underwriting

Secrets of Bonding #148: The Greatest Impediment to Bonding

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Surety bonds are hard to get. Contractors and their insurance agents know that underwriters are conservative. They ask lots of questions. Then they ask more questions. Then they say they can’t help you. It’s a fun-filled process.

Some contractors can’t get bonded because they have a poor credit history. Others have weak or insufficient financial statements. There are plenty of reasons for an unhappy ending, but what is the single biggest reason – and what can you do about it?

Crappy credit: This is a very common problem. The company may be struggling to get enough work, resulting in a weak credit report. So they decide to move into public work for additional revenues – but the bad credit report makes this impossible. Sometimes the report can be improved by correcting errors and updating the info. This is not the greatest impediment contractors and their agents face.

Weak or insufficient financial statement: There are innumerable potential problems. No financial statement, only an internal statement, only a compilation, an interim FS, a net loss, no working capital – the pitfalls are endless! It’s not the biggest impediment though.

Unsavory circumstances: Excessive bid spreads, inadequate prior experience, bad bond forms, harsh contract terms, too much other work. They are all bad, but they are not the king.

The Greatest Impediment

Picture how the process starts. When the contractor decides to go after bonding, a list of information is requested. The underwriter wants business and personal financial statements. A current work in process schedule is needed. Prior tax returns, resumes of key people and a bank reference letter are desired.

The contractor wants to pursue this, but MAN, that’s a lot of stuff!

He has not needed to make company financial statements, so how to come up with them now?

The company owner never needed to make a resume, always been self-employed. How do I write that up?

The WIP schedule: I don’t have that info available. I know where I am on all my jobs. Why would I take the time to fill out a bunch of forms anyway?

I can get the bank reference letter completed and make copies of prior tax returns (they want the WHOLE THING?!) But if I do that, who’s gonna do the estimating so we don’t run out of work? And I have to visit the projects or everything will grind to a halt. The workers want to milk every job like it’s their last. They’ll suck the profits out of everything if I give them the chance.

Conclusion 

The greatest impediment is the applicant themselves! In my 40+ years of surety bond underwriting, I have concluded that MOST contractors deserve to be bonded, but many fail to acquire surety support. It is because they stop trying, or never really start.

People must make choices. They have to put bread on the table. If they can succeed by doing what they know, why try some experiment that may fail? Sometimes it’s just easier to keep doing the same thing – even if you are discontent.

Our observation is that bonding takes perseverance and patience. It is a journey, a path with unexpected twists. There can be obstacles, but we have solutions! If contractors or agents expect it to be fast and easy… they may be disappointed.

Applicants for bonding must plan to devote some time and energy to achieve a goal they know is worthy. It says a lot to have a surety backing you. They are vouching for your ability, and putting up their own money to prove it. It’s a big deal and not always easy, but always worth it in the end.

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 #147: Surety Challenge Question “If It Quacks Like a Duck…”

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Up for a challenge?  Here is the scenario:

A Performance and Payment Bond has been approved on a project. The lender (funding the contract) is requiring it.

There is a discussion regarding the procedures that will be used to control disbursement of the contract funds – they are extensive.

A licensed architect is being used and they will oversee the processing of each monthly payment to the contractor.  To protect the lenders interests, they will not only review the paperwork that is submitted (called a Pay Requisition), they will also conduct a physical inspection of the site.  The point of this is to assure that the contractor is only paid for work actually in place.

If approved by the architect, the pay requisition then goes to the lender for their review and handling.  Finally, the money is paid to the general contractor (GC) who then pays subcontractors and suppliers.

The GC has additional controls in place.  They monitor the status of all their subcontractors and suppliers.  Each month lien releases are obtained which is a guarantee that all the people downstream are being properly paid.  This step prevents future claims against the contractor, project owner or surety for non-payment.

Everything is checked and double checked. Each month these controls assure that the funds are handled properly. 

So here is the Surety Challenge Question:

The bond underwriter has required “Funds Control” as a condition of the bond approval. Do the multiple procedures we described satisfy this requirement?  If it quacks like a duck, is it a duck?

