Secrets of Bonding #148: The Greatest Impediment to Bonding

Brought to you by…Secrets of Bonding is brought to you by Bonding Pros

Need a bond?  Talk to the Pros!  856-304-7348  www.BondingPros.com

Brokers protected.  Contractors welcomed.

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.

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.

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

Brought to you by…Secrets of Bonding is brought to you by Bonding Pros

Need a bond?  Talk to the Pros!  856-304-7348  www.BondingPros.com

Brokers protected.  Contractors welcomed.

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!

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.

Secrets of Bonding #146: Financial Statement Sniff Test

Brought to you by…Secrets of Bonding is brought to you by Bonding Pros

Need a bond?  Talk to the Pros!  856-304-7348  www.BondingPros.com

Brokers protected.  Contractors welcomed.

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!

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.

Secrets of Bonding #145: “You Can’t Fit Ten Pounds of S…”

Brought to you by…Secrets of Bonding is brought to you by Bonding Pros

Need a bond?  Talk to the Pros!  856-304-7348  www.BondingPros.com

Brokers protected.  Contractors welcomed.

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 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.

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.

Do The Right Thing / Get Screwed Anyway: Secrets of Bonding #144

Brought to you by…Secrets of Bonding is brought to you by Bonding Pros

Need a bond?  Talk to the Pros!  856-304-7348  www.BondingPros.com

Brokers protected.  Contractors welcomed.

You performed professional quality construction work, billed the general contractor and got paid.  Done deal. Now, three years later you get a letter from some attorney demanding that you return the funds!  Are they insane?  This is a horrible threat that you cannot avoid.

Situation:

  • Spiffy Construction, Inc. was a subcontractor on an unbonded project. They billed their client “Gigantic General Construction” for work completed: $262,800.
  • The invoice was reviewed and approved. Gigantic sends Spiffy a check for $262,800. Awesome!
  • Spiffy deposits the check. All the funds are used to pay bills and upgrade equipment.
  • The next monthly requisition is held up and eventually never paid. Gigantic then declares bankruptcy.
  • After incurring legal expenses, Spiffy is ultimately forced to write off this receivable. It has a severe impact on the company – but they manage to survive.
  • Three years later Spiffy receives a letter from an attorney demanding that they return the last payment. The attorney says failure to return the funds can result in a “preferential lawsuit.”  What the heck is going on?!

This is not an imaginary scenario.  It is based on true facts.  This happens all the time and can be very bad for the defendant (Spiffy aka the creditor.)

What is a Preferential Payment?

When a business declares bankruptcy, the court reviews payments made to creditors of the company in the period immediately preceding the bankruptcy to determine if any were (in the court’s opinion) inappropriate. They want to determine if any creditors were given extra favorable “preferential” treatment at the expense of others.

In our example, Spiffy was paid less than 90 days prior to the BK declaration, so the trustee is attempting to claw back the funds to be distributed as THEY see fit.  Keep in mind, everything that happened prior to the demand letter was normal and legal.  Spiffy did the work, billed the GC and got paid.  Period, end of story. However, it’s not be the end of the story…

The trustee will attempt to prove that the payment received was more than would have been allowed if made through the bankruptcy proceedings. That’s bad because Spiffy collected the full amount they were owned, but in a BK, creditors are typically paid less than 100%.

Spiffy is now forced to pay a second round of legal fees to defend this claim. If they lose, they may be required to return the last payment they received. Add this to the final payment they never received and had to write off.  This situation keeps getting worse. 

What are some remedies available to companies caught in this untenable position?

Examples of Defenses to a Preferential Payment Claim

  • Substantially Contemporaneous Exchange – this means the payment and delivery of product or services happened at the same time, such as a COD payment. A payment by check may also be included in this category if it cleared promptly.
  • New Value – If a $100 account receivable was collected during the preference period, then an additional $75 AR was billed but not received, the preference amount could be claimed to be only $25, not $100.
  • Floating Lien – This is a creditors security interest in present or acquired assets such as accounts receivable. The creditor would need to show that their collateral position has not improved during the preference period.
  • De Minimus – Means debts that are too small to include in the BK analysis.
  • Ordinary Course of Business – There is a history of accounts receivable showing invoices and payments with that debtor / client. The amount owed was in line with prior transactions.

Conclusion

The last example, “Ordinary Course of Business” may be the most natural response for Spiffy Construction and other contractors.  However, in order to raise this defense, the creditor must have appropriate records.  Copies of contracts, invoices, AR schedules and bank statements are critical documents.  Good record  keeping is needed with an efficient means of storing and retrieving the data, in this case three years after the original transaction.  Without it, defendants like Spiffy have little chance of defending such claims.

Sometimes you do the right thing, but you get screwed anyway.  At least now you know about the danger, protective actions you can take and potential legal defenses.

Reminder: We are not attorneys and are not intending to give legal advice.  For that, call your ATTORNEY.  For a bond, call us!  856-304-7348

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.

Secrets of Bonding #143: Surety Bonds and Brain Surgery

Brought to you by…Secrets of Bonding is brought to you by Bonding Pros

Need a bond?  Talk to the Pros!  856-304-7348  www.BondingPros.com

Brokers protected.  Contractors welcomed.

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 a special underwriter.  The surety business is all about relationships. So your best problem solvers have many years under their belt and deep relationships with the right underwriters.  They deal with them every day.

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. 

Steve Golia’s personal surety bond expertise dates back to 1972 (started in grade school.) Solutions to every problem you’ve seen, and some you haven’t.  Our experience is the key to your success and our service is the best.  We have the market access and expertise to handle bonding problems large and small. 

When you need a bond, call the Pros!  856-304-7348

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.

Secrets of Bonding # 142: Make Bid Bonds Great Again!

Brought to you by…Secrets of Bonding is brought to you by Bonding Pros

Need a bond?  Talk to the Pros!  856-304-7348  www.BondingPros.com

Brokers protected.  Contractors welcomed.

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: 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!

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

Not available in all states.