site bond

174. When You Can’t Get a Bid Bond

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Bid specifications often provide alternative forms of security to accompany the contractor’s proposal. Cash, a Certified Check, or a Bid Bond may be permitted.

Let’s take a look at the implications of each and when to use them, or not!

First, a quick primer on bids:

When contractors submit a proposal on bonded public work, bid security is normally required. The security assures the bidders sincerity: They will accept the contract if offered or pay a penalty for walking away.

Typically, the specifications require a Performance and Payment Bond or other form of acceptable security equal to the contract amount.

About the forms of bid security

1) Cash is King, but not when it comes to bid security. Bid security amounts are usually thousands of dollars so this method is not realistic for many contractors.

2) Certified Checks are similar to cash. This means the contractor must estimate the maximum proposal amount and arrange for a check payable to the obligee. Initially, the bid bond percentage is known but not the bid dollar amount. The specifications require security ranging from 5-20% of the proposal amount. However the actual proposal amount is often not compiled until close to bid time when all the vendor prices have been received and negotiated. To use a check, the contractor must estimate an amount sufficiently high so it is adequate to cover the bid figure when it is finally known.

3) Bid Bond issued by the surety. The advantage is that the bidder’s money is not tied up (as compared to cash or a check). As a precaution on public work, obligees hold the bid security of the second and third bidders until the contract is awarded – which could take weeks. This means the contractor’s cash or check could be tied up and the likelihood is that they will not win the project.

Looking at these options, a bid bond is the preferred choice. However, a bid bond is not always available when needed. When this happens, the bidder may consider an alternative.

Normally there is no requirement to use a bid bond specifically. The bidder also has the latitude to use one surety for the bid bond and a different one for the P&P bond (although some sureties dislike following another’s bid bond.)

Why would a bid bond not be available?

1. The contractor does not have a surety.

2. Short notice: Not enough time for the surety to make an underwriting decision.

3. Short notice 2: The surety has approved the bid bond but there is not enough time to issue.

4. Bid bond declination: The surety considered the project but will not support it.

5. Bid bond declination 2: The surety wants to support the project but they are unable to due to their lack of credentials, their insufficient capacity, licensing issues, or other problems on the surety’s part.

6. When contractors are changing bonding agents or sureties, there could be a gap in service where the new surety is not ready.

In all these cases, the contractor can decide to bid with cash or a check. However, there may be a downside to consider. Let’s look at each of the six scenarios described above.

Risks of bidding with cash or a check

1. No surety: The contractor could forfeit the bid security if they are awarded the project but are unable to produce the P&P bond.

2. Short notice: The risk here is the same as #1. Forfeiture could be the result if no P&P bond can be arranged within the timetable allowed.

3. Short notice 2: This is one situation where the check may be a reasonable alternative assuming the surety has provided a written approval to bond the contract.

4. Bid bond declination: This is a particularly troubling situation because the effort to arrange a Performance Bond faces two obstacles:

  • Time: Contract awards demand the issuance of the P&P bond by a specified date. There could be insufficient time to set up a new surety relationship.
  • The new surety, which hardly knows the contractor, is being asked to bond a project the incumbent surety declined. The incumbent was willing to lose the account over this project. Can the new underwriters be confident they are making a better decision than those who know the account well?

5. Bid bond declination 2: This example isn’t as onerous as #4. The problem is that the surety wants to bond the project but can’t. The new underwriters will be less hesitant than in #4. (So why don’t they just issue a bid bond to help the client get to the next step with another surety? See answer below.) If cash or a check is used, a surety must be arranged to prevent forfeiture.

6. Changing sureties: Handle the same as the short notice situations.

Conclusion

While it’s true bidding with cash or a check is usually an option, it places the contractors funds at risk. Contractors should not consider using cash or a check unless the availability of the P&P bond is confirmed in writing.

Answer to #5: The surety would not want to issue the bid bond if they can’t provide the performance bond, which is the main product of the surety operation. Second reason, if no performance bond is arranged by the client, the bid bond could go into claim. There is little for the surety to gain in this situation.