Answer: No!

It seems hard to believe, because no one would deny those controls are all good – and highly beneficial. But actually there is a missing piece we must add to have true “funds control.” It comes at the end of the money handling, the disbursement.

From a surety viewpoint, the funds administrator must be the Paymaster for the contract. It pays everyone, including the general contractor.  The problem with our example scenario is that the GC is paying all the subs and suppliers.  This is just what the surety does not want.

True “funds control” aka “funds administration” gives the underwriter confidence that the money will stay in the project and not get diverted to the contractor’s other work.  It also prevents claims against the Payment Bond by assuring that suppliers of labor and material are paid properly and timely.

Funds Control is a specialized process conducted by a party separate from the surety company. When utilized, applicants must be prepared to pay an additional fee for these “back room” services, and follow the required procedures for prompt money handling each month.

Learn the difference between Funds Control and Tripartite Agreements: Click!

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: 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 #146: Financial Statement Sniff Test

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Here is a list of my business and accounting courses in college:

  1. _______
  2. _______
  3. _______

I was an Education Major (teaching), so I didn’t get anything on financial statements “FSs”.  When I started as a surety bond underwriting trainee, I realized that I had no idea what a Balance Sheet was – but I learned. 

If your first reaction when you look a FS is “Duh,” we will fix that right now.  Keep reading! This will be a view from 30,000 feet.  Big picture but it will help.

To be complete, every financial statement must include at the minimum:

  • Balance Sheet
  • Profit and Loss Statement

The Balance Sheet

This document is a one-day snap shot of the funds in the company (Assets) and who owns them (Liabilities).  The assets and liabilities are equal “balance” because every dollar in the company is shown from two points of view: the Asset side and who owns it, the Liability side. 

The Balance Sheet has three important parts we can review initially.  Let’s identify them based on their functionality.

Current Assets: This line item is a subtotal found near the middle of the Asset column. It represents those assets readily convertible to cash within the coming fiscal year (such as Accounts Receivable).

Current Liabilities: Found near the middle of the Liabilities column, these are debts to be paid in the coming fiscal year (such as Accounts Payable).

Total Stockholders Equity, aka Net Worth: Usually the last subsection near the end of the Liabilities column. This is the company’s Net Worth that would remain if they shut down and liquidated everything.

The Profit and Loss Statement

This is a historical summary of all the money taken in (Sales aka Revenues) and money spent (Expenses) during the preceding period, usually one year. At the bottom of the column is the Net Profit, which is the money the company “made” for the year after paying all the related bills and taxes.

Now that you can pick out a couple of strategic numbers on any FS, what shall we do with them?

Calculate Working Capital

This is a primary measure of financial strength used by all analysts, including sureties, banks and other credit grantors.  It is found by subtracting the Current Liabilities from the Current Assets. It is an indicator of expected cash flow in the coming year. 

Here is a quick, simplified Sniff Test to use when considering a particular bid or performance bond.  The evaluation is made based on the expected contract (not bond) amount. This is an instant indication of the adequacy of the finances in regard to the upcoming project.

Part One – The Working Capital target amount is 15% of the contract amount.  For example, if the contract amount is $1,000,000, sureties hope to see Working Capital of at least $150,000.

Part Two – The Net Worth target amount is 20% of the contract amount or about $200,000 in our example.

Certainly there is more to surety underwriting than this simple analysis.  However, by using this method, you can get a quick idea of whether the financial statement easily supports the bond, or may be a stretch.  If your analysis reveals negative numbers, which are shown in parenthesis on financial reports, that’s obviously a bad sign.

Also keep in mind, applicants that do not meet these criteria may still qualify for bonds based on other factors – and the reverse is also true. Surety underwriting takes many factors into consideration.  In this article we are offering a very simplified version of the process although it is valid as a quick review. This procedure will enable you to make a fast financial evaluation, and relate it to the upcoming surety exposure.

