Month: January 2015

Secret #80: Substitute Final Bonds

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.

Secret # 22 covered the bonding of started projects.  Secret # 73 is about Substitute Bid Bonds. In this article we will look at cases where the contract was already secured with a surety or cash bond, but a new bond is under consideration.

Consider a number of scenarios:

  1. We are currently working on a case where a client put up full collateral (cash bond) because they did not have a bonding relationship. They contacted us to provide a surety bond that will enable them to recover their cash.
  2. A bonded project could unexpectedly require a replacement bond if the original is nullified by legal or administrative action. (This has happened!)
  3. Similarly, an otherwise valid bond may be deemed unacceptable if the surety’s A. M. Best rating drops below the obligee’s requirement.
  4. We have seen cases where a contractor wishes to voluntarily replace a bond because their new surety offers significantly better terms. (Only advantageous under certain circumstances, such as? Answer below. *)

swap-icon

These are all legitimate reasons to issue a performance and payment bond on a project that is underway – and already bonded. So how does the underwriter approach these opportunities?  How can the contractor and agent prepare for this process?

The first question for the underwriters is whether they are subjected to adverse selection.  There could be physical or financial problems on the project that make a bond claim likely.  A thorough investigation will ensue.

Assuming there is no adverse selection, the underwriter’s first task is to determine the status of the project.

  1. How far along is the work?
  2. Has it been performed correctly and to the obligee’s satisfaction?
  3. Is the contractor up to date paying for labor and materials?
  4. Is the job on schedule?
  5. Does the project owner know of any disputes, delays or problems of any kind?

Will the obligee go on record stating that so far, everything is OK? The underwriter will require such a letter in order to proceed.

Typically, when the new bond is issued, it will cover the entire project back to inception.  If the original contract is the subject of the new bond, it will cover the entire dollar amount of the project including the completed portion.  As a result, the contractor may have to pay two bond fees.

The only way to avoid this is to draw up a new contract for just the remaining work.  In most cases, this is not an option.

It may seem that bonding a partially completed project is attractive. After all, part of the risk has been eliminated! In reality, due to the fact that all aspects of the completed work are guaranteed by the new bond including the prior materials and workmanship, the new underwriter faces nearly the entire risk.

When you add the possibility that the underwriter may be subjected to adverse selection, most sureties are cautious when issuing a substitute final bond.

* The timing must be right. If the purpose of filing a replacement bond is to pay a lower bond fee, the greatest advantage is at the beginning of the contract when a full refund may be provided by the incumbent carrier.

Secrets of Bonding #79: Personal Indemnity, How to Avoid it

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.

If there is one universal complaint we hear from Performance Bond applicants it is their reluctance to give personal indemnity. And there is even more resistance from their spouses!  Keep in mind, people operate through corporations to protect their assets.  So why defeat the purpose by signing personally?  Why do bonding companies demand this and can it be avoided?

The giving a personal indemnity makes the company owners and spouses personally liable in the event of a bond claim or loss. It means assets such as their home and investments are literally at risk if there is a problem on a bonded contract. People typically view bonds the same as insurance where there is no such personal obligation. Therefore, there’s a natural resistance to this requirement.

Let’s stop for a moment and understand why such indemnity is expected.

A bonding relationship is much like borrowing money from a bank. Unlike insurance, neither bankthe bank nor the bonding company ever expects to have a loss.  When you apply for a bank line the lender may ask for personal signatures of the company owners (co-signers) to support the credit application. This means that if the company fails to pay the debt, the bank seeks recovery from the co-signers. The bank wants the owners to stand behind the company obligation.

The same approach is used in bonding.  Bonding companies want the company owners to share in the risk and understand the importance of preventing bond losses.  Personal indemnity accomplishes this.

Why must spouses sign?

  1. Company stock is normally a jointly owned marital asset.
  2. The success of the bonded contracts benefits both parties even if they are not both active in the company.
  3. Bonding companies want to prevent assets from being moved around to avoid the indemnity obligations.

For these reasons “full personal indemnity” is generally required by all bonding companies. However there are some exceptions. Ways to avoid indemnity:

  • Long surety relationship It is possible that after many years in a profitable relationship, the contractor may convince the surety to drop the indemnity requirement.
  • Company size Firms with a multi-million dollar net worth may be viewed as so credit worthy, the additional support (of personal indemnity) is unnecessary.
  • Public Companies Go public. Publicly owned entities normally only give company indemnity. Obtaining personal indemnity is impractical and normally waived.
  • ESOPS Form an ESOP. Employee owned companies (like public companies) tend to have a large number of stockholders, each with a small percent of ownership. It is unrealistic to expect these owners to be personally liable.
  • Pre-Nup. The existence of a Prenuptial Agreement or Non-transfer of Assets Agreement between married parties/stockholders could justify waiving the spouse.  However, the stockholder would still give indemnity.
  • Sell Your Stock Company owners can sell their stock to the next generation of owners, key employees perhaps. If you (and your spouse) are no longer stockholders, your personal indemnity will not be expected.  An exception could be a case where you remain in a key position and/or you personally are the primary financial strength.
  • Collateral Place assets with the bonding company such as cash or an irrevocable letter of credit to secure their position. If high enough, it could overcome the absence of personal indemnity.

These examples are real life solutions.  However for many contractors they may not be within reach. The simple truth is that in most cases personal indemnity cannot be avoided.

Company owners/spouses rarely like to give it, but virtually all must do so if they wish to have bonded contracts for their privately owned companies.

Call BondingPros.com to solve your next bonding problem.