payment bond

Secrets of Bonding #31: When Receivables are Not Receivable

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Surety bond underwriting involves many elements, and financial analysis is always one of them.  In this newsletter, let’s look at a single element, an important one, and how you can influence the effect it has on bonding decisions.

Accounts Receivable “A/R” are the funds owed by outside parties to the company for work it has performed.  This is a Current Asset and is part of Net Worth.   Active contractors always have such money due them.  The number can be significant for firms in a growth mode.  Problem: Sometimes bond underwriters discount, or disallow part of this figure, thus reducing the applicants recognized financial strength and bond worthiness.   Why does this happen and how can you influence the outcome?

One reason for such assets to be disallowed is the age of the individual receivable on the fiscal year-end (FYE) financial statement date.   In order to be conservative, A/Rs that are 90 days old or more “over 90” are assumed to be uncollectable, and therefore are disallowed.  (Key word: Assumed)

Same with receivables arising from change orders that are unapproved or in dispute.  Projects with performance problems may have all payments held up by the owner, and therefore related A/Rs may be disallowed.  In fact, receivables may be discounted if there is a dramatic increase over historic levels, even if there is no apparent reason to doubt the collectability of the funds.

When A/Rs are disallowed the Working Capital calculation suffers as well as the ratio analysis.

This can reduce or eliminate the contractors bonding line.

Here are some possible cures. 

Retainages – A/Rs over 90 days old may be acceptable if they are actually Retainage which is slightly different from a true “trade receivable.” Identify if any of the A/Rs are actually Retainages.  They should be separated from the A/R analysis and “allowed.”

Over 90s – Older A/Rs are allowable if they were subsequently collected (no matter how old they became.)  Ask the client or accountant for an update regarding the collection of year-end receivables.  All collected items are included in the financial strength analysis.  The underwriter should be updated if they are eventually collected at a future date.   The client will be penalized for a disallowed A/Rs for 12-15 months after the fiscal date.  Updating the file when funds come in could help achieve a bond approval any time during this period.

Change Orders – The same concept applies to COs no longer in dispute or project issues that are resolved.  All A/Rs that are ultimately collected are allowed, regardless of how late they occur.

Payment Bond – If our client is a subcontractor, there may be a Payment Bond “above them” available for claim.  An over 90 A/R might be allowed based on the existence of this safety net.

Caution: If an aged schedule of year-end A/Rs is produced at a subsequent date, items that were not over 90 at FYE (but remain open) may now may be old and therefore disallowed!  It works both ways.

Conclusion

The financial analysis associated with surety bond underwriting is primarily focused on the fiscal year-end financial condition of the company.  These numbers drive the bond line until the next FS is issued – normally about 15 months.

The receivable collection is an ongoing process that warrants interpretation and monitoring because of its changing nature.

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

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Secrets of Bonding #30: The Greatest Danger

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Bid Bonds, Performance Bonds, Payment Bonds. They each have a different purpose and include certain risks. So which one is the Greatest Danger for the surety and agent, and why?

Performance Bonds are an obvious choice.  We may think of Performance Bonds as the main reason a project is bonded – they protect against contractor default and assure completion of the work.

While this is certainly significant, it is not the Greatest Danger. Performance claims are usually preceded by events that give the surety a chance to respond.  A “Cure Notice” may be sent by the obligee alerting the contractor and surety that a deficiency exists and if left uncorrected, a bond claim may result.  Another event preceding claim is the declaration of default by the obligee.  (The contractor is thrown off the project.) This would be a major event and all interested parties would receive notification.

If the surety cannot help remediate the performance problem and a claim results, the unpaid portion of the contract amount is a financial resource that always helps the surety in addition to potential recovery via the General Indemnity Agreement.

The Payment Bond is actually the most common source of bond claims. There may be disputes about the performance of subcontract work or materials supplied.  Unjustified claims will be declined and for valid claims, the contract funds and Indemnity Agreement are resources for the surety.  Even though they have claim frequency, Payment Bonds are not the Greatest Danger.

So that leaves the lowly Bid Bond.  Some think of them as just incidental, like ordering a Builders Risk policy.  Their dollar amounts are smaller than Performance Bonds.  They are issued for free or for a small service charge.  Once produced, they are quickly forgotten like they were hardly valuable in the first place.  Nothing glamorous here.  But what are the dangers with Bid Bonds?

The first unique thing is that you get once chance to issue them correctly. On competitively bid work, such as government projects, the bid bond accompanies contractor’s proposal.  The bids are stamped for date and time when submitted, and if your proposal is late, it is rejected!  The bids are opened and examined by the contract administrators.  The bid bond and accompanying proposal can be rejected for technical errors such as the wrong project number, missing signatures, or any other details.  On the other hand, mistakes on Performance Bonds can normally be corrected without penalty.  The contractor already has the project, so there is no harm in allowing the bond to be adjusted. With bid bonds in a competitive situation, there is no chance to make a correction – the other bidders will not allow it! A bid protest or lawsuit would likely result.

In addition to accuracy and timely delivery, bid bond documents can result in a rejection if mishandled.  For example, the failure to use a mandatory bid bond form or the absence of a Surety Consent could result in proposal rejection.

