Month: July 2014

Secrets of Bonding #65: All About Bid Bonds

1. What is the bid bond amount? They are issued for an amount stipulated in the bid invitation.  The specifications often require a security equal to 10 or 20% of the bid amount. In some cases, the dollar value is preset.  For example on New Jersey public work, the dollar value is normally a maximum of $20,000 regardless of the proposal amount.

2. Does my financial statement need to show the same amount in cash to qualify for the bond? Not necessarily.  The approval is based on the total financial picture.

3. What happens to the bid bond after the bid opening? As time passes (90 days depending on the surety) it becomes void automatically.

4. Do I have to return it to the surety? No.

5. What happens if I’m 2nd or 3rd bidder? Your bid security is held until the contract is awarded so that the obligee has the option to give you the project if they wish. This is a good reason not to use cash security in lieu of a bond.

6. 4th, 5th or higher? You are released from any obligation.

7. How much of my bonding capacity is consumed when the bid bond is issued? The Contract amount is deducted from the available capacity.

8. When does my capacity get restored? It is restored when the surety is notified that you are not the “apparent low bidder.”

9. What if I decide not to bid the project at the last minute? Notify the surety and the transaction will be deleted.

10. Can there be a claim? Absolutely!  That’s the reason it is required.

11. Do all public projects require them? Generally yes, with the exception of small contracts, emergency work and a few other categories. Some federal projects only require a bonding capacity letter from the surety.

12. If I don’t have a bonding company, can I still bid the project? Yes, with alternative bid security that may be described in the bid specifications.  However, if upon award you cannot satisfy the performance bond requirement, the bid security could be forfeited.

13. What is a capped bid bond? This does not support a proposal amount in excess of a set dollar figure.

14. What is a Consent of Surety to accompany the bid? The surety issues this letter promising to provide the performance and payment bond upon request.

15. Why are Surety Capacity letters sometimes used? Some obligees use them to pre-qualify the bidders even when they do not intend to require (or pay for) a performance bond.

16. Are they easier to get than a bond? No.

17. Can one surety issue the bid bond and a different one do the performance and payment bond? Yes, as long as they both meet the stated requirements.  Many sureties are reluctant to follow another’s bid bond.

18. Do all bid bonds cost the same? Yes.  Generally they are issued at no charge.

19. What is the bid spread? This is the percentage by which the 1st bidder is  below the 2nd.

20. Are some bond forms mandatory to use? Yes, and failure to do so can result in rejection of the bid and loss of the project.

21. If the bid date is postponed, can I still use the original bid bond? Yes, if the obligee permits.

22. Are copies of bonds acceptable to use? This is at the discretion of the obligee.  For example, they may allow an extra day for delivery of the original if it is delayed in shipment.

23. Is the bid bond valid if it is not sealed? It only is if the obligee chooses to accept it.

24. Can the bond be turned in after the bid opening has occurred? No, unless the bid process is an informal one.

25. Are bid and performance bonds always required together? No. You could have either one without the other.

26. Can a check or ILOC be used with a bond? Generally, yes. They could be used on top of a capped bid bond.  However, re-approval of the surety prior to the bid is advisable.

27. Can a generic bond form be used on federal work?  No, when a stipulated form is indicated, failure to use it could cause rejection of the bid proposal.

28. Is a bid bond valid if the notary commission expires in the time between bond execution and bid submittal? It is valid if the obligee does not find it objectionable.

More on this subject: www.SecretsofBonding.com #8, 16, 30, 49

This article is provided for entertainment and education.  It is not legal advice. We are not attorneys.

Secrets of Bonding is brought to you by Bonding Pros

Contractors, Agents: When you need a bond give us a call. 

Bonding Pros: 856-304-7348  www.BondingPros.com

Secrets of Bonding #64: Think You’re Bonded? You’re Probably NOT!

Here is an interesting question, and the answer has important implications for you. Even if you are providing Bid and Performance Bonds on your projects, you may not be bonded. Sounds crazy? Read on.

For most contractors, the vehicle used to perform the construction activities is a corporation or LLC (Limited Liability Company). Remember the bonding questionnaire you completed? The top line asked for the Legal Company Name, not your name.

And consider the bonds that were issued. The “Principal” is the party whose actions the bond concerns. Who is the Principal on your bonds? Unless you are a sole proprietorship, your company is the named party, not you personally. What’s so significant about this?

For the bonding company, the decision making on bonds (the underwriting) is primarily focused on the principal. In most cases, that means they start the review by looking at the company, not you personally.

  • What projects has the company successfully completed?
  • What is the financial condition of the company?
  • How does the business D&B credit report look?

The business is the principal on the bonds, and the primary indemnitor on the General Indemnity Agreement. From the surety’s point of view, when a claim or problem arises, it is the company they’ll look to for a solution – and for financial recovery. The individual owners are secondary.

Company is a Legal Entity
Here’s the catch. You may feel that you are the company. It’s seems that all the assets should be viewed together because they ultimately belong to you, but the surety doesn’t see it that way. The bond underwriter recognizes the company as a separate legal entity.