Summary

This article doesn’t make you a bond underwriter, but now when you get a new FS instead of “Duh!” you can say “Let me analyze this!”

Running a quick analysis plus the Sniff Test will indicate the likelihood of obtaining surety support. You learned a lot in three minutes, but when you have a bond that fails the Sniff Test, that’s where our expertise and market access comes in.  Call us!

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 #143: Surety Bonds and Brain Surgery

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Your doctor says “You have a problem.  We need to call in a specialist.” How do you determine who to call? What do you expect from the specialist? The choice could not be more critical.

We are faced with important decisions every day.  And there are plenty of people trying to influence the outcome.  You need the skills to sort through the “BS” and make the choice that is most beneficial to you. 

Here is an example you have seen in many different forms:

“Our doctors have over 25 years experience”

What exactly does that mean?  You could select that firm and get a doctor with ONE year of experience.  They may have 25 doctors, each with one year in the saddle. Ugh, how misleading!

Another example:

“Dr. Mavromoustafakis has specialized in brain surgery since 1980.”

OK, Dr. Mavromoustafakis  has over 25 years experience as a brain surgeon.  See the difference?

Next question: Does the difference matter?

To answer that, think about why expert help was required.  If there is a special need, and an experienced, expert problem solver is desired, then… Yes! 

That’s how it works with brain surgery and also surety bonds.  Some situations are more complicated.  They require unique solutions and strategies.  The key may be to know a special underwriting technique, or procedure.  The surety business is all about people and their expertise. So your best problem solvers have many years under their belt and a deep understanding of the process.

Conclusion
Surety Bonds: They’re not brain surgery.  But when you need expert assistance, real experience does matter. Pick up the phone and take advantage of our long devotion to this one product. 

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 # 142: Make Bid Bonds Great Again!

Steve Golia1 Comment

You used to love them.  They were so easy.  Now they are in dollar amounts and percentages, sometimes with a limited maximum value.  They can be electronic or digital.  Sometimes a letter is required instead.  Sometimes nothing is required instead! There may be a single or annual charge for it or maybe it is free! It’s outta control…

So here is your chance to catch up with everybody’s favorite: The fun and fascinating world of Bid Bonds.

The Basics
These instruments accompany a contractor’s proposal during the acquisition process for a new project.  This is routine on public work, such as federal state and local municipal contracts.  The procedure may also be used on private projects at the contract owner’s discretion.

The bond guarantees that, if awarded, the bidder will sign the contract, furnish the required Performance and Payment Bond, and commence with the work – or – pay the difference between their bid and the next higher bidder (subject to the maximum dollar value of the bid bond.)

Cost
Usually free although the surety is entitled to charge for them.  Typical charges could be an annual bid bond service fee or a per bond charge.

Underwriting
The decision to issue the bid bond is based on the underwriter’s willingness to provide the related P&P bond, because that is the real money transaction. The decision is NOT based on the dollar value of the bid bond.  Rely on the fact that the underwriter will not provide the bid bond if they do not feel they can support the final bond.

Bid Spreads
If the bidder is more than 10% below the next bidder without a plausible explanation (we have a special machine,  already have materials, are already working next door, we’re super fabulous, etc.) the surety could decline the final bond, resulting in a bid bond claim.

Alternative Forms of Security
In addition to a bid bond, proposals may also be secured using a cashier’s check or irrevocable letter of credit, depending on what the project owner (Obligee) is willing to accept.

Percentages
The Invitation or Bid Solicitation describes the proposal requirements.  It will state if a bid bond is required and the amount.

The bond value is often expressed as a percentage. Example “20% of the attached proposal amount.”  This is convenient because the underwriter doesn’t want to know the actual bid amount (to preserve the bid confidentiality).  It is the best way to express the exactly correct amount when typing the bond in advance.

Capped
Because the percentage bond actually has an unknown dollar value at the moment it is executed, language is sometimes added establishing the most it can be worth (to prevent a wildly high amount the underwriter didn’t expect).  Example, “10% of the attached bid, not to exceed $100,000.”