Proposal Rejection – let’s talk about that.  The surety or agent makes one of the errors we described, the bid bond is deemed insufficient, and the contractor’s proposal is rejected. On public work the bid results are normally published, so the client will know if their rejected proposal would have been the winning number, and they would have acquired the contract.

In addition to the embarrassment of making an error, the loss of revenues, and maybe losing a customer, here’s the worst part: There have been cases where the contractor sued the surety for lost profits – the profits they expected to acquire from the project.  This is a constant threat on Bid Bonds, and the indemnity agreement doesn’t help if the error was solely on the part of the surety or agent.  A lawsuit like this could be for millions of dollars.

 

Bid Bonds are the winners!  They are the Greatest Risk for sureties and the agents who execute them.  We have one chance to get them right.  They must be perfect every time.

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 #18: Private Owners

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This is a study in motivation.  “What’s in it for me?”  When it comes to Performance Bonds for Private Owners, you need to understand the odds and pick your spots carefully in order to maximize your effectivity.

Understand the Basics

A Private Owner is an entity that is not funded by public money.  If it was, we’d call it a Public Body.  Examples of Public Bodies include the federal government, your state, city or school district.

A Private Owner could be a company that is renovating their office building.  Another example would be any subcontract regardless of whether the overall project is public or private (Note: ALL subcontracts are Private Contracts).

There are some distinct differences between public and private work:

  • Legal Basis: Public bodies must comply with a variety of regulatory requirements and statutes.  Private contracts are made based on business decisions. They are governed by the Uniform Commercial Code and state common laws.
  • Funding: On Public work the source is known and presumed to be dependable.  On Private each situation is different.  It is possible that the Owner signing a contract may not have adequate funding in place to pay for the work.
  • Specifications and Bond Forms: With Public contracts this tends to be consistent and predictable.  Insurance and contractual requirements are standardized.  A 100% Performance and Payment Bond (P&P) typically is required.  The approach to the bond forms is known in advance.  For example, the federal government has their own mandatory bond forms.  With Private, the owner can make any requirements they want, including the use of mandatory, unique, bond forms or no bond at all.  (Review Secrets #7 for more insights on this subject)

Now we’ll talk about motivation.

  • The Insurance / Bond Agent: Wants to serve the client and earn a commission.
  • The Surety: Wants to earn the bond fee or premium.
  • Contractor: Wants to acquire the contract and maximize their profits.
  • Owner: Wants the work performed correctly by a capable contractor for the lowest reasonable price.

Picking your spots on Private Contracts

Our point of view is obviously that of the Surety.  We have been an active writer of Subcontract Bonds and other Private Contracts for many years and here’s what we’ve learned.  Private owners know that the first service the surety provides is pre-qualifying the contractor for the work.  The surety wants to avoid a loss so there is an extensive review of all the contractors’ capabilities.  If there are weaknesses or a likelihood of failure, the surety will refuse to support the project.  So a P&P bond is like the Good Housekeeping Seal of Approval for a contractor.  The Private Owner knows that a bonded contractor has been thoroughly checked out.

Now bear in mind that the bond cost is included in the contract.  The Private Owner that requires a bond, pays the bond cost in the contract amount.  Since the bond may be optional on a private contract, some owners use the surety to screen the contractor, but then they do not actually pay to bond the project.

The losers in such cases are the surety and the agent as well as the Private Owner.  The surety and agent performed services and incurred expenses – but then don’t get paid. If there is any kind of problem on the project, failing to obtain a P&P bond could cost the Owner dearly. Bonds are an effective and economical way to prevent significant problems down the road.

Bottom line: When private contract specifications do not indicate a MANDATORY P&P bond requirement, agents should be cautioned that the bond could be waived. It is true that there is no substitute for actually having a bond in place  (guarantees good workmanship and materials, on time completion, no cost overruns, no liens against the property).  But for some private owners, the chance to save a few dollars is irresistible – even if it means engaging the surety’s services under false pretenses.

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 #14: Financial Statements – Timing

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When it comes to financial statements, no news is bad news.  Let’s talk about the timely delivery of annual financial statements.

Many construction companies have a 12/31 fiscal year-end (FYE).  This means their most important Financial Statement (FS) are based on this date each year.

By the end of March, bond underwriters and bankers are expecting to see the financial statements for the FYE.  90 days after the date is normally the time allowed for this info.  Beginning on April 1st (or 90 after the FYE, whenever that is), the contractor enters the tap dancing zone.

Q. “When will we see the 12/31 FS?”

A. “There is a slight delay due to…” (choose one)

  • My CPA was ill and got a late start
  • Our software crashed and it delayed the accounting process
  • The dog ate it

While it’s true there are outside or uncontrollable factors, sometimes contractors intentionally hold back the info.  One example we’re seen involves loan covenants.  The company may have fallen out of compliance with their lender and now is attempting to obtain a waiver from the bank.  Having such a waiver will enable the CPA to comment that the FYE non-compliance has been resolved.  That sounds a lot better!

