funds control

Secrets of Bonding #119: Lien On Me

Steve GoliaLeave a comment

“It ain’t what you don’t know that gets you into trouble.  It’s what you know for sure that just ain’t so.”  A famous quote by…?

Let’s go over what you need to know about construction liens.  They can have a big impact on construction contracts and companies.            Click for mood music!

A Mechanic’s Lien is filed when a subcontractor or supplier on a construction project fails to be paid. The lien is a form of claim filed against the project itself. For example, the unpaid mason (subcontractor) files a claim against the building owner. “My bricks and labor are in that façade. I can’t take them back now, but assert that the general contractor has failed to pay me!”

Liens are used on non-governmental projects. Typically, claimants are prohibited from liening a public building – which is where Payment Bonds come in. Issued by surety companies, the payment bond is a resource to protect suppliers of labor and material from non-payment.

So far that’s all pretty straight forward. On private contracts unpaid subs and suppliers can file a lien. On government jobs they make a claim on the payment bond instead.

Here are some implications worth knowing.

Release of Lien

The lien can be released, or “bonded off,” by the filing of a (you guessed it) Release of Lien Bond. This removes the lien from the property in question, which is beneficial for the project owner, while still providing financial protection for the plaintiff (unpaid sub or supplier.) The dispute is still unresolved, but the plaintiffs security shifts from the physical project to the surety bond.

A release of lien bond is not easy to obtain. But if a payment bond was issued, that surety has motivation to prevent a payment bond claim, and issuing the lien release bond could do so.

When the lien release bond is filed, it takes some pressure off the defendant (general contractor). You can assume the unpaid mason hopes the lien will cause the owner (who is the recipient of the lien) to force the GC to respond. When the lien is bonded off, that effect disappears from the project owner – but not the surety.

Stop Notices

California, Mississippi, Arizona, Alaska and Washington use a slightly different procedure. On governmental projects a Stop Notice is filed which freezes a portion of the project funds to protect the claimant. This forces action on the part of the GC, or they can file a Release of Stop Notice bond to keep the project funds flowing while dealing with the dispute.

Understand the Difference

Mechanic’s Liens are filed against the project owner.  The claim attaches to the real property and is recorded against the property title – which therefore restricts the owner’s ability to dispose of the property.  

With a lien, the claimant may be paid regardless of whether the owner paid the GC.  In fact, the owner may have to pay twice: First to the GC then again to the sub / vendor claimant, to remove the lien and clear the property title.

Stop Notices “trap” contract funds, assuming there are funds to trap.

If the claimant files a Stop Notice after the funds have been disbursed, it is useless. 

Other basic differences:

  • Unlike a lien, the stop notice does not give the debt any security.
  • The stop notice is sent to the relevant parties, but it is not legally recorded such as a lien filed against the property title.  The claim is inherently less official and is sometimes even ignored because of it’s less formal appearance.
  • Unlike a Mechanics Lien, the Stop Notice can affect the entire project because it freezes a portion of the contract funds – which the GC may need in order to continue working.

NOTICE: The author is not an attorney and is not giving legal advice.  This article is for entertainment only.  Gimme a break!

mark-twain

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 #68: Get Your Surety Bond for Free!

Steve GoliaLeave a comment

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

“Follow” this BLOG in the upper right hand corner for more exciting surety bond stuff!

Secrets of Bonding #53: Funds Control vs. Tripartite Agreements

Steve Golia1 Comment

You may have heard these terms used in connection with Performance and Payment Bonds.  The concepts are similar in some ways, but have different purposes.  Let’s talk about them and how they can help you as a surety bond producer.

Funds Control

Also called Funds Administration or Escrow, it is a procedure that always originates at the request of the surety.  The contractor applying for the bond (the Principal) is receiving a “conditional” approval.  The underwriters are confident there is sufficient expertise, labor, equipment, etc. to perform the bonded contract, but the contractor has some financial issues.  The underwriter is willing to bond the performance obligation, but has reservations regarding the handling of money and payment of bills (the Payment Bond exposure).  Funds Control can provide a level of protection for the surety by taking the money handling responsibilities away from the contractor.

