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.
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.
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.
These procedures have different implications. Let’s examine them.
FC= Funds Control
TA= Tripartite Agreement
- 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.
- Both processes result in the contractor successfully obtaining the project but with no handling 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!
A special note from the author: Steve Golia
I am an Independent Broker and Surety Bond Specialist. If you wish to co-broker bond business, together we will deliver the best in bonding expertise for your clients. I have a broad range of markets available and often can solve problems even when others have failed.
Call me now (856-304-7348) or email: Steven.Golia@gmail.com