Note to agents, contractors and other readers: We are not offering legal advice and do not assume to have covered all possible situations in this article. Every bonded contractor should have a good surety attorney to handle such matters.

Want this expertise and creativity on your next Bid or Performance Bond? FIA Surety is a NJ based bonding company that can help! We have specialized in Bid, Performance, Site and Subdivision Bonds since 1979.

Steve Golia is Marketing Manager for FIA Surety.  Call Steve now: 856-304-7348

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180. Completion, Performance, Site, Subdivision Bonds: What’s the DIF?!

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Po’boy, hoagie, grinder, heroe, sub: You get the idea. Different names for the same thing. 

So what about these surety bond names?  Over the years I’ve heard them all used for the same transaction. But are they really the same?  No, No, Nooooooooo!  We will explain.

“Who’s” on first: (brief definitions)

Principal – party whose actions are the subject of the bond

Obligee – is the party protected by the bond

Surety – is the bonding company providing the guarantee

  • Performance Bonds: Issued in connection with a contract that is referenced in the bond.  Guarantees that the principal will complete the project on time and in compliance with all written conditions.  The obligee is the beneficiary of the bond and is the “project owner” of the contract (they are hiring the contractor and paying for the work).  The obligee could be a public or private entity. A Dual Obligee Rider could add parties with a financial interest – such as the construction lender. They would share in the bond amount in the event of a claim.
  • Completion Bonds: Issued in connection with a construction loan. These are issued directly to the construction lender and protect the loan.  The lender is not a party to the construction contract.
  • Another version is a Movie Completion Bond for the film industry – guarantees that the new movie gets produced and “in the can.”
  • Site Bonds: Issued in connection with a specific lot.  Could be a business owner modifying the company property, parking lot, driveways, etc.  The public body with jurisdiction over the job site is the beneficiary (obligee.) The bond promises that “public improvements” required by the planning board will be built at the principal’s (property owner’s) expense.  Such work is not paid for by the township.  The township is not party to a construction contract. The principal pays for the work out of pocket, or though a construction loan.
  • Subdivision: This is the same as a site bond, although on a larger scale. The difference is that it involves multiple sites all covered under one bond.  The bond promises that “public improvements” required by the planning board will be built at the principal’s (the land owner / developer’s) expense.  These improvements are later deeded over to the township – such as streets, curbs, lighting, water and sewer lines, etc. These bonds do not concern the building of homes or buildings. The guaranteed work is not paid for by the township.

It’s no surprise that folks use these terms interchangeably.  They all involve the contractor’s performance, but with a slightly different purpose.

You can assume all bond people know these differences.  But can you assume all bonding companies provide these bonds?  No, no,  nooooo!

Developers are the applicants for subdivision bonds, but any business can require a site bond. You need to know that FIA Surety is a leading provider of Site and Subdivision bonds. We write them and we’re good at it!

Next time you need a site, subdivision or performance bond, give us a call.

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

FIA Surety

Secrets of Bonding #160: Deep in the Weeds with Set Aside Letters

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In this article we will peel back the onion on Set Aside Letters (SAL) issued by banks in connection with construction loans.  What are they, when they are useful for bonding companies and when are they not?

Here is the essence of such documents:

“The agreement covering the project will provide that the funds in said impound account are … to be disbursed for payment of the (Name of Project) mentioned above and only after (Bank) has satisfied itself that the work paid for has actually been performed… In the event (Borrower) fails to complete the project described herein… all funds remaining in said impound account shall be immediately available to Surety to complete and pay the costs of said project, and in such event, (Borrower) waives any claim or interest in the remaining funds. Surety shall not in any way be obligated to repay said funds so used to (Bank).

This is an irrevocable commitment of funds which is not subject to recall or offset by (Bank).”

Pretty interesting!  This letter / agreement keeps the loan in play to fund the completion of the project  – even if the borrower (bank customer) fails / defaults.

When Are Set Aside Letters Used?

These documents are a common underwriting tool when a Site or Subdivision Bond is issued by a surety. If the bond applicant (who is also the developer and borrower) is relying on a construction loan to fund the bonded work, the SAL protects the surety by providing funds for the completion of the work in the event of a default.

