working capital

Secrets of Bonding #160: Deep in the Weeds with Set Aside Letters

In this article we will peel back the onion on Set Aside Letters (SAL) issued by banks in connection with construction loans.  What are they, when they are useful for bonding companies and when are they not?

Here is the essence of such documents:

“The agreement covering the project will provide that the funds in said impound account are … to be disbursed for payment of the (Name of Project) mentioned above and only after (Bank) has satisfied itself that the work paid for has actually been performed… In the event (Borrower) fails to complete the project described herein… all funds remaining in said impound account shall be immediately available to Surety to complete and pay the costs of said project, and in such event, (Borrower) waives any claim or interest in the remaining funds. Surety shall not in any way be obligated to repay said funds so used to (Bank).

This is an irrevocable commitment of funds which is not subject to recall or offset by (Bank).”

Pretty interesting!  This letter / agreement keeps the loan in play to fund the completion of the project  – even if the borrower (bank customer) fails / defaults.

When Are Set Aside Letters Used?

These documents are a common underwriting tool when a Site or Subdivision Bond is issued by a surety. If the bond applicant (who is also the developer and borrower) is relying on a construction loan to fund the bonded work, the SAL protects the surety by providing funds for the completion of the work in the event of a default.

What a great idea.  So why don’t we use these on everything?  Let’s look at another example.

Commercial Projects

The project owner hires a bonded contractor and a bank loan will fund the project.  The bank needs a guarantee that the asset / project (which backs the loan) will be built as intended.  A Performance and Payment Bond accomplishes this and assures there will be no Mechanics Liens against the property for unpaid bills.  These two aspects benefit the project owner and the lender.  Keep in mind, in a borrower default situation, the bank becomes the new owner of the property.

It is common for the bank to stipulate that a bonded contractor be used, and they may want to be a named beneficiary on the P&P bond – accomplished by issuing a Dual Obligee Rider.  In turn, should the underwriter require a SAL from the lender?

On Commercial projects, the normal practice is to NOT obtain a SAL from the lender.  Why not?  Why is this different?

Choose one:

a. The bank is a secured lender

b. The bank can subrogate against the borrower’s assets

c. The Dual Obligee Rider serves a purpose similar to the SAL

a. and b. are true, but the answer is c.

Welcome to the Weeds

We’re going in now. The Dual Obligee Rider adds the lender as a beneficiary with all the rights and obligations of the obligee named on the bond (the project owner).  And what are they?  Obviously they are entitled to make a performance claim and have the project delivered as indicated in the contract.

The named obligee also has obligations, one of the most primary is to PAY the builder. Important: The obligee is prohibited from making a performance claim if they have failed to pay the contractor.

Therefore, when the bank is included under a Dual Obligee Rider, they accept the benefits and obligations.  If the borrower defaults, the lender cannot make a bond claim unless they continue to pay the construction loan to the surety.  (Now the bank owns the project and the surety has become the contractor.)

Summary

Is this starting to make sense?  When a borrower defaults on a commercial project, a lender included by Dual Obligee Rider cannot make a claim unless they continue to pay the project funds to the surety.

Deeper Weeds

On Site and Subdivision there is a unique risk – the lender can take a free ride on the surety by having the bonding company pay out of pocket to complete the project.

Site and Sub-D bonds have the local municipality as obligee, not the bank.  The bank doesn’t want a Dual Obligee Rider because they automatically receive a financial benefit if the municipality makes a bond claim to demand completion of the project.  If the borrower has defaulted, the bank has the opportunity to withhold the balance of the loan (the borrower is gone), and watch the surety pay to complete a project they now own.  And they were not even the bond claimant…

This is the risk sureties avoid on Site and Subdivision Bonds by requiring the SAL that keeps the loan in play, even if the bond applicant / borrower has failed.

Admittedly, this is a pretty obscure subject, but also interesting to us “bond nerds.”  It never hurts to understand how things fit together.  These skills help us solve your complicated bond opportunities.  Take advantage of our expertise when the next one pops up.

KIS Surety is the national contract bond underwriting department for Great Midwest Insurance Company, a national, corporate surety with an A-8 rating.  We throw all this underwriting talent at your bond opportunities and support contracts up to $10,000,000.

