surety

Secret #88: Ten Biggest Lies in Surety Bonding

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Here are the ten biggest lies in surety bonding:

  1. “The surety is your partner and we are all in this together.”

OK and I have a bridge in Brooklyn to sell you. This is true until there’s a claim or loss and then the surety is entitled to seek recovery for their loss. After all, they are a “for-profit” company that must answer to its stockholders.  They are not in business to lose money.

In cases where collateral has been required by the surety, it will not be used to help the contractor finish the project. It is used to help the surety perform the work with the replacement contractor in the event of default.

  1. “Dividing the project into multiple contracts will make it easier to bond.” pants_on_fire

This falls into the “smoke and mirrors” category.  If it’s one big job for the client, then it’s still one big job.  Experienced underwriters will recognize the true nature of the undertaking and support the client straight up if they deserve it (one contract and bond).

  1. “Slicing up the contract into phases will make it easier to cover with multiple bonds.”

Most sureties will resist this, since it is still one contract.  Their reinsurance treaties probably will not support such an approach (referred to as “stacking”).

  1. “We are requiring a 50% performance bond to save the contractors bonding capacity.”

Misplaced good intentions: Bond underwriters evaluate the contract amounts, not bond amounts.

  1. “We stipulated a 50% bond to save money.”

Too bad it doesn’t work that way. Typically the bond cost is based on the contract amount.  So you pay the normal price, but you get a bond for half as much.  Cool!

  1. “The job specifications indicate that a performance and payment bond may be required at the owners discretion and a bondability letter must accompany the proposal.”

Ughhh!  May be a time waster.  This smells like a GC who wants the subs “certified” by the surety for free.

  1. “A private owner requires a 100% Performance and Payment Bond equal to the contract amount.”

In some instances, upon receipt of the bond, they send it back, waive the bonding requirement and allow the work to proceed.  Another misuse of the surety’s services. If there is a performance issue or unpaid bill, who gets the last laugh?

  1. “The client will provide full corporate and personal indemnity.”

In order to get the bond, the client willingly signed an indemnity agreement outlining the handling of the premium and enumerating their obligations to protect the surety from loss. Now that they landed the project, some clients attempt to change the deal / ignore the agreement.

The nature of suretyship requires that underwriters rely on the good character of their clients.  Sometimes such trust is undeserved.

  1. “All company owners must give their indemnity.”

The real truth is that most, but not all do.  Typical exceptions: ESOP and publicly owned companies, low % owners, foreign / overseas owners, pre-nuptial agreements, non-transfer of asset agreements, high % collateral cases, well-heeled companies.

  1. “You got turned down for a bond, because you don’t deserve one.”

Well, often this is just not true.  In our experience, most contractors who are willing to place their own assets at risk to perform a lump sum contract, are worthy of a bond.

The problem may be the agent or the underwriter, not the applicant.  Since 1979 we have specialized in succeeding on contractors bonds even when others have failed.

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.

Secret #84: Manage the Bid Bond Account

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For many contractors and their agents, the main thing they want to know about Bid Bonds is that they have them when needed.  However, the successful management of the bid bond account requires controlling a number of elements. Let’s review them.

The bid bond facility consists of a single and aggregate limit. The “Single” is the maximum size project that can be bonded (without a special exception), and the “Aggregate” is the maximum combined exposure on the bond account at any given time.

It is important to note that the single limit refers to the project amount not the penal sum (dollar value) of the bid bond. If a contractor is bidding a $500,000 federal project with the 20% bid bond requirement, the amount of capacity involved is $500,000, not the bid bond amount which would be $100,000 (.2 x 500,000 = 100,000).  The underwriting decision is always based on the contract amount.

Bear in mind, the bonding company does not want to know the actual bid amount prior to the bid opening. When requesting a bid bond, the underwriter is given the approximate bid / contract amount in order to preserve the bid confidentiality.

Let’s stay with the $500,000 example. If the contractor’s bid calculation is actually $485,000, it would be appropriate to round up and make the bond request for $500,000. If the actual bid calculation is $510,000, again, it should be rounded up to allow for last-minute increases. A bid bond request for $525,000 or more would be advisable.

