bond capacity

Secrets of Bonding #155: The Double Bonding Conundrum

This is America. Everyone is entitled to their opinion. But on the subject of Double Bonding (Contract Surety) we will not all agree.

So here are the facts. You will decide if this is a great idea or just a waste.

What is Double Bonding?

Also called “back bonding” or “subcontract bonding” an example would be when both a subcontract and a prime (directly with the project owner) construction contract are bonded. The prime contractor is the General Contractor (GC).

The GC gives some of the work to trade contractors such as the plumbing, electrical and HVAC. These firms may be required to give a subcontract bond to the GC guaranteeing their work. In turn, the GC provides a bond that covers everything. In other words, it too covers the plumbing, electrical and HVAC. That’s the “double” part. Sounds pretty dopey so far, right? Why would anybody do that?

Turns out this occurs often. Depending on your viewpoint, it may seem helpful / essential, or just a waste of money. Let’s evaluate it and you decide.

Why Love It:

  • Owner: Subs that have been approved by a surety may perform better.
  • GCs: May have a policy to automatically bond subs over a certain dollar value. This is intended to prevent delays and unpaid bill problems.  In addition, the GC / prime contractor is the direct beneficiary, and the potential claimant against such bonds.
  • Subcontractors: With a surety backing them, they may have an advantage when pursuing new work. These are important credentials that prove they have passed the underwriters scrutiny and have the backing of a professional guarantor.
  • Sureties:  May find it easier to support the GC bond if major subs are bonded. A portion of the risk is then covered by *another bonding company.
  • Third tier subs and material suppliers: May not be protected by a payment bond unless double bonding is in place. The GC’s bond may not go down to the third tier (sub of a sub or third tier suppliers.)
  • The most important reason: It is possible that the GC’s surety may insist that major subs be bonded as a condition of supporting the GC. This can be the key to acquiring the contract.

Why Hate It:

  • Owner: Doesn’t need sub bonds because the GC’s bond already covers all the work.  They may be forced to bear the related premium costs if the sub bonds were anticipated. If they were not, the charges may come out of the GC’s profits.
  • GC: In a competitive situation, the related costs could cause them to lose the project. Sub bonds may help GC with their surety, but they do not reduce the cost or dollar value of the GC’s bond.

Bonus Conundrum

Love it or hate it, double bonding is sometimes done voluntarily, or it may be stipulated by the GC’s surety. There is no denying that the concept is important – so important that in some cases both the GC bond and the sub bonds are written by the *same surety. Why would they do that?!

~ ~ ~

KIS Surety Bonds, LLC is the exclusive underwriting department for Great Midwest Insurance Company an “A – 8” carrier licensed in all states plus D.C.

We have in-house authority for Bid and Performance Bonds up to $10 million each.

Contact us for creative solutions and a same day response: 856-304-7348.

Secrets of Bonding # 131: Maintenance Bonds – Breezy Free & Easy

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Free surety bonds.  Is there anything better? Actually we can think of a couple of things right off BUT…  are they good?  Sure they are.  

Everybody likes free stuff.  Trouble is, they’re not always breezy free or easy.  Sometimes they’re a huge P.I.A.  So let’s get into maintenance bonds and learn the issues.

The most common Maintenance Bond situation is a bonded public or private contract.  The specification stipulates there must be a 100% (of the contract amount) Performance and Payment Bond plus a Maintenance Bond, which is often for a lesser amount, maybe 20% of the contract price.  The maintenance bond covers the completed work for defective materials and workmanship, for a specified period of time.

The P&P bond is issued when the project commences, and the Maintenance Bond comes when the completed work is accepted.  It is common for the project owner (obligee) to write an acceptance letter regarding the proper completion of the contract, and stating that the Maintenance Bond must now be issued.

free-easyFor the surety, this bond is an easy decision.  They already got paid for the P&P bond. They already faced the risk of claim due to faulty workmanship or materials.  Now the contractor (Principal) will pay an additional premium to obtain another bond on the same work. 

In some cases the surety doesn’t even charge for this bond following their P&P obligation – breezy free and easy!  If they do charge, the rate may be less than for a P&P bond. So when is it not breezy free and easy… and why?