Fixed Penalty
“Bond Penalty” is the term used to express the bond dollar value.  A fixed penalty bond has a stipulated amount, regardless of the bid.  Example, “Maximum bid bond amount required: $20,000.”

Surety Letter
Some owners choose to require a letter from the bonding company, but no bond. Federal projects are handled this way at times.  The letter talks about how much they love the client and the contracts they are willing to bond.

Consent of Surety
This letter is the surety’s written promise to issue the P&P bond if the contract is awarded.

Electronic
A scanned copy (pdf) of the executed bond may be acceptable for an online bid.

Digital
Some state departments of transportation use this.  The surety registers with the obligee in advance and the bid bond is “filed” online using a unique identification number.

No Free Lunch
If you default (cause a bond claim), the surety will come after the contractor, it’s owners and spouses for recovery.  Remember: Bonds are not insurance.

Funky Land
Now some of the weird stuff:

  • You may encounter a bid bond requirement, but no final bond (P&P bond) to follow
  • Can also have the opposite: No bid security required but a final bond is needed
  • No! You are not required to use the same surety for the bid and final bonds – although the bid bond provider fully expects to write the final bond and may hunt you down and kill you. (Just kidding!!!)
  • Yes! If you obtain a bid bond under the promise to provide collateral, you are allowed to get the final bond from a different surety that is not demanding collateral. (But you face the hunt and kill thing again)
  • When you acquire a project using a Consent provided by ABC Surety (their promise to provide the bond upon award of the contract), you are not prohibited from taking the final bond from XYZ Surety. However, good protocol dictates that you remain loyal to those who enabled you to acquire the job (meaning ABC).

Make Bid Bonds Great Again
So there you have it.  These instruments are fussy and sometimes complicated.  It is imperative that they be executed correctly and filed on time or it can cause the bid to be thrown out (loss of contract.)  This always makes people very crabby (Read as: LAWSUIT).

The key is to review the written bonding requirements as described in the bid advertisement. Use any mandatory bond forms that are stipulated and double check the correct execution and typing of the document including name spelling, job description, project identification details and the correct bid bond amount.

Now that you know, you can start to love bid bonds again!

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 # 141: Surety Bonds and Zombies

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Zombies are bad.  They eat your flesh and brains.  Who wants THAT?!

Same goes for your construction business.  There are zombies that can ruin your bonding and eat up your business – destroy profits and your credit rating.  But the worst part is… it’s preventable!   

Does the zombie have a name? Yes, accountants call it “Fixed Overhead.”  This is a controllable expense that, if left unattended, can eat your flesh and brains (figuratively.) Let’s define the monster:

Fixed Overhead – Construction companies incur common fixed overhead costs. These are costs that do not vary with the level of the company’s output such as: accounting fees, advertising, insurance, interest, legal fees, labor burden, rent, office expenses, salaries, repairs, supplies, taxes, telephone bills, travel expenditures, and utilities. 

Now consider Variable Overhead – These costs vary in proportion to the amount of production. Variable overhead mostly relates to hourly indirect labor costs, supplies and utilities such as electricity, gas and telecommunications expenses.

The danger of fixed overhead is that, during times of reduced volume / revenues, the expense does not automatically go down. This means when sales are weak, your expenses do not diminish proportionately.  These bills keep rolling in relentlessly.  They just don’t care!

The only hope construction managers have is to be cautious when incurring such expenses, and always work to reduce them so the company can survive the inevitable troughs that come between the peaks of activity.

