Secrets of Bonding #145: “You Can’t Fit Ten Pounds of S…”

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You know that old expression about jamming in too much. It’s true, and it applies to Surety Bonding like everything else.  “You can’t fit ten pounds of “STUFF” in a five pound bag.”

Check this out:

“Here’s what we’ll do: We will issue a $500,000 contract and bond it.  Then, once the surety is on board, we’ll issue an addendum for an additional $500,000.  The surety will automatically cover it and we’ll have the $1 million bond we couldn’t get in the first place!”

Would that actually work?  Yes, often it could because many P&P bonds state that they will automatically cover increases in the contract amount.

The surety finds themselves bonding a contract larger than originally intended – perhaps well beyond their comfort level. Sound underhanded?  It could be and it happens in multi-million dollar amounts. 

This scenario can also come up inadvertently – in an innocent way.  The contract has a large increase and the bond gets pulled along.  Either way, the underwriter is holding an obligation far in excess of their approval amount.

It’s the sureties own fault for allowing this to happen, right?  Uh, no! When underwriters caught onto this practice, they added a bond condition stating that increases of more than a certain percentage (i.e. 10%) require the prior written consent of the surety. No more free ride.  No more 5 pound bag.  If the contract is increased in violation of this condition, the bond can be invalidated.  That’s a big deal.

So you can’t jam a ten million dollar contract into a five million dollar bond, but is there a legitimate approach?  One that does not violate the relationship with the underwriter?  Yes!

One option is to issue a phased contract. The $10 million project has “Phase One” for $5 million, and a $5 million  P&P bond is issued.  When the work is completed and accepted by the obligee, the bond is rolled forward to the next phase.  In this manner, the bond is never worth more than $5 million, but it covers every part of a $10 million contract – just not all at the same time.

This method enables the principal (contractor) to stretch their capacity on a contract larger than the surety normally would provide.  The obligee still gets a project that is 100% covered: win / win / win!

Another idea would be to issue multiple contracts (if suitable) and bond them sequentially. This technique can be used when the nature of work is such that it can be logically divided, such as multiple buildings. A separate bond is issued for each contract.

Conclusion

Bonding companies intend to automatically cover minor increases in the contract amount.  But when a big addition is considered, they are entitled to exercise discretion over their exposure.

With open communications, there can be solutions where larger projects are bonded without risking failure to comply with the bond conditions.

Insurance Agents and Contractors: Love the “Secrets” articles? You’ll really love it when we solve your tough bonding problem! We have the markets and the know-how to succeed even when others have failed.  Call us with your next surety bond need.  We guarantee a same day response.  856-304-7348

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