If you have a contract surety case that needs a fast, creative response, call us: 856-304-7348

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SECRETS OF BONDING #157: Bid Bond Quiz

Is there anything less interesting than a bid bond?

They may not seem too exciting, but the lowly bid bond is an integral part of our surety business.  For contractors, they are often the key to acquiring new revenues.  If you don’t think they are important, watch what happens when a client is waiting for one that never arrives.

As surety underwriters, we spend a great deal of effort assuring these documents are accurate, delivered on time, and we track the outcome on each one.

Everybody knows about bid bonds, right?!  OK let’s see if you do…

True or False:

  1. If you decide to not use a bid bond you ordered, you have to send it back to the surety within 48 hours
  2. They have an expiration date
  3. A bid bond precedes every performance bond
  4. The surety can cancel the bid bond
  5. The dollar value of the bid bond equals the amount of the proposal it accompanies
  6. The surety must know the exact dollar value of the bid bond before they will issue it
  7. The premium for them must be paid in advance
  8. They remain active for up to six months
  9. It is better to use a check for security than a bid bond
  10. The same surety that issues the bid bond must issue the performance bond

OK team, how’d you do?  # of True______? # of False____?

They are all False!

  1. An unused bid bond has no value but it makes a great liner for your bird cage
  2. Never has an expiration date
  3. Some contracts are negotiated (no bid bond) or may require a surety capacity letter instead
  4. Like a performance bond, these surety instruments cannot be cancelled
  5. Most often the penal sum of the bid bond equals a percentage (10-20%) of the proposal amount
  6. Most bid bond amounts are expressed as a percentage of the proposal amount, not a dollar amount, to protect the confidentiality of the proposers bid. In such cases the exact dollar value is unknown in advance.
  7. Sureties are entitled to charge for them, but usually don’t
  8. Although not stated, most sureties consider them void after 90 days
  9. Wrong! If the performance bond is not produced, the check can be forfeited
  10. Nope! Two different sureties can be used, even if a “Consent of Surety” was issued with the bid bond.

Bonus Question: If the bid is rejected because the surety’s credentials are found to be inadequate, can this result in a bid bond claim?

Answer: Theoretically, it should not. If the bond is declared inadequate, how can it be sufficient for a claim?

When flexibility and aggressive underwriting are needed, give us a call. We have in-house authority for Bid and Performance Bonds up to $10 million each, and guarantee a same day response.  Find out what you missing when it comes to surety bonds.  

KIS Surety Bonds, LLC is the exclusive surety underwriting department for Great Midwest Insurance Company an “A – 8” carrier licensed in all states plus D.C.  “steve@kisbonds.com” or call 856-304-7348.

Secrets of Bonding #154: Be A Bean Counter (The Importance of Bid Results)

It’s not sexy.  Nobody has it on their business cards.  It may not be in your “official” job description.  But this article is the start of your new vocation as an official Bean Counter!

A major area of surety bonding is “Contract Surety.”  This refers to bid and performance bonds for construction contracts.  When we set up a new account, an amount of bonding capacity is established and the individual bond requests are processed within that line.  It is possible for a client to use up the full capacity of their line, then our underwriting department could consider granting an exception to support additional work.

Efficient management of the line can minimize instances where an exception is needed.  Here’s where the bean counting comes in.

We manage bonding capacity the way a bank runs a credit line.  A series of individual transactions (bonds) can equal the full capacity amount (referred to as the “aggregate”).  Bank credit lines work the same way.  For the bond or bank customer, it is advantageous to maximize the available credit.  Prompt reporting of bid results helps accomplish this objective.