Timing

Maintenance bonds are normally required after the contract has been accepted (work completed). However, in some cases, the owner requires issuance concurrently – at the inception of the project. This is difficult for the surety to support because the approval of maintenance bonds may be relatively easy, but it is not automatic.  The surety must decide if they want to accept the risk associated with the maintenance obligation. In part, this is predicated on the smooth performance / completion of the contract. If the job was fraught with problems and difficult to complete, they may not want to support the such an obligation.

Requiring the underwriter to issue the bond at the beginning takes away the opportunity to make an informed decision. 

General Underwriting Concerns

There is a time factor involved in each of these bonds. The surety must be confident that for the one or two-year period, the principal will be willing and able to respond to any call-backs (things that crack, malfunction, etc.).

If the applicant has recently deteriorated, such as declining credit scores or a poor financial statement, the underwriter may refuse to support their request.

Term

The duration of the maintenance obligation can present an underwriting issue. A one-year obligation is normal.  Two years may be possible.

What about five years or ten?  Probably not.

No P&P Bond

Sometimes a Maintenance Bond is requested, but there was no Performance Bond.  Or, another surety may have issued the P&P bond.

If there was another surety involved in the project, it will be very difficult to gain a new underwriter’s support – the thought being “this risk belongs to anther surety.”

If there was no P&P bond, the maintenance bond underwriter will require an Obligee’s Contract Status Report. This is the obligees written statement that the contract has been completed in a satisfactory manner, and related bills paid. A clean bill of health is needed to gain the underwriters support.

Conclusion

You wont get a maintenance request on every project.  But when you do, it may be very easy and cheap – but not always.  Now you know why.

Insurance Agents and Contractors: When tough bonding situations arise, we have the markets and the know-how to succeed even when others have failed.

Give us a call today!  856-304-7348

Not available in all states including Idaho.

Secrets of Bonding #126: Surety Bonds in the Bizarro World

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There have been 24 movies about Superman, but I loved the original TV series starring George Reeves (the real Superman). Even before that, there were Superman comic books published by DC Comics.

BizarroThe character, “Bizarro #1,” first appeared in 1958 – a mirror image of Superman but from a world where everything was opposite from that of humans. That was over 50 years ago, but strangely, there is a little piece of Bizarro World that still survives today. It is alive in our surety rate system. See if you agree…

Example #1

A contractor won a $1 million contract. The specification calls for a 50% performance bond: $500,000. The surety’s maximum exposure is $500,000.

Bizarro Fact: The bond rate is based on the contract amount, the full $1 million!

Example #2

Sureties often issue a Performance and Payment Bond in a single combined instrument that states the bond amount once (the penal sum). However, if required, they will issue two separate instruments, one Performance and the other Payment, each with it’s own penal sum (double the amount in the combined bond form.)

Bizarro Fact: When required to issue this double bond amount, the bond premium remains the same as for the combined bond form!

Example #3

The contractor has already started the project. Now it has been verified that 50% of the work is completed and accepted by the project owner. It is confirmed that all related bills have been paid. It is apparent that 50% of the exposure has been eliminated.

Bizarro Fact: The bond costs the same as if it had been issued at the start of the work. There is no reduction or recognition for the portion of the exposure that has been eliminated.

Example #4

The contractor has negotiated a $1 million contract. Now the project owner has indicated that a P&P bond must be provided. The surety states that the cost of the bond will be 2% of the contract amount. Is the cost 2% of $1 million or $20,000?

Bizarro Fact: No! The correct calculation is 2% of $1,020,000 or $20,400. The bond premium is calculated on itself, even though it cannot be classified as part of the contract exposure.

There you have it: The upside-down world we actually live in. Naturally there are justifications for all the procedures sureties use, but still, they are Bizarro!

Insurance Agents and Contractors: when tough bonding situations arise, we have the markets and the know-how to succeed even when others have failed.

Give us a call today!  Bonding Pros: 856-304-7348

Not available in all states including Idaho.

Secrets of Bonding #125: When to Call It Quits

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Construction contracts can be terminated by either party under certain circumstances.  Let’s take a look at it from the Contractors point of view.