What a great idea.  So why don’t we use these on everything?  Let’s look at another example.

Commercial Projects

The project owner hires a bonded contractor and a bank loan will fund the project.  The bank needs a guarantee that the asset / project (which backs the loan) will be built as intended.  A Performance and Payment Bond accomplishes this and assures there will be no Mechanics Liens against the property for unpaid bills.  These two aspects benefit the project owner and the lender.  Keep in mind, in a borrower default situation, the bank becomes the new owner of the property.

It is common for the bank to stipulate that a bonded contractor be used, and they may want to be a named beneficiary on the P&P bond – accomplished by issuing a Dual Obligee Rider.  In turn, should the underwriter require a SAL from the lender?

On Commercial projects, the normal practice is to NOT obtain a SAL from the lender.  Why not?  Why is this different?

Choose one:

a. The bank is a secured lender

b. The bank can subrogate against the borrower’s assets

c. The Dual Obligee Rider serves a purpose similar to the SAL

a. and b. are true, but the answer is c.

Welcome to the Weeds

We’re going in now. The Dual Obligee Rider adds the lender as a beneficiary with all the rights and obligations of the obligee named on the bond (the project owner).  And what are they?  Obviously they are entitled to make a performance claim and have the project delivered as indicated in the contract.

The named obligee also has obligations, one of the most primary is to PAY the builder. Important: The obligee is prohibited from making a performance claim if they have failed to pay the contractor.

Therefore, when the bank is included under a Dual Obligee Rider, they accept the benefits and obligations.  If the borrower defaults, the lender cannot make a bond claim unless they continue to pay the construction loan to the surety.  (Now the bank owns the project and the surety has become the contractor.)

Summary

Is this starting to make sense?  When a borrower defaults on a commercial project, a lender included by Dual Obligee Rider cannot make a claim unless they continue to pay the project funds to the surety.

Deeper Weeds

On Site and Subdivision there is a unique risk – the lender can take a free ride on the surety by having the bonding company pay out of pocket to complete the project.

Site and Sub-D bonds have the local municipality as obligee, not the bank.  The bank doesn’t want a Dual Obligee Rider because they automatically receive a financial benefit if the municipality makes a bond claim to demand completion of the project.  If the borrower has defaulted, the bank has the opportunity to withhold the balance of the loan (the borrower is gone), and watch the surety pay to complete a project they now own.  And they were not even the bond claimant…

This is the risk sureties avoid on Site and Subdivision Bonds by requiring the SAL that keeps the loan in play, even if the bond applicant / borrower has failed.

Admittedly, this is a pretty obscure subject, but also interesting to us “bond nerds.”  It never hurts to understand how things fit together.  These skills help us solve your complicated bond opportunities.  Take advantage of our expertise when the next one pops up.

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 #152: I’m SO confused…

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We recently had a long conversation regarding “Completion Bonds.” Think you know what they are?  We couldn’t agree on it!

  • Is a Performance Bond a Completion Bond? They do guarantee that a project will be completed. 
  • Is a Completion Bond required when a surety has a defaulted contract and they hire a completion contractor to finish the job? 
  • Are Completion Bonds required by lenders to assure that projects with construction loans are completed? 

Here are a few more confusing bond things:  