While it is true that the penal sum of the bid bond, if expressed as a “percentage of the attached bid,” will automatically adjust up or down to the actual bid amount, a problem arises if the bonding company issues a “capped” bid bond.  This means it cannot adjust upward beyond the amount stated on the approved bond request. If a capped bid bond is used, the contractor will invalidate the bond, and their proposal, if the bid exceeds the amount approved by the surety.

maestro1. The first rule in managing the bid bond account is to request the bond for an amount sufficiently high to accommodate last-minute increases.  This avoids the temptation to bid above the approved amount – a practice that is damaging to the surety relationship.

2. The second important guideline concerns the aggregate capacity.  The aggregate calculation is made on a daily basis and includes the incomplete portion of open projects, jobs signed but not started, awarded projects, low bids, plus undecided bids. As a result, a portion of the available aggregate will be unnecessarily consumed if bid estimates are rounded up unnecessarily high. In our example, if the contractor calculated a $510,000 bid and requested approval for $600,000, they may needlessly consume capacity that could have remained available to support another bid.

3. Another point, submit the bond request early enough to allow time for discussion and processing.  Usually a couple of days is needed.

In conclusion, when requesting bid bonds, round up the estimated contract amount to allow for last-minute increases, but remember to preserve aggregate capacity for future bids.

Allow sufficient time for processing and keep in mind, to the decision makers, it is not “just a bid 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.

Secret #82: Who’s On First? Understand Surety Bonding Terms

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The world of surety bonding may seem mysterious and complex. Let’s face it, it’s not like insurance. It’s actually more similar to banking. No wonder the subject is not well understood by the very people who need to know.

abbott-and-costelloIn this article we will cover some of the basics such as who the parties are and what they do so the subject does not seem so foreign.

Who is the “insured”?  The insured is the party buying insurance. Therefore, in bonding there is no insured, instead there is a “principal.”  This is the party whose actions the bond concerns.   If a construction company needs a bond, it is the principal, the bond applicant.

The intermediary who assists the contractor may be a bond producer, a bonding agent, or an insurance agent. In every case, the person is licensed by the state to process surety bond transactions.

The firm the agent works for is called an insurance agency or bonding agency. This entity provides the channel between the principal (bond applicant) and the surety, the bonding company, the provider of the bond and party holding the risk.

In the world of bonding, the term “company” is used to describe the bonding company. The agent and the agency would not be referred to as “the company” even if the name of the firm was the ABC Local Insurance Company Inc.

A reference to “the paper” relates to the bonding company.  “Whose paper is the agency using?” means “Who is the bonding company?”

Since the bonding company holds the exposure on the bond, it is their employee who makes the decision to approve or decline it.  This person is called a surety underwriter or bond underwriter.

It is true that insurance agencies may employ individuals with underwriting expertise, and their title may be “underwriter.” They may even have some decision-making authority that has been delegated to them by the bonding company (referred to as “having the pen.”)  But the fact remains that the the bonding company is responsible for the underwriting decisions.

When a contractor is asked “Who is your bonding company?” sometimes they give the name of their bonding agency. Now you know the difference!

Other areas of confusion: The owner of the construction company is not the applicant for bid and performance bonds. In the eyes of the surety, the construction company is the primary applicant because that is the name on the bonds.  The underwriting process is primarily focused on the company, its history and capabilities. The personal factors surrounding the business owner are considered secondarily.

We cannot overstate the importance of our bonding agent. The agent plays a critical role in gathering, shaping, and presenting the file for review by the underwriter – and they guide the process forward as bonds are needed. 

OK, now it’s time for one of our famous Pop Quizzes!  Choose the most appropriate word in each case:

  1. When Elmer the contractor realized he would need a bond, he got right on the phone and called his (Principal / Agent).
  2. Morty the underwriter had a few more questions and sent them to the (Surety / Bond Producer).
  3. The (Surety / Bonding Agency) was not willing to hold any additional risk on the account.
  4. Surety bonds (are / are not) insurance policies.
  5. LaFawnduh, the (Underwriter / Agent), knew it was time to arrange for a new surety.
  6. Thor, the Bonding Specialist, only used quality (Pens / Paper).

7. Bonus Question (Extra credit!): When all else failed, Moonbeam knew it was time to file a bond claim with the (Carrier / Insured).

Answers:

  1. Agent
  2. Bond Producer
  3. Surety
  4. are not
  5. Agent
  6. Paper
  7. Carrier

FIA is a bonding company (carrier) that has served contractors and their agents since 1979.  We are flexible and creative surety bond experts.  Call us for Bid and Performance Bonds.