Normal contract, the project owner (Obligee on the bond), is required to pay the contract funds to the Principal.  This is usually in monthly payments, each for the work recently performed.

With Funds Control, the money handling is taken away from the contractor and moved to a party chosen by the surety and empowered by the Principal.  The surety will require that the contractor execute a letter of instructions directing the obligee to pay the Funds Administrator instead of them.  The administrator becomes the paymaster on the project paying all suppliers of labor and material, and paying the principal, too.  This procedure eliminates most of the risk of claim on the Payment Bond.   (#Why not 100%?)

There are companies that are professional Fund Administrators.  They may be well known to the surety and handle a series of contracts with them.  A dedicated bank account is opened for the contract, and checks are issued each month which are then distributed by the principal to the vendors.  In some cases, the surety may perform the Funds Administration in house.

Tripartite Agreements

This arrangement also involves the contract funds being redirected to a third party, instead of being paid to the contractor.  And similar to Funds Administration, the point is for the Tripartite Administrator to be the paymaster on the contract.

The primary difference between the concepts is that there is no bond when a Tripartite Agreement is used – it is in lieu of a P&P bond and actually only replaces the Payment Bond.

  • Funds Control is required by the surety providing the P&P bond.
  • A Tripartite Agreement is stipulated by the obligee in lieu of bond.

Review federal regulations regarding Tripartite Agreements: A tripartite escrow agreement.  http://www.acquisition.gov/far/html/Subpart%2028_1.html

“The prime contractor establishes an escrow account in a federally insured financial institution and enters into a tripartite escrow agreement with the financial institution, as escrow agent, and all of the suppliers of labor and material. The escrow agreement shall establish the terms of payment under the contract and of resolution of disputes among the parties. The Government makes payments to the contractor’s escrow account, and the escrow agent distributes the payments in accordance with the agreement, or triggers the disputes resolution procedures if required.”

This procedure may be used for contracts between $30,000 and $150,000. The Performance Bond may be waived at the contracting officer’s discretion.

Conclusion

These procedures have different implications.  Let’s examine them.

FC= Funds Control

TA= Tripartite Agreement

The Obligee:

  • FC – They are getting Payment protection and a Performance Bond. The surety will monitor the project and step in to keep things on track (and prevent a claim or default) if necessary. In the event of failure, the surety completes the project.
  • TA – Even unbondable contractors can be awarded work. A TA may be less expensive than a bond with FC. Limitation: There may be no Performance guarantee.

The Principal:

  • Both processes result in the contractor successfully obtaining the project but with no handling of the project funds.
  • TA – No need for personal or company indemnity.  No collateral for the surety. Financial reporting, legal fees and other expenses may be less.  Limitations: Federal only permits TA on small contracts.  Fails to build a track record of “performing under bond”

Subs and Suppliers:

  • Under both procedures they are paid by a professional intermediary, which may be more dependable and faster.
  • FC – They can make a claim against the Payment Bond
  • TA – Limitation: No opportunity to claim against a surety bond if they are unpaid, or not fully paid.  What is their recourse?

Agent and surety:

  • TA – No Bond!  (Beans for supper again?)
  • FC – A normal P&P Bond is issued

# If the principal fails to list any subs or suppliers during the set-up process, they will not be under the protection of the funds administrator.  However, they WILL still have the right to make a claim against the payment bond!

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 want to miss our next exciting article?  Click the “Follow” link in the upper right corner.

Secrets of Bonding #46: Turn IRON into GOLD

Steve GoliaLeave a comment

When contractors apply for Performance Bonds, the underwriting review always includes a financial analysis along with other elements.

Two key components of the financial analysis are Working Capital (WC) and Net Worth (NW).  WC is a measure of short term financial strength.  NW is the ultimate value of the company upon liquidation.

The inspiration for this article came from a new bond account we recently reviewed.  The company is a trade contractor, the kind that normally performs their own work rather than subcontracting. This means their financial statements should show appropriate levels of labor, plant, and equipment.

