Federal bond

Secrets of Bonding #149: Be A Surety Bond Fixer

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Being a problem solver is a great way to deliver value for your customers.  When it comes to surety bond problems, do you have any creative solutions?  Are there tricks up your sleeve that make your clients say “Mr. / Ms. Bond Fixer, I’m sure glad I called you today!

Well try your hand at solving these surety bond problems.  They may have more than one good solution, but I will give at least one for each at the end.

  1. The company owner is willing to give personal indemnity, but the spouse refuses. Your solution?
  2. The underwriter has approved a performance bond but collateral is required (money the contractor lets the surety hold as a security deposit against possible bond claims.) The contractor doesn’t have the cash to put up. Your solution?
  3. The subcontractor is required to provide a P&P bond, but no surety will support it. Your solution?
  4. In order to support a Performance Bond, the underwriter requires a CPA Reviewed financial statement. The client didn’t anticipate this and only produced a Compilation (lower quality) report at their last year-end. Your solution?
  5. A property owner has awarded a project to the contractor, but he is being required to issue a performance bond to the local township. The underwriter declines this stating “there is no contract for the performance bond to cover.” Your solution?
  6. Company Working Capital is too low. Main problem is that Accounts Receivable were overdue at fiscal year-end. Your solution?
  7. An old line excavation contractor can’t get bonded because their Net Worth is too low and the Debt to Equity ratio is too high! Your solution?

 

Feel free to post your ideas on how to fix these bond problems.

 

Possible Solutions:

  1. Indemnity – Get the spouse to sign a “non-transfer agreement” prohibiting the indemnitors assets from being moved over. Other possibilities: Spouse indemnity that excludes certain assets, capped indemnity with a maximum dollar value or trigger indemnity that is active only under special circumstances.
  2. Collateral – Can another party put up the money? Could be in the form of a loan to the company owner. Maybe an interested subcontractor or supplier will put it up so the contract can proceed (and they get the work.) How about using Funds Control with a hold back that collects the collateral account from the contract funds as the work progresses?
  3. No subcontract bond – The general contractor could add a retainage clause to the contract, or increase it in lieu of the bond (hold back some money until completion as a security deposit.) On a short term subcontract, make a single payment for the full contract amount at the end when the work is satisfactorily completed.
  4. Compilation FS – Have the CPA go back and do the additional work to upgrade the report. Sometimes, if it is late in the fiscal year, the underwriter may proceed with bond issuance based on proof that the next CPA statement will be a Review. Get a copy of the engagement letter with the CPA.
  5. No contract – The underwriter is correct. There is no contract with the township, it is with the property owner.  A bond on the property owners contract would be for the wrong amount in any event.  A Site or Subdivision bond is the correct way to protect the interests of the municipality.  It would guarantee the construction of the “public improvements” such as roads, sidewalks, sewers, etc. Caution: The property owner should be the applicant for this bond (not the contractor!) or they should at least be an indemnitor.
  6. Slow Receivables – Slow receivables are disallowed by analysts based on the expectation that they will never be collected. Obtain a current update on the collections of the A/R list from the financial statement date. If they have subsequently been collected, they are included in the Working Capital analysis despite being old on the FS date.
  7. Low NW – After years of operation, depreciation can wipe out the asset value of heavy equipment on the Balance Sheet. Document the current value to re-capture these dollars for the financial analysis. Get a copy of the equipment floater and a current appraisal to determine the current “forced sale” value.
  8. Other problems – Think we listed all the possible bonding problems in this article? No, we left out a few million! When you get tough bond problems, or just want the help of experts, give us a call. That’s all we do!  We have the markets and the expertise.

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

Not available in all states.

Secrets of Bonding #148: The Greatest Impediment to Bonding

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Surety bonds are hard to get. Contractors and their insurance agents know that underwriters are conservative. They ask lots of questions. Then they ask more questions. Then they say they can’t help you. It’s a fun-filled process.

Some contractors can’t get bonded because they have a poor credit history. Others have weak or insufficient financial statements. There are plenty of reasons for an unhappy ending, but what is the single biggest reason – and what can you do about it?