  • Working Capital does means the same as Net Quick: It is a measure of a company’s short term financial strength.
  • Net Worth is the same as Equity: What’s left over if the company sells everything and shuts down.
  • Sales = Revenues: The money a company takes in during a certain period of time.
  • Net Profit = Net Income: The after tax earnings of a company.
  • Under Billings = Costs and Estimated Earnings in Excess of Billings. A measure of the extent to which the contractor’s billings are not concurrent with (less than) the degree of job completion.
  • Over Billings = Billings in Excess of Costs and Estimated Earning. This measures the portion of the billings that are more than the % of completion.
  • Back Bond = Subcontract Bond: A Performance Bond given “back” by a subcontractor to the general contractor in support of their subcontract.
  • Site Bond = Subdivision: Subdivision projects are bigger and involve multi-unit housing. Bond guarantees the construction of “public improvements.”
  • Funds Control = Funds Administration = Escrow:  A professional paymaster handles all the money and pays the bills on a contract.  They pay everyone, including the contractor.
  • Retainage = Hold Back:  A % of contract funds held (retained) by the project owner or Funds Administrator to assure completion of the final contract details.  Then the money is released to the contractor.
  • Completion Bonds are technically called “Film Production Completion Bonds.” They guarantee a  Movie Producer’s work in financing / creating a film and getting it “in the can.”
  • FIA Surety = Your Bond Problem Solver: Our experts have been solving surety bond problems since 1970. We’ve seen it all (and know how to fix it.)  

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

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

First Indemnity of America Ins. Co.

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

Secrets of Bonding #151: It’s Time For…Timing!

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With Surety Bonds, Timing can be critically important.  There are certain things that must happen first.  You can’t get them out of order. Here are some examples.  Do you know which comes first, and why?

Cover the answers with a piece of paper as you scroll down. (Paper is white stuff people used to write on. Really!)

  1. Bid Bond / Performance Bond
    • OK that was an easy one. They get harder. Bid bonds always come first – if there is one.  Not all performance bonds are preceded by a bid bond. Negotiated projects would be an example.
  2. Bond execution / Indemnity Agreement execution
    • The Indemnity always comes before the bond. It is the promise to pay back the surety in the event of a claim / loss. Sureties want this protection in place before they assume any risk.
  3. Surety Consent to Final Payment / Obligee Status Inquiry Form
    • The Status Inquiry form comes first. It is the obligees statement that the work is acceptable.  The surety requires to see this before agreeing to release the final payment.  If there are unresolved issues, the contractor must address them before the last contract funds come over. (That’s true motivation!)
  4. Payment Bond Release (exoneration) / End of Lien Period
    • Since the bond guarantees the payments that may be owed during the lien period, the time for liens must end before the bond is concluded.
  5. Contract Acceptance / Maintenance Bond Issuance
    • Sureties want the contract accepted first and the P&P bond released before assuming the risk associated with a Maintenance bond. Some obligees require issuance of the maintenance bond simultaneously with the P&P bond at the start of the project, but underwriters resist this.
  6. Bid Results / P&P Bond Issuance
    • Underwriters want to evaluate the adequacy of the contract price prior to bond issuance. They do this by evaluating the bid results, comparing the various proposals from different companies.  In some cases, the bid results are not published, in which case they have wing it!
  7. P&P Bond for Started Project / All Right Letter
    • The All Right letter is the obligee’s assurance that there is not already a problem on the contract that will result in an immediate bond claim. Sureties require a clean bill of health before bonding a started project (unless the degree of completion is very low i.e. 5%).
  8. Award Letter / Notice to Proceed
    • Award letter comes first, then the contract signing and Notice to Proceed is issued. Then “Grab ya hamma!”
  9. Tough Bond Problem / Call FIA Surety!  856-304-7348
    • You can call us for discussion or general info any time. However, when a tough bond problem arises, that’s your cue to call in the experts. 

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 #145: “You Can’t Fit Ten Pounds of S…” (Covering Contract Additions)

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You know that old expression about jamming in too much. It’s true, and it applies to Surety Bonding like everything else.  “You can’t fit ten pounds of “STUFF” in a five pound bag.”

Check this out:

“Here’s what we’ll do: We will issue a $500,000 contract and bond it.  Then, once the surety is on board, we’ll issue an addendum for an additional $500,000.  The surety will automatically cover it and we’ll have the $1 million bond we couldn’t get in the first place!”

Would that actually work?  Yes, often it could because many P&P bonds state that they will automatically cover increases in the contract amount.

The surety finds themselves bonding a contract larger than originally intended – perhaps well beyond their comfort level. Sound underhanded?  It could be and it happens in multi-million dollar amounts. 