Advantages Of Reporting Bid Results Promptly

  • When a bid bond is approved / issued, the underwriter debits the amount against the aggregate capacity. However, the full contract amount is used, not the dollar value of the bid bond.  For example, a 10% bid bond for $100,000 actually uses $1 million of aggregate capacity.  Therefore, when it is known that the bid is not likely to result in a contract award (the client is not “apparent low bidder”), this fact should be reported so we can restore the capacity.
  • Detailed bid results are needed on low bids in order to process final bonds. Example: Our guy has a low bid for $5,000,000. The second bidder is at $5,400,000.  Third bidder submitted $5,550,000. Because our bid is less than 10% below the second bidder, the adequacy of the contract amount is supported.  If our client is more than 10% below the second bidder, there will be an additional evaluation before proceeding with the P&P bond.
  • Bid Spreads – in cases where the bid spread is excessive, it is important to have a prompt discussion with us. If there is a bid calculation error, and the contract price is inadequate, there is a limited amount of time to withdraw the bid without penalty (such as a bid bond default / claim).  Learn more about bid spreads:  Click!
  • Low bids may be for lesser amounts than the original bid approval. Example: We approve a bid for an estimated contract amount of $9 million, but the actual bid goes in at $8,500,000 due to last minute changes and reductions. Therefore, when the low bid results are reported, $500,000 in capacity is restored to the aggregate.
  • Postponements – sometimes bids are postponed at the last minute, with no immediate reschedule date. The bid approval may never be used. If it dies on the vine we will restore the capacity immediately.
  • Withdrawal – clients may decide not to bid a project after ordering the bid bond. They may have determined that the plans are unclear or unacceptable.  Advise us so capacity can be restored.

If you are now sufficiently impressed with the importance of minding these small details, you may don your green eye shade and declare yourself an Official Bean Counter.  It’s not glamorous, but it is necessary for proper management of the bond account.  (Actually, we think it is glamorous!)

~ ~ ~

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.

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Secrets of Bonding #151: It’s Time For…Timing!

With Surety Bonds, Timing can be critically important.  There are certain things that must happen first.  You can’t get them out of order. Here are some examples.  Do you know which comes first, and why?

Cover the answers with a piece of paper as you scroll down. (Paper is white stuff people used to write on. Really!)

  1. Bid Bond / Performance Bond
    • OK that was an easy one. They get harder. Bid bonds always come first – if there is one.  Not all performance bonds are preceded by a bid bond. Negotiated projects would be an example.
  2. Bond execution / Indemnity Agreement execution
    • The Indemnity always comes before the bond. It is the promise to pay back the surety in the event of a claim / loss. Sureties want this protection in place before they assume any risk.
  3. Surety Consent to Final Payment / Obligee Status Inquiry Form
    • The Status Inquiry form comes first. It is the obligees statement that the work is acceptable.  The surety requires to see this before agreeing to release the final payment.  If there are unresolved issues, the contractor must address them before the last contract funds come over. (That’s true motivation!)
  4. Payment Bond Release (exoneration) / End of Lien Period
    • Since the bond guarantees the payments that may be owed during the lien period, the time for liens must end before the bond is concluded.
  5. Contract Acceptance / Maintenance Bond Issuance
    • Sureties want the contract accepted first and the P&P bond released before assuming the risk associated with a Maintenance bond. Some obligees require issuance of the maintenance bond simultaneously with the P&P bond at the start of the project, but underwriters resist this.
  6. Bid Results / P&P Bond Issuance
    • Underwriters want to evaluate the adequacy of the contract price prior to bond issuance. They do this by evaluating the bid results, comparing the various proposals from different companies.  In some cases, the bid results are not published, in which case they have wing it!
  7. P&P Bond for Started Project / All Right Letter
    • The All Right letter is the obligee’s assurance that there is not already a problem on the contract that will result in an immediate bond claim. Sureties require a clean bill of health before bonding a started project (unless the degree of completion is very low i.e. 5%).
  8. Award Letter / Notice to Proceed
    • Award letter comes first, then the contract signing and Notice to Proceed is issued. Then “Grab ya hamma!”
  9. Tough Bond Problem / Call KIS Surety!  856-304-7348
    • You can call us for discussion or general info any time. However, when a tough bond problem arises, that’s your cue to call in the experts. 

KIS Surety is the national contract bond underwriting department for Great Midwest Insurance Company, a national, corporate surety with an A-8 rating.  We throw all this underwriting talent at your bond opportunities and support contracts up to $10,000,000.

If you have a contract surety case that needs a fast, creative response, call us: 856-304-7348

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Secrets of Bonding #148: The Greatest Impediment to Bonding

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.

KIS Surety is the national contract bond underwriting department for Great Midwest Insurance Company, a national, corporate surety with an A-8 rating.  We throw all this underwriting talent at your bond opportunities and support contracts up to $10,000,000.

If you have a contract surety case that needs a fast, creative response, call us: 856-304-7348

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Secrets of Bonding # 142: Make Bid Bonds Great Again!

