lien releases

Bonded Contracts – Show Me The Money! (Secrets of Bonding #139)

 Laurel and Hardy. Ben and Jerry. Bonding companies and money. They just go together!

Let’s take a look at the focus bonding companies place on money when providing Bid and Performance Bonds. It’s a matter of survival. If called upon, the surety hopes to complete the project with the remaining (unpaid) contract funds. They track a number of elements and there are critical milestones. Learn about them so you know what’s ahead.

Of course there is a significant financial evaluation of the applicant (the construction company), a subject we have written about extensively. Visit our index of article subjects. Here we will only talk about the bonded construction project.

An early money question is “how is the work funded?” Most bonded jobs are public work. This means the project is paid for with tax dollars. On private contracts, the work can be funded in a number of ways. For commercial building, the project owner may have a construction loan or set funds aside in an escrow account. In any event, the bond underwriter wants to be sure the contractor will be paid after they incur costs for labor and material. Not being paid could cause the company to fail and result in claims on all open bonds.

Regarding the new contract, the surety will ask:

  • How often will the contractor be paid?
  • Is a portion of the contract amount paid up front, immediately when the work commences?
  • Are there Liquidated Damages – a financial penalty assessed per day for late completion of the work?

Once the contract is underway, the surety wants to monitor the money:

  • Is the job proceeding profitably, and therefore headed for a successful conclusion?
  • Do the contractor’s billings correlate with the degree of completion? It can be dangerous when they get too far ahead by billing the job aggressively.
  • Are suppliers of labor and material being paid on a current basis (by the contractor / surety client)?
  • Is the project owner paying the contractor in accordance with the written payment terms?

Sometimes underwriting issues are resolved by using a “funds administrator.” This procedure is intended to enable the contractor to perform the work, while the money handling is performed by a professional paymaster. The paymaster pays all the suppliers of labor and material, plus the contractor. This procedure minimizes the possibility of claims under the Payment Bond.

When the project reaches a conclusion, there may be important final transactions:

  • Final payment – the contractor collects the last regular payment under the contract. The bonding company issues a consent for release of this payment. If there are any problems or issues, they may withhold such approval. Underwriters can require copies of lien releases (from suppliers of labor and material) to assure that everyone has been paid – to prevent Payment Bond claims.
  • Release of Retainage – the contractor now collects a percentage of the contract amount that was methodically held back (retained) as security for the protection of the project owner. Surety consent is often required for this, too. The owner will not release this money unless all the loose ends are resolved, referred to as a “punch list.”
  • Bond “overrun” premium – normally the surety is automatically required to cover additions to the contract amount (bond automatically increases.) Therefore, they are entitled to an additional premium for such exposure. If not collected during the life of the project, this would be a clean-up item at the end. Sometimes a refund is issued for an “underrun” (net contract reduction.)

Bonus Question: Why do some underwriters require premium payment in advance for Performance and Payment Bonds?

Answer: Unlike insurance, surety obligations (P&P bonds) are not cancellable. Therefore, if the underwriter doesn’t get paid the bond premium, they are still “on” the risk!

Conclusion

Surety underwriters strive to bond reputable, capable companies. But even the biggest, best contractors cannot avoid the financial aspects that pop up during the life of all bonded jobs.  Deal with them as they arise. Now you know what to expect.

Enjoy  this scene from Jerry Maguire (click): Show me the MONEY!!!  

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.

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Secrets of Bonding #33: Good Alternatives to a Bond?

Sometimes contractors cannot qualify for the bonds they need.  Or maybe the bond cost, or underwriting terms are unacceptable. What are some of the alternative methods project owners can employ to assure the completion of their projects and the correct handling of money?

Standby Letter of Credit – This instrument is issued by a commercial bank and is available for draft by the project owner.  Typically these are very difficult for a contractor to obtain, especially for 100% of a large contract amount.

Drawbacks: There is no pre-qualification of the contractor’s ability to perform the work.  In the event of default, the project owner must manage the process of assessing the contract status and acquiring a completion contractor.  This method does not prevent liens against the project or provide the process to resolve them. (Lien: Suppliers and subcontractors can place a lien against the title of the property to secure their claim that they are owed money by the contractor.)

References – The project owner can contact previous clients of the contractor who had similar projects. This may give some assurance regarding the ability to perform the work.

Drawbacks: It provides no safety net for completion in the event of default, or for failure to pay bills and the resulting liens – the latter being exposures covered by a Payment Bond.

Tripartite Agreement or Funds Control – All the project funds are handled by the project administrator who acts as the paymaster, paying everyone including the contractor.  The purpose is to assure the money stays in the project and that all the bills are properly paid.

Drawbacks: This addresses a large part of the Payment Bond exposure but does not prevent all liens (*why not?)  The Performance exposure is also left uncovered.

Joint Checks – Obligee writes individual checks each month in the name of the contractor plus each sub or supplier.  This is intended to address the payment exposure by assuring the money actually reaches such payees and thus prevent liens.

Drawbacks: This procedure does not necessarily prevent all liens, nor does it facilitate resolving them if they do occur. There is no protection for the Performance Bond exposures.

Retainage – When each monthly invoice is generated by the contractor, the project owner deducts (retains) a percentage of the payment and holds those funds until 100% satisfactory completion of the project. This is intended to keep the contractor motivated.

Drawbacks: It will not prevent or resolve a default, and does not prevent liens.

Sub Guard – Subcontract Default Insurance obtained by general contractors in lieu of a Subcontract P&P Bond – covers failure to perform.

Drawbacks: Does not cover the Payment Bond exposures.  There is no pre-qualification the subcontractor’s expertise or financial condition.  The default insurance does not arrange for the completion of the failed subcontract, it only reimburses the costs.

Lien Releases – They are executed by subs and suppliers to confirm they received the last payment owed them.  Requiring these monthly from the contractor is a step toward assuring such payments were made.

Drawbacks: It does not prevent all liens (* why not?)  This procedure also does nothing in regard to the Performance obligation.

Conclusion

So what we have here is a box of band aides.  ALL these procedures are less effective than a P&P bond.  None of them address both the Performance and Payment exposures.  They all fail to pre-qualify the contractors the way a surety does.  This is the first service the surety provides and it is one that sureties are uniquely qualified to perform.

The second important deficiency is that in the event of default, none of them facilitate the efficient completion of the project.  Performance Bond claims can result in the surety taking all the steps needed to complete the project.  This is a great benefit for the project owner.

Now you know the real truth: There is no good alternative to a P&P bond!  That’s why they are routinely required by statute on public work.  They are the most efficient means of obtaining a qualified contractor. They assure the work will be performed in accordance with all aspects of the written contract, and they protect the owner from liens or the need to “pay twice” to resolve unpaid subs and suppliers.

Public owners are usually required to bond their projects and private owners are wise to do so.

* Funds Control and Lien Releases do not prevent liens from claimants who were project payees known only to the contractor.


A special note from the author: Steve Golia

I am an Independent Broker and Surety Bond Specialist. If you wish to co-broker bond business, together we will deliver the best in bonding expertise for your clients.  I have a broad range of markets available and often can solve problems even when others have failed.

Call me now (856-304-7348) or email: Steven.Golia@gmail.com