This scenario can also come up inadvertently – in an innocent way.  The contract has a large increase and the bond gets pulled along.  Either way, the underwriter is holding an obligation far in excess of their intended approval amount.

It’s the sureties own fault for allowing this to happen, right?  Uh, no! When underwriters caught onto this practice, they added a bond condition stating that increases of more than a certain percentage (i.e. 10%) require the prior written consent of the surety. No more free ride.  No more 5 pound bag.  If the contract is increased in violation of this condition, the bond can be invalidated.  That’s a big deal.

So you can’t jam a ten million dollar contract into a five million dollar bond, but is there a legitimate approach?  One that does not violate the relationship with the underwriter?  Yes!

One option is to issue a phased contract. The $10 million project has “Phase One” for $5 million, and a $5 million  P&P bond is issued.  When the work is completed and accepted by the obligee, the bond is rolled forward to the next phase.  In this manner, the bond is never worth more than $5 million, but it covers every part of a $10 million contract – just not all at the same time.

This method enables the principal (contractor) to stretch their capacity on a contract larger than the surety normally would provide.  The obligee still gets a project that is 100% covered: win / win / win!

Another idea would be to issue multiple contracts (if suitable) and bond them sequentially. This technique can be used when the nature of work is such that it can be logically divided, such as multiple buildings. A separate bond is issued for each contract.

Conclusion

Bonding companies intend to automatically cover minor increases in the contract amount.  But when a big addition is considered, they are entitled to exercise discretion over their exposure.

With open communications, there can be solutions where larger projects are bonded without risking failure to comply with the bond conditions.

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 #122: Don’t Sign That Lien Release!

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WAIVER OF LIEN BY CONTRACTOR, SUBCONTRACTOR(S) AND SUPPLIER

We, the undersigned, acknowledge receipt of the amounts stated below as full payment for all labor, professional services, materials, or equipment furnished for use on or about the property of…”

In construction, lien releases are common. Project owners expect their general contractor to execute them. GCs demand them from their subcontractors and suppliers. They are part of the routine. If you want to get paid, you sign it. But when should you not sign it? Let’s look at what a lien release does, and when you should be cautious about executing.

The Purpose of Lien Releases
Typically, a lien release is required in connection with a monetary payment. It comes up in any of these situations:

  • Monthly payment made from project owner to the general contractor
  • Monthly payment from GC to a sub or suppliers
  • Final contract payments to any of these

The lien release enables the accounting to transition from one billing cycle to the next. It is a form of receipt that protects the Payor by acknowleging that the Payee has received funds – they relinquish the right to claim they were not paid.

danger-aheadNormally, when contractors and suppliers are unpaid, they can file a lien (a security interest) against the title of the physical property. With such a lien in place, the property cannot be sold.  The lien release / waiver gives up the right to file such a lien and possibly other legal remedies as well.

Lien releases come in two basic flavors, and it is very important to recognize the difference between them.

The Good One: Conditional

“THIS DOCUMENT WAIVES THE CLAIMANT’S LIEN, STOP PAYMENT NOTICE, AND PAYMENT BOND RIGHTS EFFECTIVE ON RECEIPT OF PAYMENT. A PERSON SHOULD NOT RELY ON THIS DOCUMENT UNLESS SATISFIED THAT THE CLAIMANT HAS RECEIVED PAYMENT.”

A release / waiver is Conditional if it waives rights once a condition (usually the receipt of payment) occurs. An example of conditional language is:

“Upon the receipt of $____, Subcontractor hereby waives and releases its lien and bond rights for labor and materials through _________ (date).”

Unless the waiver states otherwise, the conditional waiver is not effective until the condition, such as payment, occurs.

Also note, this wording includes a condition regarding time which protects the claimant’s lien rights arising in the next billing period.

The Bad One: Unconditionalcaution-proceed-carefully-md

“THIS DOCUMENT WAIVES AND RELEASES LIEN, STOP PAYMENT NOTICE, AND PAYMENT BOND RIGHTS UNCONDITIONALLY AND STATES THAT YOU HAVE BEEN PAID FOR GIVING UP THOSE RIGHTS. THIS DOCUMENT IS ENFORCEABLE AGAINST YOU IF YOU SIGN IT, EVEN IF YOU HAVE NOT BEEN PAID. IF YOU HAVE NOT BEEN PAID, USE A CONDITIONAL WAIVER AND RELEASE FORM.”