Crappy credit: This is a very common problem. The company may be struggling to get enough work, resulting in a weak credit report. So they decide to move into public work for additional revenues – but the bad credit report makes this impossible. Sometimes the report can be improved by correcting errors and updating the info. This is not the greatest impediment contractors and their agents face.

Weak or insufficient financial statement: There are innumerable potential problems. No financial statement, only an internal statement, only a compilation, an interim FS, a net loss, no working capital – the pitfalls are endless! It’s not the biggest impediment though.

Unsavory circumstances: Excessive bid spreads, inadequate prior experience, bad bond forms, harsh contract terms, too much other work. They are all bad, but they are not the king.

The Greatest Impediment

Picture how the process starts. When the contractor decides to go after bonding, a list of information is requested. The underwriter wants business and personal financial statements. A current work in process schedule is needed. Prior tax returns, resumes of key people and a bank reference letter are desired.

The contractor wants to pursue this, but MAN, that’s a lot of stuff!

He has not needed to make company financial statements, so how to come up with them now?

The company owner never needed to make a resume, always been self-employed. How do I write that up?

The WIP schedule: I don’t have that info available. I know where I am on all my jobs. Why would I take the time to fill out a bunch of forms anyway?

I can get the bank reference letter completed and make copies of prior tax returns (they want the WHOLE THING?!) But if I do that, who’s gonna do the estimating so we don’t run out of work? And I have to visit the projects or everything will grind to a halt. The workers want to milk every job like it’s their last. They’ll suck the profits out of everything if I give them the chance.

Conclusion 

The greatest impediment is the applicant themselves! In my 40+ years of surety bond underwriting, I have concluded that MOST contractors deserve to be bonded, but many fail to acquire surety support. It is because they stop trying, or never really start.

People must make choices. They have to put bread on the table. If they can succeed by doing what they know, why try some experiment that may fail? Sometimes it’s just easier to keep doing the same thing – even if you are discontent.

Our observation is that bonding takes perseverance and patience. It is a journey, a path with unexpected twists. There can be obstacles, but we have solutions! If contractors or agents expect it to be fast and easy… they may be disappointed.

Applicants for bonding must plan to devote some time and energy to achieve a goal they know is worthy. It says a lot to have a surety backing you. They are vouching for your ability, and putting up their own money to prove it. It’s a big deal and not always easy, but always worth it in the end.

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

Not available in all states.

Secrets of Bonding #140: Make Tax Liens Disappear!

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When tax liens, bankruptcies and judgments appear on credit reports, they can prevent sureties from issuing bonds and banks from granting loans.  This can be devastating for construction companies that need both to succeed. 

Are there ways to get the tax lien off the credit report?  Yes! Let’s find out how.

According to the government: “A federal tax lien is the government’s legal claim against your property when you neglect or fail to pay a tax debt. The lien protects the government’s interest in all your property, including real estate, personal property and financial assets.”

For surety bond underwriters, the tax lien is a red flag for a number of reasons:

  • It can mean the bond applicant had insufficient cash flow to meet their financial obligations.
  • It may be a sign of poor management or weak internal controls.
  • The scariest part may be the “weapons” used by the IRS to collect their tax money. They can issue a tax levy.  This permits the legal seizure of property to satisfy the tax debt. They can garnish wages and take money from a bank or other financial account.  They also have the ability to seize and sell vehicles, real estate and personal property. These collection activities can threaten the success of bonded projects to the detriment of the contractor and surety.  Bad for everyone except the IRS agent.

Here is how to remove tax liens from the credit report:

  1. Eventually the credit bureau may drop it from the report even if it is not paid, but this can take years.
  2. Pay the tax bill. Eliminating the debt will not remove the lien from the credit report, but will show it as “released.”  For credit grantors, this is still negative, but less threatening.  Paid liens remain on the report for seven years. So the next step is also needed…
  3. Federal form 12277. With this document you can ask the IRS to withdraw (remove) the lien notice, even when the debt is not paid off!