Here are 40 ideas that may help reduce / eliminate fixed overhead:

  1. Lease-purchase options for vehicles and equipment
  2. Employ part-time mechanics and administrative staff
  3. Pay employees for use of their vehicles
  4. Keep equipment longer
  5. In unprofitable years, slow down depreciation schedule
  6. Overhaul facilities and equipment instead of purchasing new
  7. Review / quote insurance annually. Consider self-insurance or association captives. 
  8. Eliminate overlapping insurance coverages
  9. Improve safety program
  10. Examine Workers Compensation classifications
  11. Consider increasing deductibles
  12. Eliminate over insurance, such as reducing inventories
  13. Deactivate, de-register and uninsure unused vehicles
  14. Challenge property valuations (taxes)
  15. Avoid the expense of audited financial statements if possible
  16. Reduce accounting fees by assisting your CPA
  17. Consider using a local CPA rather than a national firm
  18. Lease unused space
  19. Consider a smaller building
  20. Consider high density stacking and storage systems
  21. Renegotiate rent or move
  22. Get indefinite lease with 6-month cancellation rather than fixed term
  23. Pay moderate salaries with bonuses for exceptional performance
  24. Reduce number of management staff
  25. Reward managers with stock instead of cash
  26. Trim fringe benefits (deferred compensation, automobiles, club memberships, etc.)
  27. Cut managers first
  28. Pay bonuses to field staff first
  29. Pay raises based on merit, not cost of living
  30. Cross train office staff to eliminate temporary employees
  31. No vacations during “busy season”
  32. When hiring, seek individuals whose employment qualifies for tax credits
  33. Four day work week
  34. Charge employees for replacement tools
  35. Put company ID on tools, keep records
  36. Centralize tool storage with check in / out system
  37. Close dormant companies
  38. Consider solar panels and solar water heat
  39. Monitor unemployment claims
  40. Consider an office maintenance service instead of employing a janitor, or use a part-time after hours person

Conclusion

Companies can achieve better financial performance, support their bonding and banking and survive the weak years by controlling these relentless expenses. 

Remember: You can’t kill a zombie because technically they’re already dead.  And you can’t entirely eliminate fixed overhead either – but good managers work to control it.

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.

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

Secrets of Bonding #135: Surety Bond Challenge Question!

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Our articles have covered some of the oddities of the surety world: Seemingly crazy bond forms and rating procedures.  Out of all of them, one is the strangest. An agent colleague called us on one this week, so let’s talk about this ugly baby.

Characteristics:

  • Inexpensive, but hard to get.  Often collateral for more than the bond amount plus full indemnity is required.
  • The bond penalty (dollar amount) may not be fixed.
  • Banks and insurance companies can be both the applicant and beneficiary of such bonds.
  • This bond “renews” for free – for years.
  • It is a surety bond that can have another bond as it’s subject.

Sounds pretty weird? Raise your hand if you know.

It is a Lost Instrument Bond.

So what do these do? No, you don’t get one when you can’t find your tuba.tuba

These bonds are required when an instrument such as a cashier’s check or stock certificate has been lost, and a replacement is desired.  The bond protects the interests of the issuer, and is subject to claim if both the original and the duplicate are cashed.  The bond applicant would be responsible for the financial loss – thus the common need for collateral.

The subject of the surety bond can be a government issued investment bond.  So this is the one surety bond that covers another bond!

Bonding companies are not fond of these because they make a one-time annual premium charge, but the bond must remain in effect for a statutory term, typically years (ugh!)

drummerUnderwriters may refuse to provide a bond immediately after the instrument is lost.  The concern is that the original may be found and the bond returned for a refund.  The surety may require a cooling off period to see if the original is located (90 days?)

Instruments with a changing dollar value, such as shares of stock, are covered with an Open Penalty bond.  This means the dollar value will automatically increase to cover the current value of the instrument, in the event of a claim. This is one more reason to make underwriters reluctant – and require more than 100% of the initial value in collateral.

Lost Instrument Bonds: The ugly babies of the surety world.  So now you know.  They aren’t ugly, they’re just “different!”

(BTW, the author thinks ALL babies are beautiful!)

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.

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

Secrets of Bonding #134: How to AVOID the T-List

Steve Golia1 Comment

cat-hiding-in-snowFamiliar with this?  “T-List” is the bond vernacular for the Treasury List or more formally: Circular 570. The document is produced annually and maintained by the Bureau of Fiscal Service, US Department of Treasury.  Why do some contractors want to avoid it?