Call us for Site and Subdivision Bonds – our specialty!

Steve Golia, Marketing Mgr.  856-304-7348

FIA Surety / First Indemnity of America Insurance Company, Morris Plains, NJ

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Secret #80: Substitute Final Bonds

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Secret # 22 covered the bonding of started projects.  Secret # 73 is about Substitute Bid Bonds. In this article we will look at cases where the contract was already secured with a surety or cash bond, but a new bond is under consideration.

Consider a number of scenarios:

  1. We are currently working on a case where a client put up full collateral (cash bond) because they did not have a bonding relationship. They contacted us to provide a surety bond that will enable them to recover their cash.
  2. A bonded project could unexpectedly require a replacement bond if the original is nullified by legal or administrative action. (This has happened!)
  3. Similarly, an otherwise valid bond may be deemed unacceptable if the surety’s A. M. Best rating drops below the obligee’s requirement.
  4. We have seen cases where a contractor wishes to voluntarily replace a bond because their new surety offers significantly better terms. (Only advantageous under certain circumstances, such as? Answer below. *)

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These are all legitimate reasons to issue a performance and payment bond on a project that is underway – and already bonded. So how does the underwriter approach these opportunities?  How can the contractor and agent prepare for this process?

The first question for the underwriters is whether they are subjected to adverse selection.  There could be physical or financial problems on the project that make a bond claim likely.  A thorough investigation will ensue.

Assuming there is no adverse selection, the underwriter’s first task is to determine the status of the project.

  1. How far along is the work?
  2. Has it been performed correctly and to the obligee’s satisfaction?
  3. Is the contractor up to date paying for labor and materials?
  4. Is the job on schedule?
  5. Does the project owner know of any disputes, delays or problems of any kind?

Will the obligee go on record stating that so far, everything is OK? The underwriter will require such a letter in order to proceed.

Typically, when the new bond is issued, it will cover the entire project back to inception.  If the original contract is the subject of the new bond, it will cover the entire dollar amount of the project including the completed portion.  As a result, the contractor may have to pay two bond fees.

The only way to avoid this is to draw up a new contract for just the remaining work.  In most cases, this is not an option.

It may seem that bonding a partially completed project is attractive. After all, part of the risk has been eliminated! In reality, due to the fact that all aspects of the completed work are guaranteed by the new bond including the prior materials and workmanship, the new underwriter faces nearly the entire risk.

When you add the possibility that the underwriter may be subjected to adverse selection, most sureties are cautious when issuing a substitute final bond.

* The timing must be right. If the purpose of filing a replacement bond is to pay a lower bond fee, the greatest advantage is at the beginning of the contract when a full refund may be provided by the incumbent carrier.

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 #73: Substitute Bid Bonds

Steve GoliaLeave a comment

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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FIA Surety is your go-to market for Site & Subdivision bonds.

FIA Surety / First Indemnity of America Insurance Company
2740 Rt. 10 West, Suite 205
Morris Plains, NJ 07950
Office: 973-541-3417
Visit us: www.fiasurety.com
We are currently licensed in: NJ, PA, DE, MD, VA, NC, SC, WV, TN,  FL, GA, AL, OK, TX

Secrets of Bonding #72: Surety Consents 1, 2, 3.

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Sorry OCD, we are starting with Consent #3!

#3: Surety Consent to Release of Final Payment

This may be one of the final steps in the life of a bonded contract. The obligee (party protected by the bond) may give the surety the opportunity of providing a “consent to release final payment” before the last money is paid out.

 It is common for contractors to be paid on a monthly basis.  When it is time for the final payment, it may be the obligee’s last opportunity to influence the contractor to resolve deficiencies in the work product.  The contractor may be more likely to make corrections before the last money is paid out than after.  Un-resolved problems can eventually become bond claims.

 The bonding company should determine if the obligee is satisfied with the work (Status Inquiry form) before issuing the consent. In this manner, they may spur the contractor to action and  eliminate a potential bond claim.

