Secrets of Bonding #61: Sample (Real Life) Bonding Problem

A key vendor is demanding that the GC provide protection for their purchase agreement. However, the project owner did not stipulate a Performance and Payment bond on the contract and none was provided. The work has started and the contractor needs to get materials delivered from the reluctant vendor.

So what are the possible solutions that may satisfy the vendor?

Q. Can we issue a bond on the Purchase Agreement?
A. The vendors purchase agreement is not the same obligation as the construction contract. A bond guaranteeing payment of the purchase agreement would be considered a Financial Guarantee bond (Why?  See below *) They are more difficult to obtain than a P&P bond, so that may not be the best solution.

Q. So what about issuing a P&P bond on the Purchase Agreement?
A. This is not an option due to the differences between a purchase agreement and a construction contract.  (Details below *).

Q. Can we bond the contract in a normal way (100% Performance & Payment)? That Payment bond would cover all vendors, so it would cover the one in question.
A. Bonding a started project is always a red flag. The underwriters initial question is “Why do they want a bond now?” It does seem suspicious, like there may be a problem with the performance of the construction work or the owner received some negative info on the contractor. The contractor could have a problem and the work may be in jeopardy.

Another issue is the cost. If a bond was not originally required, the bond cost is not included in the contract price. This means a bond purchased subsequent to the execution of the contract will be paid for out of the contractor’s profit margin. The Principal will be looking for the most inexpensive solution possible.

Keep in mind that the purchase order amount is less than the contract price, so bonding the contract would result in a bond higher (and more expensive) than actually needed.

Q.Can we issue just a payment bond on the contract?
A. This too will be viewed as a red flag by the underwriters. Who asks for a payment bond but doesn’t want a Performance Bond? That would be unusual.

Summary
We have concluded that it will be difficult to retroactively bond the contract, and only a financial guarantee bond can be issued on the purchase agreement, so a bond may not be the solution at all!

Our Solution

In this case, we offered Funds Administration instead of a bond. This was an inexpensive alternative, and provided an assurance for the vendor that bills would be paid in a routine manner.

Keep in mind, however, that the Funds Administrator has no obligation to the vendor. If there is an unexpected event, such as termination of the contract, the Funds Administrator does not guarantee to the vendor that they will be made whole.  A bond would.

*The nature of purchase orders is different from a construction contract. When issuing a P&P bond on a contract, the surety depends on the fact that the obligee is paying for the work, and that money may be the key to solving any claim or default.

When bonding a purchase order, the obligee (vendor), is not paying – they are receiving payment. That is why a Financial Guarantee Bond must be used, and is why they are harder to obtain.

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