Actually it is only bad if the claimant has not yet been paid. Then it would be inadvisable to provide an unconditional release. The claimant will have no recourse if they do not receive their payment, and they will also relinquish their ability to claim against the Payment Bond.

Conclusion
The Conditional Lien Release includes conditions and wording that protects the claimant’s interests.

The Unconditional Release can be detrimental if executed unintentionally or under inappropriate circumstances.

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 #121: Are Court Bonds Like Fruit?

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produce_manMostly we issue site, subdivision and contract surety bonds (Performance & Payment).  However, we are also an important provider of Court and Probate bonds.  We issued a number of interesting court bonds recently so here is some info on this subject.

What Are Court Bonds Are Why Are They Needed?

Generally, court bonds serve three purposes.

  1. They provide required protection for the other party in the litigation (opposite the bond applicant)
  2. They guarantee the payment of related court costs
  3. The court likes them

An Injunction Bond is a good example.  In these legal actions one party wants to limit or prevent the actions of another.  An insurance agency may request an injunction to prevent a former salesman from soliciting their clients.  The court requires the plaintiff (insurance agency) to provide a bond for the protection of the defendant (salesman) in the event it is found that (s)he has been wrongfully restrained.

A Replevin Bond is similar.  These are required when the plaintiff (a bank) wants to seize an asset (your private jet) for failure to pay your finance charges.  The bond will protect you if it is later found they wrongfully seized “Wings Over Yonkers.”  See how these work?  In different situations the bonds provide the same type of function.  The name of the bond identifies the underlying legal action.

Why Do Courts Like Them?

You may think “what’s not to like?!” That’s true. But the court may require a surety bond for a practical reason.  If the litigation involves a financial matter, they could require that an escrow deposit be placed with the court for the benefit of the other party. They would hold this money until the case is decided.

This works, but is not convenient.  Where will the funds be held?  Who is responsible for their safekeeping?  Will there be periodic accounting if the case runs for years?  Who pays the expenses associated with this?  What if the money is misplaced or stolen? 

Compare this to a surety bond: Get the bond, throw it in the folder. Done!

cherriesEven though the court may have the option to take cash in lieu of bond, they may demand the issuance of a surety bond simply for its convenience.

Other Court Bonds

When a money judgment is rendered, the defendant may want the matter heard by the Appellant Court. Let’s say Maynard sued Dobie for money and wins a $10,000 judgment.  Maynard figures “Ok here comes 10 big ones!”  However, Dobie wants to dispute the decision so now Maynard has to wait.

In order to bring the Appeal, Dobie must obtain an Appeal Bond which protects the interests of the court and guarantees prompt payment if Dobie loses again.  To get this bond, he’ll have to give his personal financial statement, his indemnity, and put up maybe $11,000 for the surety to hold.  Oh, and pay the bond premium!  Why is all this necessary?

Bond underwriters know that most defendants lose at the Appellate level.  They also know that the court will simply claim on the bond to pay off the judgement.  This means that underwriters expect full penalty claims on defendant’s appeal bonds – which is why they normally require full collateral for the judgment amount plus interest and expenses.nanners

Conclusion

Hopefully it is apparent that there is a thread of similarity between these different types of court bonds.  This can make it easier to understand them when tey are needed.

Oh, so why are court bonds like fruit?  Because they have appeal!

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 #73: Substitute Bid Bonds

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substitute teacher

Remember how much fun it was to have a substitute teacher? Well, this is a little less exciting…

In Secret #49 we talked about bidding with a check.  This is a related topic. Substitute bid bonds are an odd part of what we do as surety professionals.  Here’s how you may run into one.

It is common for project specifications to offer a number of methods to provide the bid security that accompanies a contractors project proposal.  The options may include a check made out to the obligee, or a bid bond.