In this case, the Profit and Loss Statement (P&L) showed sales in excess of $10 million, not a small company. The Balance Sheet showed an acceptable amount of WC, but NW was low – resulting in some weak ratios.

Another element caught our attention: On the Balance Sheet, the net value of the equipment asset was only $65,000! This made us wonder how a company could perform $10 million in sales with so little in physical resources.

There could be a couple of explanations:

  1. They could be subcontracting most of their work.  This is unlikely, however, because they themselves are subcontractors. Typically there is not enough profit to share between two firms. A review of this company’s P&L statement did not indicate extensive subcontracting.
  2. They could be renting almost everything (instead of owning).  This doesn’t sound like a practical approach with sales as high as $10 million, and the P&L did not show high rental expenses.
  3. The equipment could be substantially depreciated resulting in a low net value on the Balance Sheet.  This did turn out to be the scenario in their case.

Let’s talk more about #3. But first off, what is depreciation?

IRS definition: http://www.irs.gov/Businesses/Small-Businesses-%26-Self-Employed/A-Brief-Overview-of-Depreciation

It says in part, “Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property. It is an annual allowance for the wear and tear, deterioration, or obsolescence of the property.”

This means when a $100,000 backhoe is purchased, its value as an asset on the Balance Sheet goes down each year as the depreciation progresses.  Bear in mind, this is an accounting entry.  It is not an indication of the current market value of the asset.

Eventually, the asset is depreciated to zero. However, even if it is valueless on the Balance Sheet, it may still be out on a job site working and producing revenues.  It may still have a market value. So therein lies the Gold.

Assets such as heavy equipment (referred to as “Iron”), may have value that is not reflected on the Balance Sheet. So the question is: How to recapture that value and help the bond worthiness of the account?

One way is with a professional appraisal.  Even if the backhoe is depreciated to zero, if the current market value is $25,000, that represents NW that can be added to the financial ratios.

Imagine the effect for the company in question.  Upon further review, we determined that the cost of their equipment was nearly $2 million.  They had a lot of it and it was older so depreciation had reduced the net value on the Balance Sheet to $65,000.  However the current market value was actually $500,000!

Q. Based on these facts, what value should the bond underwriters use for the equipment:  $65,000, $2,000,000, $500,000 or some other amount?

A. If you’ve been following along, that’s where the appraised value comes in.  You need an independent determination of current market value that recognizes the amount of cash these assets could bring.  If well maintained, they have a value higher than that shown on the Balance Sheet. ($500,000)

How else can the value be determined?  The client could provide a copy of their equipment floater as evidence of current value.  You could also get an informal appraisal from their equipment dealer.  Any of these options are better that living with the unrealistically low value shown on the Balance Sheet.

Going back to our example, if the backhoe’s market value is currently $25,000, give that info to the underwriter.  The newly found net worth for all such assets can be added to the bonding analysis.  You turned the Iron into Gold, a POT of Gold!  It can totally transform the ratios and the client’s ability to qualify for the bonds they desire.

Consider this technique for companies with a sizable fleet of mature equipment, especially when their Net Worth is less than desired for bonding purposes.  This analysis can also help strengthen the banking relationship.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

P.S. Check out our upcoming Free CE schedule here!

Follow this BLOG in the upper right hand corner for more cool bond stuff…

Secrets of Bonding #43: Subcontractors and Subcontracts

Steve GoliaLeave a comment

“If you are a bonding company, why won’t you bond subcontractors?”

It might seem odd, but some Sureties do not embrace the opportunity to serve subcontractors.  So what’s differentfish about subcontractors and subcontracts?  Why do some sureties red line this entire segment of the market?

The Food Chain

One complaint underwriters may have about subcontractors is that they are farther down the food chain than General Contractors. GCs have a “prime” contract, meaning they work directly for the project owner, and are the first recipient of monetary payments.  The subcontractors are subsequently paid by the GC.  Subs may face delays and sometimes even harassment at the hands of GCs. Remember, subcontracts are all private contracts not regulated by governmental rules even if the prime contract is public. Put simply, subs have a harder time collecting their money.