Why do people form companies and operate through them instead of conducting all business personally? There are tax advantages, of course. But the other reason is the legal protection that is afforded. There is a hint in the name “Limited Liability Company.” The separation that exists between the assets of a company and its owners is a primary reason to form corporations and LLCs. This separation is the reason underwriters focus on the company, and depend on it as the primary buffer between the surety and a bond loss.

Financially Strong Applicant
For the business owner, it is important to remember that money left in the company is more beneficial to your bonding than funds that are taken out by bonus or distribution. When we look at companies that have not typically needed surety or bank credit, we may see profitable operations but very little net worth. The owners are not interested in making the company rich. After all, the mission of the business is to make money for its owners, so the net worth flows out to their personal financial statement.

For bonding purposes, this strategy can be detrimental. When a profitable company is kept poor, it can have great difficulty qualifying for bonds. The company is the applicant. If the applicant looks weak because funds have been drained, bonding support may be difficult or impossible to obtain.
When owners choose to leave money in the company, and allow it to build up, they are making a direct investment in the company’s future. The benefit is paid back in multiples when higher bonding capacity facilitates the acquisition of larger contracts, more sales, and more profits.
Who Has the Experience?
Another important underwriting element is the prior experience. When a highly experienced person starts a new company, how is this issue addressed? The company may have little or no experience, but the key person may have a long personal track record. Can that help the new company? It is not equivalent to work accomplished by the new organization, but it is relevant nevertheless. Provide details concerning the size, nature and location of the prior jobs. Identify the key person’s role. (Project Manager? Field Superintendent?) These facts can help overcome the company’s lack of history.

Summary
If you operate as a sole proprietorship, everything is “you.” However, if you use a corporation or LLC, it is a separate entity. Your business vehicle must be cultivated and groomed so it can qualify for surety and bank credit when needed. Failure to do so can hinder future bonding and growth opportunities.

Think like an underwriter. Make sure your company can qualify for bonds. It is the company that is the applicant and bonded entity, and it is your means of achieving personal financial success.

Secrets of Bonding is brought to you by Bonding Pros

Contractors, when you need a bond give us a call. We also welcome brokerage opportunities.

Bonding Pros: 856-304-7348  www.BondingPros.com

Secrets of Bonding #63: How to Get the Lowest Surety Bond Rate

Competitively bid work is always hard to win. During times like these, when not enough work is available, it’s even harder. Margins are thin and contractors are looking at every cost element. Where can a little bit be shaved that might make the difference in winning a new project?

You have the big elements such as the cost of equipment, and subcontracting that may be hard to manage. Then there are internal items, such as the cost of “our” labor and supervision, overhead and maybe even some profit! You hope to exercise some control over these. The cost of the bond is one such item. It’s hard to miss. You know the bond rate, and it gets added on at the end of the bid calculation. So how do you manage the bond rate and get your best deal?

Let’s take a step back and think about what that “best deal” looks like. It is not just a bond rate. What if you have a low rate, but the surety refuses to support the project in question? That’s a BAD deal. So we have to say capacity is an important aspect of the best deal. You need to be sure the bonding company will support the size contracts you are pursuing.

Service is equally important. Sometimes contractors request bonds and no answer is given – they miss the opportunity to bid. That may sound incredible, but believe me – it happens!

So while we’re thinking about the bond rate, we are also looking for good capacity and customer service.

Now let’s talk rate. The bond cost is normally based on the contract amount, and the rate could be a percentage ranging from 1%-3%. A typical rate may be 2.5% of the contract amount. The rate can be fixed (straight up) or could be a sliding scale that is less expensive on larger projects.

When we talk about the competitiveness of bond costs, keep in mind, we’re not considering a 2.5% or 3% rate. We’re comparing the difference in rates paid by contractors. If 3% sounds unacceptably high, it may only be .5% above the competition – meaning it may have a very small effect on overall competitiveness.

Racers know “You can’t finish first unless you first finish.” For contractors, if they don’t have capacity, they’re not in the game. And rate doesn’t matter if you don’t get the bond in time. So I suggest that rate may not be the most important thing when it comes to bonding.

While you let that sink in, let’s answer the rate question. Generally, bonding companies have one bond rate. This means contractors may find it necessary to change bonding companies in order to get a reduction. Changing sureties is usually a painful process. Contractors are not inclined to switch unless all elements, including capacity, are improved.

The process of acquiring a lower rate is typically a gradual one in which the contractor shows ever improving credentials such as longevity, profitability and general financial strength. Maintaining a long term relationship with one surety can be a key element, assuming the company has the ability to offer rate concessions.

Summary:

• The difference between the rates paid by different contractors is typically very small.
• By building up the company, contractors can gradually achieve lower rates with their current or new bonding company.
• Everyone wants the lowest possible rate. But equally important, you must locate a surety that is willing to provide sufficient capacity and service. The true “best deal” has all three!

Secrets of Bonding is brought to you by Bonding Pros

Contractors, when you need a bond give us a call. We also welcome brokerage opportunities.

Bonding Pros: 856-304-7348

Secrets of Bonding #62: ILOC: What is it? What isn’t it?