Their web page says it is the Treasury’s “Listing of Certified Companies”  https://www.fiscal.treasury.gov/fsreports/ref/suretyBnd/c570_a-z.htm

The purpose of the list is to establish a pool of surety companies that the government finds acceptable to bond federal projects.  Having this group established in advance avoids the need for federal contracting officers to vet the bonding company during each contract award process.  It helps speed things up except for one problem: Not all bonding companies are on the list.

Why is this?  Does it mean they are not strong or ethical?  Does it mean their bonds are no good?  Not necessarily.

Remember, when it comes to corporate sureties, they are subject to state regulation even if they are not on the T-List. So not being on the list could mean:

  • The surety has applied for approval and is still being processed
  • They applied and were declined or deferred to a future date.
  • They have chosen to not apply to be on the list.

Point is – it does necessarily mean anything bad.

For some contractors, they may have a surety relationship in place, but when they go after a federal job, they learn that their surety is not T-Listed.  Must they avoid federal work or find a new surety that is on the approved list?

dog-hiding-in-a-drawerNo…. It turns out there are situations in which the federal government does not require a T-Listed surety.

For construction contracts from $35,000 to $150,000, the government can accept alternative methods of payment protection other than a surety bond. These are: 

  • Irrevocable Letter of Credit issued by a commercial bank
  • Tripartite Agreement managed by a federally insured bank
  • Certificate of Deposit
  • Deposit of acceptable securities (Reference F.A.R. section 28.102-1)

For work performed in a foreign country, the bond can be waived entirely if the contracting officer concludes it is impracticable for the contractor to provide a surety bond. (Reference F.A.R. section 28.102-1)

Individual Surety bonds are an alternative to corporate sureties and they are never on the T-List. (Reference F.A.R. section 28.201)

Other forms of security may be used such as

  • United States Bonds or notes
  • Certified or Cashier’s Checks
  • Bank Drafts
  • Money Orders
  • Currency
  • Irrevocable Letter of Credit

Conclusionhiding

Being T-Listed is not always mandatory for federal contracts, although it is in the majority of cases.  Nevertheless, it is interesting to note that there are a series of exceptions, and these are always in play.

Armed with this info, contractors can go after federal work while avoiding the need for a T-Listed surety, or (heaven forbid!) any surety at all.

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.

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

Secrets of Bonding # 131: Maintenance Bonds – Breezy Free & Easy

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Free surety bonds.  Is there anything better? Actually we can think of a couple of things right off BUT…  are they good?  Sure they are.  

Everybody likes free stuff.  Trouble is, they’re not always breezy free or easy.  Sometimes they’re a huge P.I.A.  So let’s get into maintenance bonds and learn the issues.

The most common Maintenance Bond situation is a bonded public or private contract.  The specification stipulates there must be a 100% (of the contract amount) Performance and Payment Bond plus a Maintenance Bond, which is often for a lesser amount, maybe 20% of the contract price.  The maintenance bond covers the completed work for defective materials and workmanship, for a specified period of time.

The P&P bond is issued when the project commences, and the Maintenance Bond comes when the completed work is accepted.  It is common for the project owner (obligee) to write an acceptance letter regarding the proper completion of the contract, and stating that the Maintenance Bond must now be issued.

free-easyFor the surety, this bond is an easy decision.  They already got paid for the P&P bond. They already faced the risk of claim due to faulty workmanship or materials.  Now the contractor (Principal) will pay an additional premium to obtain another bond on the same work. 

In some cases the surety doesn’t even charge for this bond following their P&P obligation – breezy free and easy!  If they do charge, the rate may be less than for a P&P bond. So when is it not breezy free and easy… and why?

Timing

Maintenance bonds are normally required after the contract has been accepted (work completed). However, in some cases, the owner requires issuance concurrently – at the inception of the project. This is difficult for the surety to support because the approval of maintenance bonds may be relatively easy, but it is not automatic.  The surety must decide if they want to accept the risk associated with the maintenance obligation. In part, this is predicated on the smooth performance / completion of the contract. If the job was fraught with problems and difficult to complete, they may not want to support such an obligation.

