Price  /  Original % GP  /   Billed    /     Costs to Date  / Remaining Costs

$1,100,000      /     10%               / $550,000 /   $350,000     /  $700,000

Is the current estimated profit $50,000?    Yes, it is!

To find the % divide $50,000 into $1,100,000 which gives you .045 or 4.5%.

This means that now, after this project has commenced, a profit that was projected to be 10% of the original contract amount has now deteriorated to 4.5% of the current contract amount. This is vital info for the contractor to have during the project.  It shows a trend that must be controlled. Prompt action may prevent the project from producing a loss for the company or could even improve the final profit figure. The surety underwriter will monitor such projects, even if they are not bonded.

Critically Important: This analysis is impossible if the contractor fails to record the labor and material costs incurred specifically on each project. They must also make a CURRENT estimate of the remaining costs to complete. They cannot rely on the original estimate of costs and merely hope the profit will be there at the end.

Billings: Overbilled / Underbilled

Now let’s shift gears. The next point to determine is whether the project is billed ahead or behind the degree of completion.  For example, the contractor’s office may be slow in processing the invoices to the project owner, so they may not have collected funds that are rightfully earned (they are Underbilled).  Conversely, they may be billed beyond the degree of completion (they are Overbilled) and therefore have dollars in hand that are not yet earned. This is calculated in dollars by first comparing the % of completion to the % Billed to Date.  Try it on our example contract.

Here are the questions:

  1. What was the % of completion?
  2. What dollar amount is that percentage of the current/revised contract amount?  (This gives you the “correct” amount of billings at this stage in the project.)
  3. Are the actual Billings to Date more or less than this amount?  Are they Underbilled or Overbilled, and by how much?

OK, what did you get?

  1. The % of completion is 33.3%
  2. Therefore the “correct” billings are $363,000
  3. If the actual billings are $550,000, the company is $187,000 Overbilled on this project.

They have succeeded in billing the client beyond their current degree of completion. This may not be bad if the contractor knows they are overbilled.  Management should not be unpleasantly surprised when they are 100% billed but the work is still not complete (Yipes, no more money coming in! Who’s gonna pay for the labor and materials?)

Another issue: Overbillings can become a concern for the surety.  Overbillings (money) may be diverted by the contractor into another project.  In the event of contractor default and completion by the surety, this means there may be funds missing that rightfully belong in the project.  This could increase the surety’s net loss.

Underbillings may indicate an intentional, conservative billing practice on the part of the contractor – leave money in the project and take it out at the end when successful completion is assured.  If it is unintentional, they may be depriving themselves of earned profits that are currently needed.

Underbillings can also be an indication of poor management and / or administrative practices.

The point is that all these issues are important for the contractor and surety, and therefore, the agent.

Our last segment in this series will cover how all this affects the contractor’s financial statement.  Important!

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 #51: Writing Bonds to Your Uncle

Steve GoliaLeave a comment

Sam, that is…

There are lots of federal bonds.  It’s a unique corner of the surety world with special requirements and mandatory bond forms.  Here is a general overview and some specific comments on Performance Bonds for federal contracts.

With so many federal forms for specific situations there’s bound to be some strange ones: Adulterated Butter Bond, Opium Smoking Bond and the Tobacco Tube Manufacturers Strengthening Bond to name a few!

The general categories are:

  • Official Bonds covering the actions of people in office
  • Immigrant Bonds covering foreign persons in the U.S.
  • Excise Bonds cover taxation
  • Customs Bonds relating to import and export

In addition to all the various small bonds, there are the Performance and Payment Bonds which often are for millions of dollars covering contracts for construction and services. Let’s talk about these.

For construction, the federal forms are Bid Bond #24, Performance Bond #25 and Payment Bond #25A.

Some unique aspects to note:

  • If issued by a corporate surety, they must appear on the current version of Circular 570 (T-List) for an amount sufficient to cover the bond in question.  You can refer to the current list here: http://www.fms.treas.gov/c570/c570.html
  • The use of 24, 25 and 25A is mandatory on contracts offered directly by a branch of the federal government. Projects that include federal funding, but are offered by a local non-federal entity, are governed by whatever bonding requirements they designate.
  • On Bid Bonds, the “Date Bond Executed” and “Bid Date” are not required to be identical, but the execution date cannot be after the bid date.
  • Federal bids bonds are normally for 20% of the proposal amount.
  • On the #24 Bid Bond, it is not necessary to fill in a dollar amount for the penal sum of the bid bond – as long as the Percent of Bid Price (such as 20%) has been indicated.  It is also not necessary or correct for the surety to indicate their T-List limit in the Penal Sum area or in the signing area “Surety A.”  The correct dollar amount of responsibility is automatically calculated based on the proposed contract amount.  Entering a dollar figure is only necessary if the surety wishes to cap the bid bond amount by setting a maximum value.  (Refer to Secret #8.  Call if you don’t have it. (856) 304-7348.
  • On 25 and 25A, it is not necessary to enter a dollar amount in the signing area “Surety A” unless there is a co-surety on the bond.  Liability Limit in the Surety A section is not asking for the T-list amount.
  • Federal bonds are always made out to the United States of America.  They do not name the actual governmental agency.
  • In the current edition, the nature of the work is listed on the Bid Bond, but not on the Performance or Payment Bond.  Only the contract number is indicated.
  • You can download the current edition of these Standard Forms here: http://www.gsa.gov/portal/forms/type/SF  That’s important because a bond can be rejected by the C.O. if an obsolete version of SFs are used.
  • In the current edition (2004), the form 24 Bid Bond says “Pervious edition is usable.”  Which, despite the poor spelling, means older versions are OK, same with the form 25A Payment bond.  Be sure to always read the printed details on the form which indicate the expiration date and other important facts.
  • Another “Ooops!” from Uncle: There is no typable field provided on the form to enter a bond number.  You need to do this manually. “Perviously” the form was not even typable.  Small steps!

There you have it.  Federal Bond forms are different, but that doesn’t mean we can’t still be friends.

Readers please note: These posts are for your entertainment and enjoyment.  We do not assume responsibility for your correct execution of bonds, nor are we responsible to any third parties.

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 #45: Backpedaling and How to Avoid It

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Sureties commonly rely on a variety of elements when deciding if they will provide surety bonds for contractors. All relevant underwriting factors are considered, including the applicant’s financial condition.

In most bonding scenarios, the applicant for the bonds is a construction company – typically a corporation or LLC. An important element of the financial evaluation is the company’s financial statement.

Why so much emphasis on this one document? The financial statement is considered a report card on the quality of management. It shows a range of important indicators. To name a few:

  1. How strong a financial commitment the owners made to the company (capitalization)
  2. The amount of revenues management has acquired in the previous operating cycle
  3. The extent to which construction contracts were realistically estimated and successfully managed
  4. Management of overhead expenses
  5. Tax planning
  6. Adequacy of cash flow
  7. Liquidity
  8. Profitability
  9. Reliance on banks and other creditors to finance operations
  10. Collectability of receivables

The analyst’s favorite financial statement date is the company’s fiscal year-end (FYE), which is “tax day.” We prefer this date for two reasons.

  • Underwriters need to make a periodic review to monitor the applicant’s financial status, so an annual review on the FYE is perfect.
  • The tax day numbers will be realistic and conservatively presented – to minimize the tax exposure. This conservative approach is ideal for the bond underwriters who hope to make a realistic analysis of the applicant.  For most companies tax day is December 31st.

So where does the backpedaling come in?

Company managers rely on their Certified Public Accountant for financial advice, especially tax planning. Limiting taxes is a popular goal, but at what price? Lower taxes may be the result of lower pre-tax profits. Lower profits mean less financial growth and possibly an inadequate net worth. (See Secret #3: Taxes) Why should stockholders continue to support a company that fails in its primary mission: Producing a profit?

Obviously these issues are a great concern to surety underwriters, who want successful, well-managed companies as clients. If tax avoidance is aggressively pursued, it is not unlikely that bonding capacity will be compromised. The surety may limit their support or even terminate the relationship if financial performance is weak.

Once the financial document is carved in stone, company management may face an entire year of backpedaling: “We showed poor results because…” until the next FYE report can show better numbers.

The problem is not uncommon, and the solution is simple if executed properly. Avoid backpedaling by having a draft financial statement initially produced by the CPA. The document will be marked “For Discussion Purposes” and discussion is exactly what’s needed. A review by the underwriter will determine if any elements of the report are detrimental for bonding purposes. Plans for the coming year can be discussed and bonding capacity evaluated.

If the financial statement does not support the desired amount of surety capacity, now is the time to make adjustments before the final version is produced. Backpedaling is avoided!

With some planning and open dialogue agents can help their contractors avoid the missteps that prevent companies from realizing their full bonding and financial potential.

  • Agents, 60 days prior to your client’s fiscal year-end is the time to act. Get the ball rolling!
  • Contractors, tell your accountant a draft fiscal year-end statement will be needed for discussion with the bonding company.

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.  856-304-7348

First Indemnity of America Ins. Co.