A substitute bid bond may be issued after bid security has already been given with the contractor’s proposal.  This bid bond will replace, or be substituted for the existing security – thus the name.

This may arise when the contractor has no surety at the time of the bid.  They bid with a check.  Now, with a surety in place, their first request is “How about helping us get our cash back?  It’s tied up with that bid.”

What a great way to start off by helping the new client. However, sureties are not always in favor of issuing these, and some refuse to do so under any circumstances.  Why?!

1. Bid Spread: In this case, the contractor is the low bidder, but they are too low. (Read Secret #16 to learn about unacceptable bid spreads.) The contractor may be in line for the project, but the surety does not want to issue the performance bond (aka final bond).  If the bonding company provides the substitute bid bond, they become obligated to issue the final bond or face a bid bond claim (two bad options!) “Sorry, we are not able to provide a substitute bid bond for that project.”

The fallout is that the contractor may blame the surety when they lose their bid security for failing to deliver the final bond. They will also lose the expected income from the project – pretty ugly.

2. Final Bond Optional: The specs may indicate that a Performance & Payment bond is not mandatory. It is optional at the obligee’s discretion. This amounts to adverse selection against the surety.  If the obligee thinks the contractor looks capable: No bond.  If there is some doubt about their ability to perform or the adequacy of the price, better pass the risk over to the bonding company.

For this reason, substitute bid bonds may be declined if a final bond is not mandatory.  Remember, final bonds are where sureties make their money.  Bid bonds are usually free.  The contractor will not lose anything as a result of the refusal to issue the substitute and they are already eligible to win the contract.

3. Not Low Bidder: This is similar to Number 2. Here the contractor is second or third bidder. The common practice is for obligees to hold the bid security of the second and third bidders in case they need to give them the project (maybe the low bidder can’t get their final bond issued?) The bid checks could be held for months!

From the surety’s perspective there is no question about the adequacy of the second or third bidder’s number.  This may be a well-priced contract. The problem is that they are unlikely to issue a final bond.  (Projects are rarely awarded to the second or third bidders.) This has even less chance of making money for them than a normal bid bond request.

To the contractor, a substitute bid bond may seem like a great idea. For the surety, the only desirable situation is when their client is low bidder with an acceptable bid spread and a mandatory final bond. Absent that, don’t be surprised if the surety only wants to get involved after the contract award takes place and the final bond is needed.

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Secrets of Bonding #62: ILOC: What is it? What isn’t it?

Steve GoliaLeave a comment

Sample #1

IRREVOCABLE LETTER-OF-CREDIT
Wisconsin Department of Transportation
Motor Carrier Services – IRP Unit
P.O. Box 7955
Madison, WI 53707-7955

We hereby establish our irrevocable letter of credit in your favor for ACCOUNT NAME, in an amount not to exceed $00.00.
All checks written by ACCOUNT NAME payable to Registration Fee Trust, (Wisconsin Department of Transportation) for the remaining registration fees will be honored by BANK NAME up to the irrevocable credit limit.

If ACCOUNT NAME fails to make payments to the Wisconsin Department of Transportation when due, the BANK NAME will allow the Department of Transportation to draw on the Irrevocable Letter of Credit up to the credit limit, provided the BANK NAME receives written documentation from the Wisconsin Department of Transportation stating registration fees have not been paid when due.

This IRREVOCABLE LETTER OF CREDIT expires: _______, ______, ______

Sample #2

CITY OF FREDERICK
IRREVOCABLE LETTER OF CREDIT
Date of Issue: _____ Date of Expiry: _____ Issue Number: __________

Beneficiary:
The City of Frederick
c/o DPW Projects Division
Attention Linda Dutrow
111 Airport Drive East
Frederick, Maryland 21701

Gentlemen,
We hereby authorize you to draw on us for account of (name)____________ at (address) ______, up to an aggregate amount of $ _____ (_____) dollars and _ cents) US Dollars, available by your drafts at sight accompanied by a signed statement that the funds are being drawn and required for payment in accordance with an executed Public Works Agreement between the City of Frederick and the party named in this paragraph for (project description) _________________.