 

You used to love them.  They were so easy.  Now they are in dollar amounts and percentages, sometimes with a limited maximum value.  They can be electronic or digital.  Sometimes a letter is required instead.  Sometimes nothing is required instead! There may be a single or annual charge for it or maybe it is free! It’s outta control…

So here is your chance to catch up with everybody’s favorite: The fun and fascinating world of Bid Bonds.

The Basics
These instruments accompany a contractor’s proposal during the acquisition process for a new project.  This is routine on public work, such as federal state and local municipal contracts.  The procedure may also be used on private projects at the contract owner’s discretion.

The bond guarantees that, if awarded, the bidder will sign the contract, furnish the required Performance and Payment Bond, and commence with the work – or – pay the difference between their bid and the next higher bidder (subject to the maximum dollar value of the bid bond.)

Cost
Usually free although the surety is entitled to charge for them.  Typical charges could be an annual bid bond service fee or a per bond charge.

Underwriting
The decision to issue the bid bond is based on the underwriter’s willingness to provide the related P&P bond, because that is the real money transaction. The decision is NOT based on the dollar value of the bid bond.  Rely on the fact that the underwriter will not provide the bid bond if they do not feel they can support the final bond.

Bid Spreads
If the bidder is more than 10% below the next bidder without a plausible explanation (we have a special machine,  already have materials, are already working next door, we’re super fabulous, etc.) the surety could decline the final bond, resulting in a bid bond claim.

Alternative Forms of Security
In addition to a bid bond, proposals may also be secured using a cashier’s check or irrevocable letter of credit, depending on what the project owner (Obligee) is willing to accept.

Percentages
The Invitation or Bid Solicitation describes the proposal requirements.  It will state if a bid bond is required and the amount.

The bond value is often expressed as a percentage. Example “20% of the attached proposal amount.”  This is convenient because the underwriter doesn’t want to know the actual bid amount (to preserve the bid confidentiality).  It is the best way to express the exactly correct amount when typing the bond in advance.

Capped
Because the percentage bond actually has an unknown dollar value at the moment it is executed, language is sometimes added establishing the most it can be worth (to prevent a wildly high amount the underwriter didn’t expect).  Example, “10% of the attached bid, not to exceed $100,000.”

Fixed Penalty
“Bond Penalty” is the term used to express the bond dollar value.  A fixed penalty bond has a stipulated amount, regardless of the bid.  Example, “Maximum bid bond amount required: $20,000.”

Surety Letter
Some owners choose to require a letter from the bonding company, but no bond. Federal projects are handled this way at times.  The letter talks about how much they love the client and the contracts they are willing to bond.

Consent of Surety
This letter is the surety’s written promise to issue the P&P bond if the contract is awarded.

Electronic
A scanned copy (pdf) of the executed bond may be acceptable for an online bid.

Digital
Some state departments of transportation use this.  The surety registers with the obligee in advance and the bid bond is “filed” online using a unique identification number.

No Free Lunch
If you default (cause a bond claim), the surety will come after the contractor, it’s owners and spouses for recovery.  Remember: Bonds are not insurance.

Funky Land
Now some of the weird stuff:

  • You may encounter a bid bond requirement, but no final bond (P&P bond) to follow
  • Can also have the opposite: No bid security required but a final bond is needed
  • No! You are not required to use the same surety for the bid and final bonds – although the bid bond provider fully expects to write the final bond and may hunt you down and kill you. (Just kidding!!!)
  • Yes! If you obtain a bid bond under the promise to provide collateral, you are allowed to get the final bond from a different surety that is not demanding collateral. (But you face the hunt and kill thing again)
  • When you acquire a project using a Consent provided by ABC Surety (their promise to provide the bond upon award of the contract), you are not prohibited from taking the final bond from XYZ Surety. However, good protocol dictates that you remain loyal to those who enabled you to acquire the job (meaning ABC).

Make Bid Bonds Great Again
So there you have it.  These instruments are fussy and sometimes complicated.  It is imperative that they be executed correctly and filed on time or it can cause the bid to be thrown out (loss of contract.)  This always makes people very crabby (Read: LAWSUIT).

The key is to review the written bonding requirements as described in the bid advertisement. Use any mandatory bond forms that are stipulated and double check the correct execution and typing of the document including name spelling, job description, project identification details and the correct bid bond amount.

