Secrets of Bonding #147: Surety Challenge Question “If It Quacks Like a Duck…”

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Up for a challenge?  Here is the scenario:

A Performance and Payment Bond has been approved on a project. The lender (funding the contract) is requiring it.

There is a discussion regarding the procedures that will be used to control disbursement of the contract funds – they are extensive.

A licensed architect is being used and they will oversee the processing of each monthly payment to the contractor.  To protect the lenders interests, they will not only review the paperwork that is submitted (called a Pay Requisition), they will also conduct a physical inspection of the site.  The point of this is to assure that the contractor is only paid for work actually in place.

If approved by the architect, the pay requisition then goes to the lender for their review and handling.  Finally, the money is paid to the general contractor (GC) who then pays subcontractors and suppliers.

The GC has additional controls in place.  They monitor the status of all their subcontractors and suppliers.  Each month lien releases are obtained which is a guarantee that all the people downstream are being properly paid.  This step prevents future claims against the contractor, project owner or surety for non-payment.

Everything is checked and double checked. Each month these controls assure that the funds are handled properly. 

So here is the Surety Challenge Question:

The bond underwriter has required “Funds Control” as a condition of the bond approval. Do the multiple procedures we described satisfy this requirement?  If it quacks like a duck, is it a duck?

Answer: No!

It seems hard to believe, because no one would deny those controls are all good – and highly beneficial. But actually there is a missing piece we must add to have true “funds control.” It comes at the end of the money handling, the disbursement.

From a surety viewpoint, the funds administrator must be the Paymaster for the contract. It pays everyone, including the general contractor.  The problem with our example scenario is that the GC is paying all the subs and suppliers.  This is just what the surety does not want.

True “funds control” aka “funds administration” gives the underwriter confidence that the money will stay in the project and not get diverted to the contractor’s other work.  It also prevents claims against the Payment Bond by assuring that suppliers of labor and material are paid properly and timely.

Funds Control is a specialized process conducted by a party separate from the surety company. When utilized, applicants must be prepared to pay an additional fee for these “back room” services, and follow the required procedures for prompt money handling each month.

Learn the difference between Funds Control and Tripartite Agreements: Click!

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