Requiring the underwriter to issue the bond at the beginning takes away the opportunity to make an informed decision. 

General Underwriting Concerns

There is a time factor involved in each of these bonds. The surety must be confident that for the one or two-year period, the principal will be willing and able to respond to any call-backs (things that crack, malfunction, etc.)

If the applicant has recently deteriorated, such as declining credit scores or a poor financial statement, the underwriter may refuse to support their request.

Term

The duration of the maintenance obligation can present an underwriting issue. A one-year obligation is normal.  Two years may be possible.

What about five years or ten?  Probably not.

No P&P Bond

Sometimes a Maintenance Bond is requested, but there was no Performance Bond.  Or, another surety may have issued the P&P bond.

If there was another surety involved in the project, it will be very difficult to gain a new underwriter’s support – the thought being “this risk belongs to anther surety.”

If there was no P&P bond, the maintenance bond underwriter will require an Obligee’s Contract Status Report. This is the obligees written statement that the contract has been completed in a satisfactory manner, and related bills paid. A clean bill of health is needed to gain the underwriters support.

Conclusion

You wont get a maintenance request on every project.  But when you do, it may be very easy and cheap – but not always.  Now you know why.

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

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

First Indemnity of America Ins. Co.

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Secrets of Bonding #130: Rob Peter to Pay Paul

Steve GoliaLeave a comment

It’s only human nature.  You have a problem, a need.  A financial issue has come up and the timing is inconvenient. So if you just move things around, you can handle the problem and back-fill later.

For construction companies managing multiple projects, not every job goes smoothly.  Construction work is complicated with many variables and uncontrollable elements.  Sometimes the only solution is to throw money at the problem. When cash flow on the project is “temporarily” insufficient, there is a natural temptation to borrow money out of another healthier contract, with the intention of paying it back at a later date. Is this bad?robbing_peter

Trust Funds

From a legal standpoint, money a general contractor (GC) holds, that is destined to pay the subcontractors (plumber, electrician, HVAC, etc.) he hired on the project, is held “in trust” for the benefit of those subs.  The law says it is their money, and the GC must safeguard it.  Therefore, any money in this trust fund category cannot be “loaned” to another of the company’s projects.

Bonded Contracts

When a Performance and Payment Bond covers a contract, the payment section of the bond guarantees that suppliers of labor and material will be paid.  This includes the subcontractors that were hired by the GC. The bonding company is guaranteeing that the trust funds will make it into the hands of the subs.

If money has been diverted into another project by the GC, and subs remain unpaid, they are entitled to make a claim against the payment bond.  Sureties are risk averse and strive to avoid all bond claims.  Underwriters are well-aware of the “Peter Paying Paul” scenario where the funds are never restored and a payment claim results.

Protective Measures

Bonding companies may take steps to prevent such misapplication of funds.  One is Joint Checking.  Under this procedure, the project owner (paying for the work) issues joint payee checks in the name of the GC and the sub or vendor.  Now there is absolute certainty that the funds will get to the sub as intended.

This procedure does not cost money to implement (other than the administrative expense), but is dependent on the willingness and continuing participation of the project owner.

Another protective device is the use of Funds Control, also called Funds Administration.  Think of this as a professional paymaster who pays everyone on the project, including the GC.  Money goes from the owner to the funds administrator, who then issues all the checks.  By limiting the GC’s money handling, misapplication of funds to another project is prevented.

The funds administrator charges a fee, which is paid by the GC.  For this procedure to be successfully implemented, the owner must officially agree to pay the funds administrator instead of the GC.

Conclusion

When it comes to money handling on construction projects, many people have a stake in the process.  The GC’s obligation is more than to simply complete the work.  They have a fiduciary responsibility to handle funds properly and assure that deserving parties are paid.  That’s what the bonding company expects, and it’s simply the right thing to do.

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.

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