Federal contracts make it easy for the government to end a project.  The “termination for convenience” clause spells out how the project can be ended (with no fault on the part of the contractor) and provides a method of payment for the work in place. Other public and private contracts may also contain this clause.

Sometimes it is the contractor who is motivated to end the project early. In these situations, it is important to know how and when to proceed.no-work

The Disputes Clause

“The Contractor shall proceed diligently with performance of this contract, pending final resolution of any request for relief, claim, appeal, or action arising under the contract, and comply with any decision of the Contracting Officer.”

Found in federal contracts, this clause means you must continue to work when facing a dispute. This assures that the contractor doesn’t hold the project hostage while the dispute is under review. 

Other public and private contracts may include language regarding unresolvable disagreements, so it is important to…

Read the Contract

Contractors should only quit a project when they have a legal right to do so.  You need to read the contract and, with the help of your attorney, choose a course of action.

An Unresolvable Disagreements clause may allow the contractor to stop work.  An example could be engineering issues that make it impossible to proceed.

Stop Work for Nonpayment

In these cases, the contractor should send written notification of the overdue payment and allow a time period to collect the funds.  Some contracts require that a second notification be sent before work may be suspended.

Because nonpayment may be a material breach of the contract, it can be justify stopping work.  However, state laws vary on this subject.  An attorney can help determine if such action is advisable.

Surety Bonds

If a Performance and Payment Bond covers the contract, it can play an important role.

General Contractors should alert their surety regarding any disputes.  They should also remember that stopping work can result in a Performance Bond claim.  This can hamper the availability of bonds for other projects. The surety will want to understand the dispute and may offer guidance to the contractor and attorney.

Subcontractors have these same issues if they have bonded their subcontract.  In addition, contracts with “pay when paid” wording may justify the GCs nonpayment – another reason to read the contract.

An advantage for subcontractors may be a P&P bond above them, filed by the general contractor.  This Payment Bond is available for claims by subs and suppliers.  It can be a powerful tool to protect subcontractors.  Even a letter to the GC threatening to file a payment claim can shake the money loose in some cases.

Conclusion

Stopping work can be an important remedy for the contractor, providing the action is legally permitted.  When a contractor considers suspending work they must weigh the risk that they may ultimately be found in breach of contract themselves.  On the other hand, the larger situation of the nonpaying party may demand action, such as an impending bankruptcy.

The best approach is to review contracts in advance and negotiate the addition of language that allows work stoppage under appropriate circumstances.  The goal is to acquire the contract while limiting the risks.

Note: we are not attorneys and are not giving legal advice.  If you have a project dispute, call your attorney for help.

Insurance Agents and Contractors: when tough bonding situations arise, we have the markets and the know-how to succeed even when others have failed.

Give us a call today!  Bonding Pros: 856-304-7348

Not available in all states including Idaho.

Secrets of Bonding #111: WIP Quiz

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 When it comes to Bid and Performance Bonds, nothing may be required more often than financial statements and WIP schedules (Work In Process aka Work On Hand).  For mood music, click here.australian-whip

The WIP schedule could be required monthly for active bidders.  Certainly, the construction company management team monitors this critical info.  It tells the tale of how things are going, and where they’re headed. Profitability is revealed.  It is a preview of the upcoming Profit and Loss section in the next financial statement.  Poor results on the WIP schedule equal low Gross Profits on the next P&L – and maybe a net loss.

Let’s look at a couple of examples and see if you can spot what’s going on.  For the sake of illustration, we’ll use an abbreviated format.

On each of the following WIP schedules, compare the expected profit upon completion to the original profit estimate.

Joe Shmoe Construction

Project

Current/Revised Contract Amount

Original Gross Profit Percentage

Billed to Date

Costs to Date (Including change orders)

Revised Remaining Costs to Complete

1001

$1,000,000

10%

$700,000

$602,000

$202,000

Is the current profit projection more or less than originally expected?

  1. More
  2. Less
  3. Exactly right

 

Global Construction and Gutter Cleaning

Project

Current/Revised Contract Amount

Original Gross Profit Percentage

Billed to Date

Costs to Date (Including change orders)

Revised Remaining Costs to Complete

4321

$1,000,000

10%

$700,000

$602,000

$410,000

Is the current profit projection more or less than originally expected?