More about form 12277

This is part of the federal “Fresh Start” program, which provides certain benefits to taxpayers.  12277 is the Application for Withdrawal form.  The IRS will consider withdrawing the lien notice if the debt is being paid through a Direct Deposit installment agreement, plus a few other conditions.  See the form.

The purpose of the Application for Withdrawal is not to eliminate the lien, but to remove it from public view when there is no longer the threat of a tax levy.  Consider using this procedure on liens that are not paid off, and those that are!  In both cases it is legal and beneficial to have the lien disappear.  But is this practice unfair or deceptive?   No, because banks and bonding companies have other ways of detecting the lien.  They are not being deprived of relevant information.  For example, the debt will appear in the financial statements and also on the Contractor Questionnaire.

One more comment about the dreaded, draconian tax levy: Before the IRS proceeds with the levy they are required to send the taxpayer a Final Notice of Intent to Levy and Notice of Your Right to A Hearing. This gives the taxpayer one last chance to argue against the levy before it is implemented.  Go for it. Maybe it will help.  Remember – they’re from the government and they’re here to help!!!

Now you know the ways to remove a federal tax lien from view.  By waiting, paying and / or using form 12277, the lien can be wiped from the credit report.  For the taxpayer, it can be an important step toward financial recovery.

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

Not available in all states.

Secrets of Bonding #137: Identify 5 Mystery Bonds Contractors Need

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Think you are pretty familiar with the various surety bonds contractors may need?  See if you can identify these five that we are commonly asked to provide by contractors and our agency partners. Also try for the Bonus Question at the end!

  • Mystery #1: In this instrument, the bonding company guarantees that a contractor / “principal” will correct defective materials and / or workmanship in a completed project.  These bonds are often written for one or two years.
  • Mystery #2: This bond is issued with a municipality as beneficiary.  It guarantees that the construction company, if allowed to disrupt public property, will restore the area after performing a contract and prevent the municipality from having to pay for such reconstruction. Hint: A plumbing contractor may need these.
  • Mystery #3: Number three is a form of financial guarantee that promises a money penalty will be paid if the construction company does not enter into a contract when expected to do so.
  • Mystery #4: This one is a guarantee that the construction company will comply with all the terms in a written contract and faithfully pay suppliers of labor and material used in connection with the project.
  • Mystery #5: Also written with a municipality are beneficiary, this bond promises that the principal will build certain “public improvements” stipulated by the municipal engineering firm. The municipality does not have a contract with the principal, nor will it pay for the work.Question mark

OK, got your answers? 

#1: This is a Maintenance Bond.  They normally are issued after the completion / acceptance of a contract.  The dollar amount is often for less than the contract.

#2: A Street Opening Bond is an example of a Permit Bond.  This enables a contractor to cut the street open for access to water and sewer connections.  If the municipality grants permission for the work, they expect it to be reconstructed in accordance with local building standards, and not at public expense.

#3: Is a Bid Bond. Bid bond amounts are often expressed as a percentage of the proposal they accompany (such as a “10% bid bond”).  This is because the actual bid amount is confidential to the bidder at the time of bond issuance.  If the bidder fails to accept an award of the contract, the bid bond penalty may be claimed by the obligee to reimburse them for going to the second (higher) proposal.

#4: A Performance and Payment Bond (aka Labor and Materialmen’s Payment Bond) is issued usually for 100% of the contract amount.  These are commonly required to protect the public interest on government contracts.  Private owners and lenders may also stipulate them.

#5: A Site Bond. Contractors sometimes ask us for these, but the correct applicant is the property OWNER, not the construction company being hired to do the work.

If the contractor furnishes this bond (we do NOT recommend this), they become obligated directly to the municipality, and must build the required public improvements even if they are not paid by the property owner.  Bad!  The site bond obligation more correctly lies with the property owner / developer.

Bonus Question: This bond is different.  It has the construction company as the obligee / beneficiary of the bond.  The “principal” (the party whose actions are the subject of the bond) are the company employees.  The bond reimburses the company for dishonest acts committed against it by its employees.  What type of bond is it?  Unscramble these letters for the answer:  

l e f i y t i d

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

Not available in all states including Idaho

Secrets of Bonding #133: “Please Sign Here” (with caution!)