Other Issues for Subs and Their Sureties

  • GCs do not normally disclose bid results (2nd & 3rd  bidder’s figures).  This makes it difficult to evaluate contract price adequacy – a disadvantage for both the sub and surety.
  • Unregulated procurement procedures and contract administration – GCs may be aggressive in their procurement methods, pressuring subs for price concessions: “Knock their heads together.” Such practices make the subcontracts less profitable and therefore more risky for the sub and surety.  Subs can also be victimized with verbal awards and unwritten change orders.
  • Contract documents (including bond forms) may be non-standard, drafted by GCs specifically to give strong advantages over subs and sureties.  In some cases the normal Performance bond is transformed into a forfeiture type financial obligation.
  • Flow-down or pass-through clauses in subcontracts force subs to assume obligations rightfully belonging to the GC. An example would be wording that makes the sub responsible for the liquidated damage amount on the prime contract if they are found to have caused a delay on the subcontract.
  • “Pay when paid” language can result in delayed payment to the sub.  “Pay if paid” can result in the sub never being paid.
  • Unbonded public work is rare, but in such cases there is no Payment Bond at the GC level to protect the sub, and liens (filed against the project for failure to receive payment) may be prohibited.
  • Indemnification: Broad form indemnity clauses in the contract can make the sub financially responsible even if they are not at fault.
  • Delay damages: Subs may be barred from seeking financial recovery.
  • Lien waivers: When read literally, these documents may operate to waive and release claims for which the subcontractor has not yet been paid. (Learn about Conditional and Unconditional Lien Waivers: Click!)
  • Termination for Convenience: This contract clause can enable the GC to terminate the contract and leave the sub with a series of unreimbursed expenses and lost profits.
  • Some trades perform their work late in the project, meaning the bond is carried for a lengthy period with no progress on the contract.
  • Certain trades can operate with minimal capitalization, so the field may be populated with lightly financed companies. Such competitors can drive down contract prices making it harder to bond their work.
  • Financial reporting may be less sophisticated than for GCs (CPA financial statements vs. bookkeeper or QuickBooks).
  • Due to their size and circumstances, subs may lack bank support, such as a working capital line.

Conclusion

Subcontractors literally perform the majority of all construction work.  They are the backbone of the construction industry and cannot be ignored by sureties.

When it comes to bonding, subcontractors need to demonstrate that they are well-managed companies that reflect the same attributes as a successful GC.

Secrets #5 and #15 contain important guidance to help agents get subcontractors approved.

Start by choosing a surety that is actively seeking to support subcontractor accounts without requiring collateral.

Steve Golia
First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

“Follow” this BLOG in the upper right hand corner for more exciting surety bond stuff!

Secrets of Bonding #42: My Bond Amount Can Beat Your Contract Amount

Steve GoliaLeave a comment

Q. What is the normal relationship between the contract and bond amounts?

A. Performance and Payment Bonds are normally issued for 100% of the initial contract amount.

Q. What do you call a bond that’s for less than the full contract amount?

A. Underwriters call these “percentage bonds,” such as a 50% Performance and Payment bond. Some obligees stipulate these in order to make the bond cheaper (doesn’t work), to help the contractor preserve their bond capacity (doesn’t), or to make the bond easier to obtain (nope). What it does do is deprive the obligee of part of the protection they are buying.

Q. What happens with the original 100% bond amount if there is a subsequent amendment increasing the contract price?

A. The bond is often required to automatically follow an increase in the contract amount, without “notice to or consent of” the surety.

Q. Is there a limit to how much the bond can be automatically increased?

A. A limitation may be stipulated in the bond to protect the surety from huge unanticipated increases, such as no more than a 10% increase without the written agreement of the surety.

Q. What is the basis of the calculation for the bond cost?

A. The cost of the bond is normally based on the amount of the contract being guaranteed, not the bond.  If the bond is for 75% of the contract amount, the bond cost would be unchanged. Why does this make sense?