  1. More
  2. Less
  3. Exactly right

 

Dummenhappie Contracting

Project

Current/Revised Contract Amount

Original Gross Profit Percentage

Billed to Date

Costs to Date (Including change orders)

Revised Remaining Costs to Complete

007

$1,000,000

10%

$700,000

$630,000

$270,000

Is the current profit projection more or less than originally expected?

  1. More
  2. Less
  3. Exactly right

 

Got your answers?  Let’s go over these:

Joe Shmoe originally projected $100,000 profit (10% of $1,000,000).  Now it has nearly doubled! (602,000+202,000=804,000.   1,000,000-804,000=196,000)  “a. More”

Global starts with the same numbers (to help illustrate our point), but the costs are different.

(602,000+410,000=1,012,000   1,000,000-1,012,000= -12,000)  Not only has the profit margin slipped, it exceeds the contract amount resulting in a projected overall loss. “b. Less”

And finally Dummenhappie.  This one is amazing!  They are about ¾ of the way through the project (actually 70%), and right on target profit wise. The expected profits and total costs are exactly as predicted before they started the work.

(630,000+270,000=900,000   1,000,000-900,000=100,000)  “c. Exactly right”

Think about that. This answer “Exactly right” means prior to actually starting the project, they accurately predicted the exact number of labor hours.  Do you think the reality of the project might be somewhat different from the prediction?  Maybe they will hit unexpected obstacles and things will go slower (higher labor costs).  Or they may find more efficient ways to perform the work as it progresses (lower labor costs).  The cost of material purchases can also vary.  Get the point? It’s hard it imagine any project in which the costs can be perfectly predicted in advance.

indy-whipSo what’s going on here if Dummenhappie isn’t brilliantenluckie?  Our assumption is that the contractor has failed to RE-estimate the remaining costs to complete.  They are still relying on the original estimate – not analyzing the actual “costs to complete” during the life of the project.

Relying solely on the original cost estimate is a dangerous and weak practice.  The contractor may be unpleasantly surprised if unanticipated costs (such as labor inefficiency) have eroded the profit margin.  The worst part: They won’t know about it until the end, when it’s too late to make a correction!

Surety underwriters will detect if the remaining costs are not being reevaluated.  It reflects poorly on the contractor’s management practices.  It also means their profit projections may be totally unreliable.

The solution is to keep accurate records of the labor and material costs that go into each job, and periodically reevaluate (re-estimate) the remaining costs to complete. 

You can have a lot of fun with WIPS!  We’ve just touched on one part in this article. The analyst must not only review the profit trend, but also the method of calculation to confirm that accounting procedures are appropriate.

The experts at Bonding Pros can help Insurance Agents and Contractors when tough bonding situations arise. We have the markets and the know-how to succeed even when others have failed.

Give us a call today!  856-304-7348

Secrets of Bonding #110: Contract Additions – Is More Always Better?

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USUALLY more is better. 

  • “Would you like more ice cream?”
  • “Congratulations on your raise!”
  • “Honey, we’re pregnant!”more2

The same is true when it comes to construction contracts.  It is not uncommon for the scope of work to be modified. The project engineer may have discovered a problem and they will pay the contractor to fix it.

There could be a desire to expand or enhance the project, resulting in an increased contract price.  These additions occur routinely. Sometimes there are also “deducts” meaning an amendment that reduces the contract amount.

Additions to the contract mean more revenues for the contractor – it’s a good thing, unless unexpected problems pop up.

In this discussion, we are talking specifically about bonded contracts.  Whether public or private, prime or subcontract, our comments herein apply.

more3Bond Amount vs. Contract Amount

Surety bonds, Performance and Payment Bonds on contracts, are all similar but may have important variations.  It is common for the bond to adjust upward to follow an addition in the contract amount.  This means if the $1,000,000 contract is increased by amendment to $1,200,000, the bond is increased so that 100% coverage is maintained.

Not only does the bond increase, the adjustment is usually automatic.  Most bonds say there is an automatic increase with no obligation to inform the surety of the change.