 This procedure benefits the obligee in two ways:

  1. The surety will require responsiveness to the obligees reasonable performance demands before consenting to the payment
  2. It reduces the surety’s ability to refuse a future bond claim on the basis that funds were improperly released by the obligee

View sample: http://74.218.115.26/wp-content/uploads/2010/07/4D-AIA-CONSENT-OF-SURETY-FINAL-PAYMENT.pdf

 #2 Consent to Release / Reduce Retainage

This is similar to the Final Payment, but it can occur during the life of the contract.

The obligee may ask the surety for consent to release or reduce the retainage funds.  This money is a portion of each monthly payment (called a requisition) that is held back (retained) by the obligee.  For example, in a contract with a 10% retainage, the obligee will pay $9,000 on a monthly requisition for $10,000.  The retainage is accumulated in the hands of the obligee and used as motivation to assure acceptability of the work as the project concludes.

The retainage percentage may also be reduced during the contract.  There could be 10% retained during the first half of the project, then 0% for the balance.  This enables the obligee to gather some protective money in the early stages, while allowing the contractor to have better cash flow toward the end. View sample: http://www.state.nj.us/treasury/dpmc/Assets/Files/Contractor%20Award%20Doucuments/DPMC-20r(1),%20Consent%20of%20Surety%20to%20Reduction%20in%20Retainage.pdf

Now we come to #1.  Why did we cover these in reverse?

#1 Surety Consent to Issue Final Bond

This consent, which concerns the Final or Performance bond,  is commonly used on all public construction contracts in NJ, and may be used by obligees on private work anywhere (such as a GC soliciting for subcontractors).  View sample: http://www.njsbga.org/yelbook_sec_c-all.pdf

We saved this one for last, because without it, there is no contract!

Important points:

  1. If required in the bidding specifications, the contractors proposal could be rejected for failure to include a consent or if the document is defective.
  2. The surety may issue a “capped consent.” It includes a condition that voids the surety’s obligation above a stipulated amount: “…however, such contract/performance bond amount shall in no event exceed $___.” This language protects the surety from having to support a contract higher than the approved amount. If the contractor does bid above the approved figure, it is likely the bid will be rejected by the obligee based on such language. The contractor must be mindful of this limitation.
  3. Sureties do not automatically issue these consents. They must be specifically requested when ordering the bid bond.
  4. Bonding companies issue this form of consent reluctantly. It deprives them of the discretion to not issue the performance bond if the contractor’s condition has deteriorated, or if there is an unacceptable bid spread. (Read Secret #16: Bid Spreads)
  5. The consent does not require that the same surety be used for the bid and performance bonds. However, if the bid surety balks on the final bond, the contractor and obligee may remind them they are obligated to provide it.

Consents of Surety: They are one more intricate piece in the surety puzzle.

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 #69: Actual, Consequential and Liquidated Damages. Wazzat?

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You may encounter these legal terms when handling construction contracts and surety bonds. Bid and performance bond request forms typically ask about “Liquidated Damages.” Does this refer to marine contracts?

A typical Performance Bond form may not mention liquidated damages – whether they are covered or excluded. So why does the bond request ask for this detail?

Let’s start by identifying the parties involved:

  • The contractor that applies for the bond is the principal. They would be the defendant in a lawsuit relating to the bond.
  • The owner of the contract, the party protected by the bond, is the obligee. In that lawsuit, the obligee would be the plaintiff, bringing suit against the bond principal and surety.
  • The third party to all such transactions is the bonding company or surety.

Bonded contracts can be between the project owner and a general contractor (GC), or between the GC and a subcontractor (sub). We mention this because sometimes the problems and claims “trickle down” from contract to contract and then onto the bond.

What does a Performance Bond Cover?

The bond language is specific. But remember, it is a guarantee of the contract it references. Construction contracts typically DO establish liability for contract delays, unanticipated increased expenses and other financial losses that may be attributable to the contractor’s actions or inactions. It is through the contract language that the surety becomes responsible for such losses. For this reason, damages are always an issue for bond underwriters. Let’s learn enough about them to be dangerous.

Liquidated Damages (also referred to as ascertained damages) are damages whose amount the parties designate during the formation of the contract for the injured party to collect as compensation upon a specific breach (such as late performance). Such penalties for failure to complete on time can amount to thousands of dollars per day and thus may deter a surety from supporting the contract.

It is not uncommon for general contractors (GC) to pass down the Liquidated Damage penalty in their contract, to the subs below them. The concern is that the subcontractor’s lack of performance could jeopardize the timely completion of the entire project.