  1. The surety’s decision making process is still based on the entire scope of the contract including all technical aspects and the difficulty of performance. The underwriting expenses are unchanged.
  2. Which 75% of the contract does the bond cover? It covers the entire contract, but subject to a lesser maximum bond penalty. You could say it covers the bad 75% where the claim lies.  Full penalty bond losses are extremely rare, so the reduction to 75% has little benefit for the surety.

Q. What is the cost difference for Performance only, no Payment bond?

A. Since the underwriting is unchanged, there is no cost reduction.

The Maximum Rule:

Does your brain hurt yet?  It will after this.

The purpose of the Maximum Rule is to limit how much is charged (the maximum) for a “percentage” bond.  Suppose you have a 10% P&P bond on a $1 million contract with a straight rate of $25 / thousand.  Based on the contract amount, the bond fee would be $25,000.  Will the obligee pay $25,000 for a $100,000 bond?  Even though the bond will cover the entire $1 million of work, it’s a hard sell.  This is where the Maximum Rule comes in.

The price calculation under the Maximum rule is different.  Here is a typical example:

If the rate used in the Maximum Rule is $50 / thousand for the aggregate of the Performance ($100,000) plus Payment bond ($100,000) amounts, it will equal $50 x 200 or $10,000.  So in this example the maximum applicable charge would be $10,000 for the $100,000 bond, in recognition of the greatly reduced bond penalty.

With the Maximum Rule, you charge the normal price or use the Max Rule price – whichever is less.  As the percentage of the bond amount increases, the advantage of using the Maximum Rule disappears.  In this example the tipping point is 25%.  The Performance and Payment bond amount must be less than 25% of the contract amount for the Max Rule to result in a reduced charge.

Conclusion

Here’s the good news.  The vast majority of contracts stipulate a P&P bond equal to 100% of the contract amount; this is the typical statutory requirement on public work.  The same routine is normally followed on private contracts as well because it is the best way to protect the obligee’s interests.

Call us with you next Contract, Site or Subdivision Bond.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

An “A Rated” Carrier

Visit our Free CE school.

Secrets of Bonding #39: Design/Build vs. Design/Bid/Build

Steve GoliaLeave a comment

Underwriters are watchful for “Design/Build” contracts.  If you feel like D/B projects are becoming more common, you’re correct!  The concept emerged in the 1980s and was formally codified by the federal government in 1996 after two years of collaboration with the private sector. The Clinger-Cohen Act established a two-step procurement process for such work.

Some sureties balk at the additional risk their clients assume on these projects. Put simply, the contractor becomes responsible for both design and construction.  In the event of a performance problem, this really cuts down on the finger pointing!

Bear in mind, it is the contractor (not the designer) who obtains the surety bond.  On “contractor-led” D/B projects, the contractor hires a licensed and insured architect to perform the design work. Another option is to form a joint venture between the architect and contractor.  In either case, a certain tension exists between these “partners” who have slightly different agendas, and this has implications for the surety – the guarantor of the project.

There is no denying we face unique risks on D/B contracts.  Let’s review them.

  • The designer must agree that their design (and subsequent revisions) will conform to the project budget “as bid.”  Without this, the contractor could be forced to absorb the cost of design changes.  Unprofitable contracts are more likely to go into default.
  • Similarly, designers must agree to conform to the project schedule. They cannot make changes that require construction timelines unsupported by the contract. Such changes could force the contractor to choose between significant unreimbursed expenses or failure to complete on time.
  • The design work must also conform to the project owner’s specifications at all times.

Design/Build contracts require some extra care, but can be bonded successfully.  Underwriters need to have the proper procedures and expertise to make these evaluations.

The alternative: Design/Bid/Build

You may encounter contracts specifically called Design/Bid/Build. So is this another new thing we have to learn?!

No, actually D/B/B this is the traditional construction method where the project owner hires and directs the architect. It is nothing new but may be named as such to identify the project as not Design/Build.

