In the world of Bid and Performance Bonds, size matters. Underwriters want to know about the contractor’s largest successfully completed project. The agent and contractor ask about the single job limit (largest available bond size.) Size is a subject of constant interest.
So what do you do when an unusually large project comes along? Let’s assume it is more than the single job limit. For example, the surety set a bonding line of $1 million single (per project) and $2 million aggregate (the maximum one day total for incomplete bonded and unbonded work). The new project is for $1.5 million. Does the contractor pass up the opportunity to acquire a desirable project? Will the agent and surety risk losing a client because of their failure to deliver the bond?
There are three possible outcomes to this situation:
- Decline the bond
- Restructure the contract so it fits the existing bond line
- Grant an exception (a bond approval) to the line
Let’s look at each one in detail:
- Contractor fails to obtain the project. Agent and surety may lose the account.
Restructure – Reduce the risk, and the bond amount, by restructuring the contract into a dollar amount that falls the bond line.
- A contract for multiple buildings can be broken into a smaller contract for each building. The idea would be to NOT issue all the bonds at once.
- The scope of work can be reduced (smaller bond) or broken into phases (bite sized pieces).
- The obligee can purchase the materials directly, thus removing them from the contract price (smaller contract and bond).
- Multiple primes: Instead of one General Construction contract and a big bond, individual smaller contracts are issued for each trade.
An Exception is granted – The bond is issued even though it is beyond the current line. How do you get to that point?
- The contractor may be uniquely well-suited for the project based on prior experience such as working for the obligee and / or architect before, done “the same job” previously or some other special advantage. Examples of this would be a job the contractor helped design, a project located close to their office or maybe they have special equipment, materials or skills.
- The project may be exceptionally low risk. Example: a project that is repetitive in nature (four identical buildings at the same site) or simple in design (a large building, only one story.)
- Reduce the risk: Hire a major subcontractor and bond back the work.
- Individuals in the construction company may personally have special skills or prior experience playing a key role on a similar project.
- Mentoring – a larger more experienced firm may provide expertise to help the contractor through the project.
Teaming: This technique is in the same family as Mentoring and Subcontracting, but is different. Structural arrangements in this area are more complicated than we can cover in this brief article. Suffice to say, as a Surety, we have a great deal of experience in this area. Despite operating in the “hard to place” niche, our outstanding underwriting results arise from knowing how to put these transactions together properly for our agents and contractors.
The following are incorrect solutions to the size problem:
- Issue more than one bond on the contract. Unacceptable because reinsurance limitations require only one bond per contract. This is referred to as “stacking.”
- Breaking the contract in an unnatural manner. For example a GC dividing the construction of a single building.
- Stipulating a bond for less than 100% of the contract amount. The surety bases the underwriting decision on the contractor’s obligation, which is the contract amount.
- Issue a smaller contract (and bond), then follow it with a huge increase change order. This doesn’t work because the bond may say it does not automatically cover large increases in the contract amount.
- Reduce or eliminate the contractor’s profit margin.
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