 

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sign-here-arrow-2

We have written about indemnity agreements before (enjoy Secrets #19 and #79) but recent activity with our clients has inspired yet more on this vital subject.

As a follower of the “Secrets” series, you may already know what a General Indemnity Agreement (GIA) is, and that it is a requirement all bond applicants face.   Basically, it contains a payback obligation to the surety similar to a promissory note.

As a bond applicant, why should you be cautious when signing such documents?

The first reason is that it may include companies or individual people who are inappropriate. Some examples:

  • An affiliated company in which the bond applicant has a minority interest. These should be excluded if the bond client doesn’t have a controlling interest.  
  • Another example would be an individual person with little or no ownership in the company who is not married to an officer, key person or major company owner.

The second reason is that there may be clauses in the indemnity agreement that may be subject to negotiation – although underwriters tend to resist such modifications. Nevertheless, if you see something objectionable such as “Confession of Judgement” which is not even permitted in some states, you should ask for it to be removed. 

This would also be the time to ask for additions to the document, such as a dollar limitation on personal indemnity of certain individuals (Spouses? Minority owners?) or Trigger Indemnity which is only activated under specific circumstances.  No harm in trying.

The third reason is because of the gravity of the indemnity obligation. Through the GIA, the bond applicant company and its owners agree to repay the surety for losses and expenses.  They are literally putting everything on the line. sign-here-arrow-204x300

What is the dollar limit of this obligation?   Is it:

a) The contract amount? 

b) The Payment Bond amount?  or

c) The T-list of the surety? 

Answer: The liability amount is unlimited

This is a big deal. Keep in mind (see Secret #1!) “Bonds Are Not Insurance.”  The surety is a guarantor of the principal’s performance. If the contractor fails to perform, the bond is not insurance to protect them from the consequences of their failure.

In conclusion, the bond applicant should approach the signing of a GIA with some caution.  Certainly it is a document to read and manage where possible but this brings us to the final point: If you want surety bonds, it is mandatory that the surety be indemnified.  Regarding the indemnity of spouses not active in the business, they too must sign.  We tell contractors “Nobody likes it, but everybody has to do it.”

sign_here_manIf you want bonds, be cautious, but get ready to sign on the dotted line.

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 #129: What It Takes To Get a $1 Million Bond

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Here is a common fallacy held by observers of the surety bonding industry: whellbarrow money

How much cash do you need to get a $1 million bond?  The answer is NOT $1,000,000. Surprisingly, you only need a fraction of the $1 million, but you do need other elements as well.  Let’s dive in!

Our readers may be familiar with the 3 Cs of Surety Bond Underwriting: Coercion, Corruption, Cowardice.  Actually they are Character, Capacity and Capital. These describe areas of analysis that are important to the bond decision-makers.  Cash falls under the Capital heading.  Other factors are also important.

  • Character includes the applicant’s credit rating and operating history. Bill paying habits are reviewed along with references from suppliers and lenders. Character evaluates if the applicant is likely to honor their obligations under the contract and bond.
  • Capacity cover the skills of key people, company experience overall, plant, equipment and other factors.
  • Capital includes all financial resources, including Cash.

The Magic Number

Stacks of US currency

There is no magic number. When underwriters review the company financial statement they do look at the cash position.  In addition, they evaluate the Working Capital, which is the sum of cash, accounts receivable, inventory, and other items, minus Current Liabilities.  Working Capital consists of elements that will become cash during the current fiscal period (the accounting year).  For example, a dollar of “good” receivables is the same as cash to credit analysts.  So to this extent, less pure cash is needed.

Financing New Projects

One of the reasons contractors need Working Capital (WC) is to finance the start of new projects.  They must mobilize the job site, pay laborers and purchase materials – all out of their pocket initially.  As the project proceeds, it starts to fund itself. 

For the $1 million contract with the $1 million bond, would it take $1 million to finance the start?  No, it would just be a percentage of the $1 million.