Sample #1

IRREVOCABLE LETTER-OF-CREDIT
Wisconsin Department of Transportation
Motor Carrier Services – IRP Unit
P.O. Box 7955
Madison, WI 53707-7955

We hereby establish our irrevocable letter of credit in your favor for ACCOUNT NAME, in an amount not to exceed $00.00.
All checks written by ACCOUNT NAME payable to Registration Fee Trust, (Wisconsin Department of Transportation) for the remaining registration fees will be honored by BANK NAME up to the irrevocable credit limit.

If ACCOUNT NAME fails to make payments to the Wisconsin Department of Transportation when due, the BANK NAME will allow the Department of Transportation to draw on the Irrevocable Letter of Credit up to the credit limit, provided the BANK NAME receives written documentation from the Wisconsin Department of Transportation stating registration fees have not been paid when due.

This IRREVOCABLE LETTER OF CREDIT expires: _______, ______, ______

Sample #2

CITY OF FREDERICK
IRREVOCABLE LETTER OF CREDIT
Date of Issue: _____ Date of Expiry: _____ Issue Number: __________

Beneficiary:
The City of Frederick
c/o DPW Projects Division
Attention Linda Dutrow
111 Airport Drive East
Frederick, Maryland 21701

Gentlemen,
We hereby authorize you to draw on us for account of (name)____________ at (address) ______, up to an aggregate amount of $ _____ (_____) dollars and _ cents) US Dollars, available by your drafts at sight accompanied by a signed statement that the funds are being drawn and required for payment in accordance with an executed Public Works Agreement between the City of Frederick and the party named in this paragraph for (project description) _________________.

Drafts must be drawn and negotiated not later than ______ at our counters. Partial drawings are permitted.

Each draft must state that it is drawn under the Irrevocable Letter of Credit of (name of issuing bank) _____________ Number _____________ dated _______. This Letter of Credit is not transferable or assignable without written consent of (name of issuing bank) ___________________________.

This credit is subject to the “Uniform Customs and Practice for Documentary Credits” (1994, or latest revision) International Chamber of Commerce, Brochure Number 500.

It is a condition of this Letter of Credit that it shall be deemed automatically extended without amendment for one (1) year from the present or any future expiration date of this Letter of Credit unless at least forty-five (45) days prior to such expiration date we notify you by certified mail that we elect not to consider this Letter of Credit renewed for such additional period.

We hereby agree that all drafts drawn under and within the terms and amount of this credit and accompanied by the documents above specified, that such drafts will be duly honored upon presentation to the drawee.

These are two examples of ILOCs. Let’s find out about these, and why they look so different.

“ILOC” stands for Irrevocable Letter or Credit. They may also be called a Standby Letter of Credit. These instruments are only issued by Commercial Banks. The purpose is to enable one party to draw on the account of another in connection with a business transaction. If the beneficiary makes a draft (draw) upon the ILOC, the bank records it as a loan to the account holder who is the subject of the letter (the contractor in a construction scenario). The beneficiary is not required to repay the bank.

A perfect example is the overseas practice to use an ILOC in the same manner we normally use a Performance and Payment Bond in support of a contract. The contract owner is entitled to draw on the ILOC in the event of the principal’s default.

The two examples above are actual suggested formats from those beneficiaries. The Wisconsin DOT is unusual because of its brevity. The City of Fredrick form is more typical of what you may see, particularly if using an ILOC to give collateral to a surety.

What are the important elements missing in the DOT form?

If the duration of the related business transaction is longer than the term of the ILOC, the beneficiary normally demands an “evergreen clause” which provides for automatic renewal. It means if no action is taken prior to anniversary, the instrument does not expire. This gives the beneficiary confidence that they will be formally notified prior to anniversary that the bank intends to non-renew, and they will have sufficient time to draw down (cash out) the entire ILOC so they remain protected.

It is also normal for the instrument to allow partial draws, and require the return of drawn funds that are ultimately unused.

It is important for the document to correctly state the party whose actions are the subject of the guarantee (the principal) and the circumstances under which a draw can be made should be standard.

Beneficiaries of these instruments must scrutinize the financial condition of the issuing bank. In cases where the FDIC rescues a banking institution, they have the ability to unilaterally nullify these instruments to aide in the bank rehabilitation. For bonding companies, this means they can lose their collateral even though they remain “irrevocably” obligated on the P&P bond. Check the bank strength here: http://www.fitchratings.com

Summary
We have covered what an ILOC is, the key aspects and what to look for.

What isn’t it?

It may not be a good alternative to a Performance and Payment bond.

1. The bank does not pre-qualify the contractor’s ability to perform the work the way a surety does.
2. In the event of default, the project owner must assess the contract status, arrange for a completion contractor and manage the process to a successful conclusion. With a bond, the surety may do all this.
3. An ILOC does not prevent liens against the project or provide the process to resolve them.

Owners may accept an Irrevocable Letter of Credit as an alternative to a surety bond. However, the fact remains that an ILOC does not match the comprehensive protection of a Performance and Payment Bond.

Secrets of Bonding is brought to you by Bonding Pros

Contractors, when you need a bond give us a call. We also welcome brokerage opportunities.

Bonding Pros: 856-304-7348

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