Now that you know, you can start to love bid bonds again!

KIS Surety is the national contract bond underwriting department for Great Midwest Insurance Company, a national, corporate surety with an A-8 rating.  We throw all this underwriting talent at your bond opportunities and support contracts up to $10,000,000.

If you have a contract surety case that needs a fast, creative response, call us: 856-304-7348

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)

Secrets of Bonding # 141: Surety Bonds and Zombies

Zombies are bad.  They eat your flesh and brains.  Who wants THAT?!

Same goes for your construction business.  There are zombies that can ruin your bonding and eat up your business – destroy profits and your credit rating.  But the worst part is… it’s preventable!   

Does the zombie have a name? Yes, accountants call it “Fixed Overhead.”  This is a controllable expense that, if left unattended, can eat your flesh and brains (figuratively.) Let’s define the monster:

Fixed Overhead – Construction companies incur common fixed overhead costs. These are costs that do not vary with the level of the company’s output such as: accounting fees, advertising, insurance, interest, legal fees, labor burden, rent, office expenses, salaries, repairs, supplies, taxes, telephone bills, travel expenditures, and utilities. 

Now consider Variable Overhead – These costs vary in proportion to the amount of production. Variable overhead mostly relates to hourly indirect labor costs, supplies and utilities such as electricity, gas and telecommunications expenses.

The danger of fixed overhead is that, during times of reduced volume / revenues, the expense does not automatically go down. This means when sales are weak, your expenses do not diminish proportionately.  These bills keep rolling in relentlessly.  They just don’t care!

The only hope construction managers have is to be cautious when incurring such expenses, and always work to reduce them so the company can survive the inevitable troughs that come between the peaks of activity.

Here are 40 ideas that may help reduce / eliminate fixed overhead:

  1. Lease-purchase options for vehicles and equipment
  2. Employ part-time mechanics and administrative staff
  3. Pay employees for use of their vehicles
  4. Keep equipment longer
  5. In unprofitable years, slow down depreciation schedule
  6. Overhaul facilities and equipment instead of purchasing new
  7. Review / quote insurance annually. Consider self-insurance or association captives. 
  8. Eliminate overlapping insurance coverages
  9. Improve safety program
  10. Examine Workers Compensation classifications
  11. Consider increasing deductibles
  12. Eliminate over insurance, such as reducing inventories
  13. Deactivate, de-register and uninsure unused vehicles
  14. Challenge property valuations (taxes)
  15. Avoid the expense of audited financial statements if possible
  16. Reduce accounting fees by assisting your CPA
  17. Consider using a local CPA rather than a national firm
  18. Lease unused space
  19. Consider a smaller building
  20. Consider high density stacking and storage systems
  21. Renegotiate rent or move
  22. Get indefinite lease with 6-month cancellation rather than fixed term
  23. Pay moderate salaries with bonuses for exceptional performance
  24. Reduce number of management staff
  25. Reward managers with stock instead of cash
  26. Trim fringe benefits (deferred compensation, automobiles, club memberships, etc.)
  27. Cut managers first
  28. Pay bonuses to field staff first
  29. Pay raises based on merit, not cost of living
  30. Cross train office staff to eliminate temporary employees
  31. No vacations during “busy season”
  32. When hiring, seek individuals whose employment qualifies for tax credits
  33. Four day work week
  34. Charge employees for replacement tools
  35. Put company ID on tools, keep records
  36. Centralize tool storage with check in / out system
  37. Close dormant companies
  38. Consider solar panels and solar water heat
  39. Monitor unemployment claims
  40. Consider an office maintenance service instead of employing a janitor, or use a part-time after hours person

Conclusion

Companies can achieve better financial performance, support their bonding and banking and survive the weak years by controlling these relentless expenses. 

Remember: You can’t kill a zombie because technically they’re already dead.  And you can’t entirely eliminate fixed overhead either – but good managers work to control it.

KIS Surety is the national contract bond underwriting department for Great Midwest Insurance Company, a national, corporate surety with an A-8 rating.  We throw all this underwriting talent at your bond opportunities and support contracts up to $10,000,000.

If you have a contract surety case that needs a fast, creative response, call us: 856-304-7348

(Don’t miss our next exciting article.  Click the “Follow” button at the top right.)