When parties contract for liquidated damages to be paid, the clause will be enforceable if it involves a genuine attempt to quantify a loss in advance and is a good faith estimate of economic loss.

Actual Damages In a breach of contract case the prevailing plaintiff may be entitled to actual, or compensatory, damages.

Actual damages can be split into direct and consequential damages.

  • Direct damagesresult naturally from the defendant’s wrongful conduct. The defendant will have foreseen the damages would result from the breach. The benefit of the bargain that is directly and strictly tied to the contract is a measure of direct damages.
  • Consequential damagesresult naturally but not necessarily from the defendant’s wrongful conduct. Consequential damages must be foreseeable and directly traceable to the breach of contract. Lost profits, lost sales, incidental damages and most other damages are consequential damages.
  • Consequential damages (also sometimes referred to as indirect or special damages) may be recovered if it is determined such damages were reasonably foreseeable or “within the contemplation of the parties” at the time of contract formation. This is a factual determination that could lead to the contractor’s liability for an enormous loss. For example, the cost to complete unfinished work on time may pale in comparison to the loss of operating revenue an owner might claim as a result of late completion.

It is important to note that the definition of what the bond covers is only limited by the imagination of the presiding court. Certainly it is true that the interpretation of bond coverage has expanded the exposure of sureties. Here are some examples of losses courts have determined are covered by performance bonds:

  1. Municipal Bond Interest
  2. Loss of Use of Building Site
  3. Interest on Construction Loan
  4. Loss of Rents
  5. Liquidated Damage
  6. Lost Profits
  7. Loan Interest
  8. Delay Damages
  9. Lost Rental Income
  10. Unemployment Insurance Taxes
  11. Prevailing Wage and Overtime Violation Penalties
  12. State and Federal Taxes
  13. Lost Equity Delay Damages
  14. Over payment
  15. Loan Repayment

In conclusion, we must keep in mind that the surety’s obligation is defined by the bond and the contract.

Does the surety have the opportunity to review the upcoming contract when considering the bid bond? It would be unusual if they did! This is why the underwriting questions are so important.

We all know contracts can vary, but bonds can vary too. It is imprudent to make assumptions in this area. Read the bond and read the contract. If necessary, ask for a written legal interpretation.

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

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

First Indemnity of America Ins. Co.

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Secrets of Bonding #55: (2 of 4) Work In Process Schedules – Own Them!

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Finding the Degree of Completion

When analyzing the financial condition of construction companies, the Work in Process schedule is always a required item.

Much of this evaluation keys into the degree or percentage of completion of each project. When you read a WIP schedule there may be no column heading for this number, but it is easy to calculate. Noteworthy: There are some inaccurate ways to determine this percentage, so you will want to figure it yourself in any event.

Formula to find the % of Completion:
Divide the Costs Incurred to Date into the Total Costs to Complete. The percentage of the total costs that have been incurred so far is the degree of completion for that project. If the Total Costs to Complete are not shown, you may need to add the Costs Incurred to Date to the Remaining Costs in order to find the Total Costs. The degree of completion is based on a cost analysis because until you incur your last cost, you are not finished – regardless of the status of the billings.bookkeeper2

Common misconceptions about the % of completion:

1. The % of completion is based on the degree of Billings. (No, it is based on an analysis of the costs.)
2. It is always based on the original contract amount. (No, the Current Revised contract amount is used if a plus or minus change occurred.)
3. It is based on the original estimate of total costs. (Incorrect, the Current Revised Estimate of Total Costs is always used.)

With all this in mind, what is the degree of completion on this contract?

Contract Price / Original % GP /      Billed    / Costs to Date / Remaining Costs
$1,100,000     /          10%          /$550,000 /  $350,000     /    $700,000

Raise your hand if you got 50%.

OK, that’s wrong… The typical short WIP schedule doesn’t show everything. It may not give you the Current Estimate of TOTAL Costs. First, you must find that.

So $350,000 + $700,000 = $1,050,000 Current Estimate of Total Costs

350,000 / 1,050,000 = .333 or 33.3% Did I hear someone say “Why didn’t I pay more attention in math class?!”

So the project is 33% complete based on the portion of the total costs that have been incurred so far.