Drafts must be drawn and negotiated not later than ______ at our counters. Partial drawings are permitted.

Each draft must state that it is drawn under the Irrevocable Letter of Credit of (name of issuing bank) _____________ Number _____________ dated _______. This Letter of Credit is not transferable or assignable without written consent of (name of issuing bank) ___________________________.

This credit is subject to the “Uniform Customs and Practice for Documentary Credits” (1994, or latest revision) International Chamber of Commerce, Brochure Number 500.

It is a condition of this Letter of Credit that it shall be deemed automatically extended without amendment for one (1) year from the present or any future expiration date of this Letter of Credit unless at least forty-five (45) days prior to such expiration date we notify you by certified mail that we elect not to consider this Letter of Credit renewed for such additional period.

We hereby agree that all drafts drawn under and within the terms and amount of this credit and accompanied by the documents above specified, that such drafts will be duly honored upon presentation to the drawee.

These are two examples of ILOCs. Let’s find out about these, and why they look so different.

“ILOC” stands for Irrevocable Letter or Credit. They may also be called a Standby Letter of Credit. These instruments are only issued by Commercial Banks. The purpose is to enable one party to draw on the account of another in connection with a business transaction. If the beneficiary makes a draft (draw) upon the ILOC, the bank records it as a loan to the account holder who is the subject of the letter (the contractor in a construction scenario). The beneficiary is not required to repay the bank.

A perfect example is the overseas practice to use an ILOC in the same manner we normally use a Performance and Payment Bond in support of a contract. The contract owner is entitled to draw on the ILOC in the event of the principal’s default.

The two examples above are actual suggested formats from those beneficiaries. The Wisconsin DOT is unusual because of its brevity. The City of Fredrick form is more typical of what you may see, particularly if using an ILOC to give collateral to a surety.

What are the important elements missing in the DOT form?

If the duration of the related business transaction is longer than the term of the ILOC, the beneficiary normally demands an “evergreen clause” which provides for automatic renewal. It means if no action is taken prior to anniversary, the instrument does not expire. This gives the beneficiary confidence that they will be formally notified prior to anniversary that the bank intends to non-renew, and they will have sufficient time to draw down (cash out) the entire ILOC so they remain protected.

It is also normal for the instrument to allow partial draws, and require the return of drawn funds that are ultimately unused.

It is important for the document to correctly state the party whose actions are the subject of the guarantee (the principal) and the circumstances under which a draw can be made should be standard.

Beneficiaries of these instruments must scrutinize the financial condition of the issuing bank. In cases where the FDIC rescues a banking institution, they have the ability to unilaterally nullify these instruments to aide in the bank rehabilitation. For bonding companies, this means they can lose their collateral even though they remain “irrevocably” obligated on the P&P bond. Check the bank strength here: http://www.fitchratings.com

Summary
We have covered what an ILOC is, the key aspects and what to look for.

What isn’t it?

For Obligees (the beneficiary of the bond) it may not be a good alternative to a Performance and Payment bond.

1. The bank does not pre-qualify the contractor’s ability to perform the work the way a surety does.
2. In the event of default, the project owner (obligee) must assess the contract status, arrange for a completion contractor and manage the process to a successful conclusion. With a bond, the surety may do all this.
3. An ILOC does not prevent liens against the project or provide the process to resolve them.

Owners may accept an Irrevocable Letter of Credit as an alternative to a surety bond. However, the fact remains that an ILOC does not match the comprehensive protection of a Performance and Payment Bond.

What about for Contractors and Developers?

  1. Bonds are not easy to get.  The contractor must pass a rigorous evaluation by the surety.  Bonded contractors and developers can promote the fact that they have the support of a surety: Bragging Rights!  Many include this info in their brochure along with their banking credentials.
  2. Having cash tied up for indeterminate time periods can put a strain on construction companies.  They need it to finance the start of new contracts and solve problems on existing ones.  Developers may lose out on opportunities to acquire new projects or property.  Reminder: Projects may be completed / released later than expected, meaning the cash remains tied up for how long?

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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