The Two-Part Answer

Many bundle of US 100 dollars bank notes

This brings us to the answer. Cash is one component of Working Capital, and underwriters expect WC to equal about 10% of the bonded exposure. This could mean that the $1 million bond requires less than $100,000 cash when combined with other working capital componentsHowever, cash alone doesn’t get bonds approved.

All of the 3 Cs are equally important. Cash is not the sole basis of the decision.  A cash rich company with bad credit or weak prior experience will still be declined.  Cash cannot overcome these deficiencies.

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 # 128: The Unexpected Cause of Contractor Failure

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Why do construction companies go out of business? What reasons have you heard for companies shutting down?

  • “The economy is terrible.”
  • “There’s no work.”
  • “Too many bidders. You can’t get a decent profit and I won’t work for nothing.”

All these explanations amount to the same thing: A lack of projects resulting in low revenues, low profits and no cash flow. The situation seems obvious. When there isn’t enough work available, many contractors are forced to shut down. So is this THE BIG cause of contractor failure? Surprisingly,  no!

closed1Many construction companies fail because they have too much work. Is it possible that too much of a good thing spells disaster? We’ve all heard the stories about lottery winners who say the money ruined their lives. Suddenly they’re rich, but they weren’t ready for it. The very thing they wanted more of, turned out to be their undoing.

For construction companies, the mission is to acquire and perform profitable contracts. A tremendous amount of effort is spent in the pursuit of new work. So what can go wrong to make the volume a disadvantage, causing the demise of the enterprise?

Capital

One answer is the Lack of Sufficient Capital – both the money kind and people. As companies grow, more liquid resources (cash) are needed to finance the start of new projects and solve problems. Human resources are needed such as field supervision and back office support. Companies can fail when the office staff is unable to keep pace with the paperwork. Billings don’t go out on time, receivables are not collected, cash flow is choked off.  It is management’s responsibility to anticipate these needs and prevent the deficiencies.

Field production can suffer when the supervisory staff is inadequate. This leads to reduced gross and net profits, less available cash, the beginning of a downward spiral.

Managmentclosed2

Consider the Corner Office: Poor leadership, lack of business knowledge and inadequate financial management can be catastrophic. In addition to setting the tone and establishing the company mission, the bosses must have the technical knowledge a larger company requires.  They must be sophisticated financial managers to control resources and garner needed support from financial institutions. The successful manager of a mid-sized business is not necessarily equipped to run a large company.

New Geographic Territory

Management’s pursuit of growth can lead the company into new geographic markets (the grass is always greener.)  This may present unexpected challenges and obstacles including local union resistance, unfamiliar underground conditions, logistics problems, reduced labor productivity rates, adverse weather conditions, etc.  On the east coast (I’m a New Yorker), bond underwriters have long shared stories of NY contractors who ventured to Florida and got their butts kicked…  They say “Florida beaches are littered with the bones of NY contractors.”

Adding New Type Work

Some companies have strayed from their normal type of work in the pursuit of added revenues. They get in trouble trying to enter and compete as newcomers to the field. The company may lack the expertise (estimating, field management) for the new type work. How can you be successful in a competitive bidding environment when going against companies already entrenched in the market?  Do you take work cheap and hope for the best? “We’re losing money but we’ll make it up on volume.”

Our point of view is based on surety bond underwriting. All these issues are well known to bonding companies. When their construction clients want dramatic growth, new types of contracts or transition to a new geographic market, that’s a red flag. They come back with the hard question, “Tell us: Why this is a good idea?”closed3

Contractors may feel that sureties hold them back. Maybe they are too conservative. Do they really want contractors to grow? They think they know better than the contractor?

Actually, the surety and the contractor succeed or fail together. Having seen good clients encounter unexpected problems, underwriters know firsthand how quickly things can unravel.

Writing more bonds and bigger bonds is how bonding companies grow. Certainly, construction companies must grow to survive, and being bigger can be better.  But uncontrolled growth is the major cause of contractor failure that sureties, and contractors, must avoid.

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.