When the surety is required to accept the additional exposure, they are entitled to be paid for it.

The Downside of Contract Additions

What could possibly go wrong to spoil this perfect picture? You have a contract and Poof!” it just got bigger!  You provided a surety bond and “Wham!” it automatically adjusted to the new amount!  All good!

  1. One problem that can occur involves the additional bond premium. The subject is sometimes complicated, but the short version is that the surety will charge for the increase.  If the contractor fails to include the additional bond fee in the negotiation for the amendment, the bond fee will come out of their profits instead of being passed on to the project owner as is normal.
  2. A second issue can arise in connection with the automatic bond increase. Sometimes it doesn’t happen.  Some bond forms state that contract increases in excess of a stated percentage (e.g. 20%) must be pre-approved by the surety.  This is to prevent the surety from being pulled into a contract amount far above the original support level. If the surety refuses to accept the increase, the contractor will have the difficult / unpleasant task of seeking a new surety and possibly paying twice to bond the project!  Doesn’t get much uglier than that…

Subtletiesmore1

On the subject of the bond fee, some sureties demand payment when the contract increase occurs.  The thinking is, “We have the exposure now, why not get paid?”

Other companies may wait until the contract ends and net out additions and deducts, then charge for the net increase over the original bond amount.

You may also run into companies that charge for increases, but do not net out or give refunds for contract deductions.

If you want to know what to expect in these situations, you must ask for written answers from the surety.  These fine points are usually not stated in writing in advance – but are worth knowing.  With contract additions, it’s what you don’t know that can hurt you.

The experts at Bonding Pros can help Insurance Agents and Contractors when tough bonding situations arise. We have the markets and the know-how to succeed even when others have failed.

Give us a call today!  856-304-7348

Not available in all states including Idaho.

Secrets of Bonding #109: Surety Letters – You Get What You Pay For

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A Surety Letter can be used like a bid bond.  It may be required by private owners (and General Contractors in connection with subcontracts) as a means of assuring the contractor / bidder can provide a Performance and Payment Bond upon award of the project.  Private owners are not the only ones who use this procedure.  You may even run into this requirement on federal jobs.

The Surety Letter is a statement of the principal’s (contractor’s) ability to provide a surety bond.  They may seem like an easy and useful alternative to a bid bond.  After all, it’s a letter. That has to be easier than a bid bond!

Cost

Theoretically, bonding companies are entitled to charge for bid bonds.  They are binding financial obligations and sureties occasionally pay out claims on these.  The industry practice, however, is to waive such charges.

When it comes to the surety letter, there is no financial obligation.  They are usually issued for no charge.  You can’t make a claim on one, and they are not a guarantee that a P&P bond will be provided.

So when a surety letter accompanies a proposal, exactly what does the project owner get?

The key points are:

  1. Sufficient Authority  Who wrote the letter? The best letters are written directly by bonding companies on their letterhead.  This is important because the author can bind the surety company. If they say they will provide a P&P bond, you can take that to the bank.  Less effective letters may be written by individuals who are not direct employees of the bonding company and who may not be able to legally bind them.
  2. Escape Hatch Typically these letters have a disclaimer that says there is no promise to provide a P&P bond. It may say the underwriter reserves the right to approve or disapprove performance bonds based on the client’s circumstances at the time the bond is requested. (Question: Do bid bonds have an escape hatch?  See below *)

What does all this mean? When a surety letter is used, it always proves one thing: The contractor has some form of a bonding relationship.

However, depending on the content of the letter, it may not include any form of commitment.  Such letters are an “indication of bondability” leaving the reader to speculate whether a P&P bond will follow.

dependability

To what extent can the project owner rely on a surety letter?  Considering most are only an “indication,” not much!  Bid bonds are binding obligations assumed by sureties, and claims can be filed against them.  If they both are available for little or no charge, which would you rather have?

* Answer: Bid bonds never contain an escape hatch.  If, upon award, an acceptable P&P bond is not provided, the surety faces a bid bond claim.

The experts at Bonding Pros can help insurance agents and contractors when tough bonding situations arise. We have the markets and the know-how to succeed even when others have failed.

Give us a call today!  856-304-7348

Not available in all states including Idaho.