We may not have known it by name, but we have been helping contractors bond Design/Bid/Build projects for years!

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 #38: Capacity – How to Preserve It

Steve GoliaLeave a comment

For contractors, Bonding Capacity is a good as gold.  It enables the company to pursue new projects with the confidence that their surety will back the contracts when the need arises.  This is the source of increased revenues and greater profits!

How is available bonding capacity calculated? First a bonding line is determined, consisting of an Aggregate (total) amount and a Single per job limit.  The Aggregate is then decreased by different factors that consume the line. What can be done to minimize this effect so bonds remain available for the client? Let’s look at how the numbers are developed and how they can be appropriately managed.

Bonded and unbonded work is included in the analysis.  (*Why is Unbonded work included?)  Here’s the math:

Aggregate Capacity amount  Minus:

  1. Undecided bids (full contract amount)
  2. Low but unawarded bids (full contract amount)
  3. Projects that are awarded, signed or started (full contract amount)
  4. Remaining Costs to Complete on open contracts

Equals the Available Bonding Capacity.

So how can agents help their contractors preserve this vital asset?

1.  Prompt reporting of bid results – When bid bonds are issued, the entire estimated contract amount is deducted from available capacity, not the bid bond amount.  The capacity is not restored until the “not low” results reach the underwriter.

2.  Updated Work In Process (WIP) schedule:

  • Surety underwriters and accountants determine a contractor’s “current work load” based on the costs they must incur (such as labor and materials) to complete their open contracts.  When there are no remaining costs to incur on a project, by definition, it is considered completed.  The WIP schedule shows revised Costs Incurred to Date and Estimated Costs to Complete. Both increased costs incurred and decreased future costs improve available capacity.  Future costs may be reduced by progress on the contracts and also by greater labor efficiency, material cost savings, improved scheduling and other factors.
  • A reduction in the contract amount (by amendment) has the same effect because it reduces unincurred costs. Report such amendments immediately.

3.  Prompt reporting of completed or terminated work, including unbonded projects, removes them from the work load and therefore increases availability.

Note: Factors that can reduce available capacity include unincurred contract costs that increase for any reason and the addition of new unbonded projects.

*The aggregate capacity amount is based on all the contractor’s professional and financial capabilities. If unbonded projects are acquired, they consume resources (supervisory staff, equipment, etc.) and therefore must be recognized within the use of the bond line.

Available Bonding Capacity is a moving target subject to frequent revision.  To maximize availability, send us the right info and keep it current.

First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

An “A Rated” Carrier

 

Secrets of Bonding #37: Counting Counts!

Steve GoliaLeave a comment

One for you, one for me.

Two for you; one, two for me.

Three for you; one, two, three for me!

What fun, unless you are a surety underwriter and you’re incorrectly evaluating a financial picture.

When we review a new applicant for bonding, a range of factors are considered and the financial aspect is always one of them.  Sureties want to be confident that the company is stable and will be able to perform the bonded contract.  This includes the financial capability to finance the start of the work and deal with any issues that arise.  Such problems, if left unresolved, are the things bond claims are made of.

Who is the typical applicant for performance bonds?  Most often it is a privately owned company.  The focus of the financial evaluation is the fiscal year-end (FYE) of the company, which frequently is December 31st.

A range of elements are reviewed to determine the health of the company and its ability to survive the issues that often arise on construction projects.  One element is Cash.  Always the first (most liquid) asset listed on the Balance Sheet, you’ve heard the expressions: Cash is king, Cold hard cash, A cash cow!  A strong cash position is universally recognized as a sign of health.

As part of the primary financial evaluation, underwriters calculate the company’s FYE cash position.  Secondarily, the finances and cash position of the company owners will be reviewed.  These parties are indemnitors to the surety even though they are not direct bond applicants (bond “Principals”).  In the event of loss, the surety is entitled to look to these parties for salvage and subrogation (financial recovery) – so the financial strength they add to the picture is relevant.

Trick Question: If financial statements show that the company has $100,000 cash at the 12/31 FYE and the owners personally have $100,000 on 1/31, do you have $200,000 for underwriting purposes?