Here is the downside: We have seen construction clients hold back the FS for 10 months in some cases.  Obviously the delay itself can become an even bigger problem.  At some point underwriters say to themselves “If the FS was good, the contractor would want us to see it…”

So the point is that timely financial reporting is beneficial to bonds and banking.  It shows that the company is well organized and professional.  There is no hiding from the financials.  If there are issues, prepare an intelligent explanation,  describe the corrective actions management is taking and provide projections for the current year.

Producing financial info on time is as important as the numbers themselves!

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 #12: This is NOT a Payment Bond!

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Post #11 was about Payment Bonds – how they work and who they help.  Let go one step deeper. We will go over a Payment Bond situation that is presented to our underwriting department at least once a year, so it’s worth mentioning.

The Situation: A Prime Contractor or Subcontractor has a project that includes a major vendor. It could be an electrical contractor buying expensive switchgear from a supplier.  In this example the project is NOT bonded.

The supplier has no prior experience with the contractor so they want their purchase order (PO) covered with a Payment Bond. When you are asked to provide it, you immediately reply “Secrets of Bonding #12 tells me this is NOT a Payment bond!”

Let’s see why not, and how you can help your client.

In a normal contract surety Performance & Payment Bond scenario, the bond makes reference to a contract in which the Principal (bond applicant) is being PAID to do work.  If the principal fails in their obligation, the Surety steps in and is PAID the remainder of the contract funds to complete the obligation.

So, if a bond is written on a PO, which way is the money flowing?  In this instance, the principal (electrical contractor) is PAYING money, not receiving.

If the surety bonds the PO and then has a claim, it could only be for the contractor’s failure to pay the supplier. This bond has a single purpose, to guarantee the principals ability to pay money at a future date.  Therefore it is considered a Financial Guarantee, not a typical Payment Bond. This is a much less desirable obligation for the surety because the money is flowing the opposite direction.  Unlike contract surety, in the event of default there is no money coming in (the remainder of the contract price) to enable the surety to deal with the claim.  In fact, many sureties are reluctant to provide such bonds other than in nominal amounts for well-established clients (i.e. Wage and Welfare bonds).

A possible solution: Remember, this is an unbonded contract.   If there was a P&P bond in place, the purpose of the Payment bond would be to protect vendors such as the switchgear provider.  So one solution could be to issue a P&P bond for the electrical contractor even though none was originally required.  The Performance side of the obligation is not needed; however the Payment Bond would be furnished to the supplier to satisfy their concerns.  It will not name them specifically, but protecting them is clearly the purpose of the instrument.

In this manner you can turn an abnormal situation into a typical P&P bond, the kind underwriters like.  Added benefit: the Payment Bond will be for the entire contract amount – which is for more than the switchgear.  This gives some added comfort to the supplier.

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

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

First Indemnity of America Ins. Co.

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Secrets of Bonding #11: Payment Bonds

Steve GoliaLeave a comment

You’ve heard of “Performance and Payment.” In this article let’s discuss the Payment part because this obligation affects more people and is the most frequent area of claim for sureties.

The old fashioned name for these is a “Labor and Materialmen’s Payment Bond.”  The name says it all: These bonds guarantee that suppliers of labor and material will receive their proper payment. We know labor and material suppliers want to be paid, but why are these bonds required on public work and other contracts?

Why Obligees Require Payment Bonds

Scenario: A company is building a new office facility and hires a general contractor.  The GC then hires a paving subcontractor to put in the parking lot.  If the paver is not properly paid, they may be entitled to file a Mechanics Lien against the property.  He can’t take back his labor and paving material, so the court allows the lien to be filed to protect his interests until there is a legal resolution.

The problem with liens is that the company may have paid the GC properly. It could be the GCs fault that the paver isn’t paid, yet the company is being penalized.  With the lien in place, the company no longer has a clear title. If they want to sell the property, they may have to pay the paver directly even though they already paid the GC!  The payment bond is a source of financial recovery for the paver so there is no need to file the lien and therefore it protects the interests of the obligee as well.

Who Are Payment Bond Claimants?

As the name says, potential claimants are “suppliers of labor and material.”  Other parties that have a direct interest in the contract are also included.

Let’s use our GC and paver situation as an example.  The GC obtains the Performance and Payment Bond.  The paver is a subcontractor to the GC and would be entitled to make a bond claim. The paver’s asphalt supplier is directly supplying materials and can also make a claim.

If the paver hires a striping contract to mark up the parking lot, they are covered. However the paint supplier to the striping contractor is not, legally they are too far removed from the prime contract.  They are working for the sub-subcontractor and are three steps down.  Here’s the flow:

  1. Owner
  2. GC (Prime contractor with owner)
  3. Paver (Subcontractor)
  4. Striping contractor (Sub-subcontractor)
  5. Paint supplier (supplier to Sub-subcontractor)

Remember that the payment bond does not protect parties that are more than two steps down.

Other key points needed for a valid claim:

  • To be covered, materials must have actually gone into the project, not just be delivered to the site.
  • There is a time limit for after which claims cannot be filed.
  • The form and proof of claim must be correct.

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

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

First Indemnity of America Ins. Co.

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