Knowing the percentage of completion is important for a number of reasons. From a project management viewpoint, it is normal for the contractor to establish a projected timetable to assure on-time completion of the project. By periodically reviewing the degree of completion, the project manager can confirm they are on track. There may be financial rewards for early completion or a punishment, “liquidated damages,” if they’re late.

There are other important uses for the % of completion. We’ll go over them in the next segment… with the haunting title: “3 of 4!”

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 #54: (1 of 4) Work In Process Schedules – Own Them!

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Short Form WIP Schedules 

In the next few articles we will explore a somewhat complicated and often misunderstood element of the contractors file, the Work In Process or “WIP” schedule (also known as Work On Hand “WOH”).

Why is the WIP schedule important?

bookkeeper1

For Contractors
The WIP schedule is a critically important project management tool, or at least it should be.Contractors use this info to increase revenues and profits.
For Sureties
Underwriters use this form to manage the account and help avoid claims and losses.
For Agents
As the intermediary, the agent must appreciate both points of view and be the facilitator who creates the “win-win” strategy.

Before we explore the details of this subject, let’s review some of the key terms that are used.  For the purpose of this article, we are focusing on a “Short Form WIP schedule.”  There is a long version of the document (more columns of info) that may be too complicated for many contractors to complete without professional assistance.  Since you are likely to see the short form, that’s what we’ll discuss.

The following terms commonly appear on WIP schedules and on company financial statements.  There is a row of column headings across the top.  Download a blank form: FIA Surety WIP Sched. Let’s go over them:

  • Project Name: This is the name of each individual contract
  • Start Date: Date the contract commenced
  • Original/Revised Completion Date: This is the completion date required in the contract, or as subsequently changed by contract amendment.
  • On Time Completion Expected?
  • Bonded?
  • Current/Revised Contract Price: It is not uncommon for the contract price to be changed after the work has commenced.
  • Original Gross Profit Percentage: This ties into the performance bond request form.  In order to facilitate analysis of the contract going forward, this number must be expressed as a %, not a dollar amount.
  • Billed to Date (including retainage): This is the sum of all the amounts invoiced to the project owner (bond obligee) by the contractor.
  • Cost to Date (including approved change orders): These are labor and material costs incurred by the contractor in the performance of the project.  They are “direct costs” exclusively, and do not include any expenses considered Overhead.
  • Revised Remaining Costs to Complete: Current reevaluation of the project costs based on the current / revised contract price. This is a revised cost estimate for only the incomplete portion of the project.

From surety to surety, you will find slight variations in the column headings on a Short Form WIP.  For a more complete analysis, additional columns are needed.  When viewing a WIP schedule prepared by a CPA, you may see the longer version which we will discuss later in this series.

An Analytic Tool

Let’s talk about the nature of this document.  Like all businesses, construction companies are in business to generate revenues and produce a “bottom line” profit for the company owners (meaning after all expenses have been paid).

Construction companies engage in individual contracts or projects, and are paid periodically during the progression of the work.

These payments are normally monthly and are a result of an invoice, or “monthly requisition,” the contractor gives to the project owner for work completed in the preceding period. When the requisition is owed or outstanding, it is an asset on the Balance Sheet called accounts receivable (meaning it is billed but the funds have not come in.)  The dollars become part of revenues or sales (top line of Profit and Loss Statement) when the dollars are received.

The construction industry is highly competitive and often contractors must bid to acquire projects, and only win them if their prices are the lowest.  This means for many contractors, margins are thin.

From a management perspective, construction companies must know if their projects are proceeding as expected.  They need to monitor the progress to assure that the work goes as planned and yields the profit expected.  Contractors must be vigilant to protect the success of the project, and avoid unprofitable contracts that drain funds from the company. The WIP schedule is the document that shows the current status of all open (incomplete) contracts, including their past and future projected financial results.

Keep in mind that financial statements (FSs) of a construction company may be prepared on one or two set dates every year (such as 12/31 and 6/30, etc.,) but they  perform contracts all year – meaning that on 12/31, some projects are partially incomplete.  In order for the financial presentation to include everything worth knowing, there must be a way to show these open jobs. That is the relevance of the WIP schedule for bond underwriters and other grantors of credit.

In number 2 of this series we will go over some of the info that is revealed on the short form WIP schedule.  You’ll agree, this document is absolutely essential!

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 #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.