Answer: You do unless that’s the same $100,000 that you’re counting twice.

Company owners may loan money to the firm and later pay it back. Money gets moved around, sometimes quickly.  There should be corresponding debt entries on the financials.  But if people “forget” to show them, readers can be tricked into counting the same asset twice.  How can underwriters prevent being fooled into double counting dollars?

The solution is to always require concurrent financial statement dates.  We will always request personal financial statements as of the fiscal year-end date of the company. Personal year-ends are automatically 12/31.  But if the company has chosen a different date, that will be the personal FS date we want.

It is also typical, when reviewing unaudited (unverified by an independent third party) financial reports, to ask for proof of the cash assets – such as bank or brokerage statements.

So there you have it.  When bond underwriters count the cash, they prevent counting the same dollars twice by requiring business and personal financials as of the same date, because Counting Counts!

Call us with you next Contract, Site or Subdivision Bond.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

An “A Rated” Carrier

Visit our Free CE school.

Secrets of Bonding #36: When Gross Profits are Gross!

Steve GoliaLeave a comment

Gross Profit, Net Profit, “I can’t remember which is which.”

Here’s an easy way to remember: Gross profit is the larger number.  A Gross of something is a big amount: Picture 144 baby chicks hopping around…  In this case, Gross means “big” not “bad.”

Net profit is the smaller number. Think of when you pour something through a net or  sieve: Less comes out.

OK, so Gross Profit is found by subtracting Direct Costs from Revenues (or Sales).  These numbers always appear on a company financial statement (FS) in the “Profit & Loss” or “Statement of Income” section, near the top.

For a masonry contractor, examples of Direct Costs are bricks, mortar and the labor to install them.  Some Indirect Costs would be rent, phone expenses and office salaries.

You may have seen a Work In Process schedule which shows the financial status of open contracts. That is literally the same as the Gross Profit analysis but is specific for  each project. (Keep this in mind when you read the cool bonding tip at the end.)

Now in order to be successful, companies need to produce a Gross Profit sufficient to cover all their indirect expenses and then yield a Net Profit (which always appears at the bottom of the page.)

As surety agents, we often see companies that are suffering from lack of work. Their projects are profitable, but they don’t have enough of them.  They show a Gross Profit but cannot cover their Indirect Costs and therefore produce a Net Loss (they lose money for the year.) Maybe if they had laid off non-essential staff, closed an office or reduced other expenses, the Net Loss could have been avoided. The point here is that the contracts were performed successfully, but other expenses were not adequately managed and a Net Loss occurred.

The inspiration for this article was a FS we received that showed a negative Gross Profit. Pretty unusual.  So what did it mean?

In this case the company lost a significant amount of money on one contract.  The loss was so great that it exceeded all the gross profits earned on other projects resulting in a negative Gross Profit (a loss). Next comes the Indirect Expenses which resulted in a significant Net Loss.

When a negative Gross Profit is produced, it is almost impossible for a company to have a profitable year.  In that case, the Gross Profit is Gross – meaning bad!

Here’s an example of what you’d see on the Statement of Income:

Statement of Income

Income

          Current Earnings – $1,000,000

          Current Costs – $1,250,000

          Gross Profit (Loss) – ($250,000)

Indirect Costs

          General & Administrative Expenses – $75,000

Net Loss – ($325,000)

Cool Bonding Tip: The Gross Profit section of the P&L describes the accumulated results of past projects, similar to the WIP schedule which shows today’s projects individually, during their performance.

By comparing the expected GP % of incomplete jobs on the WIP schedule to last years P&L, you can predict if the new projects are likely to result in a NET profit for the upcoming year-end financial statement (assuming other factors, such as expenses and total revenues, are similar to the prior year.)

Business owners facing such circumstances should consider immediately cutting indirect expenses in a proportionate amount  so a fiscal year-end net profit is more likely.

Call us with you next Contract, Site or Subdivision Bond.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417

An “A Rated” Carrier

Visit our Free CE school.