Secrets of Bonding: Show Me The Money!

Laurel and Hardy. Ben and Jerry. Bonding companies and money. They just go together!

Let’s take a look at the focus bonding companies place on money when providing Bid and Performance Bonds. It’s a matter of survival. If called upon, the surety hopes to complete the project with the remaining (unpaid) contract funds. We will see that they track a number of elements. Learn about them here so you know what’s ahead.

Of course there is a significant financial evaluation of the applicant (the construction company), a subject we have written about extensively. Visit the index of article subjects in the “Secrets” web site. Here we will talk about just the bonded construction project.

An early money question is “how is the work funded?” Most bonded jobs are public work. This means the project is paid for with tax dollars. On private contracts, the work can be funded in a number of ways. For commercial building, the project owner may have a construction loan or set funds aside in an escrow account. In any event, the bond underwriter wants to be sure the contractor will be paid after they incur costs for labor and material. Not being paid could cause the company to fail and result in claims on all open bonds.

Regarding the new contract, the surety will ask:

• How often will the contractor be paid?
• Is a portion of the contract amount paid up front, immediately when the work commences?
• Are there Liquidated Damages – a financial penalty assessed per day for late completion of the work?

Once the contract is underway, the surety wants to monitor the money:

• Is the job proceeding profitably, and therefore headed for a successful conclusion?
• Do the contractors billings correlate with the degree of completion? It can be dangerous when they get too far ahead by billing the job aggressively.
• Are suppliers of labor and material being paid on a current basis (by the contractor / surety client)?
• Is the project owner paying the contractor in accordance with the written payment terms?

Sometimes underwriting issues are resolved by using a “funds administrator.” This procedure is intended to enable the contractor to perform the work, while the money handling is performed by a professional paymaster. The paymaster pays all the suppliers of labor and material, plus the contractor. This procedure minimizes the possibility of claims under the Payment Bond.

When the project reaches a conclusion, there are some important transactions at the end:

• Final payment – the contractor collects the last regular payment under the contract. There may be a requirement for the bonding company to issue a consent for this payment to be released. If there are any problems or issues, they may withhold such approval. Underwriters may ask to see lien releases (from suppliers of labor and material) to assure that everyone has been paid – thereby assuring no Payment Bond claims.
• Release of Retainage – the contractor may now collect a percentage of the contract amount that was methodically held back (retained) as security for the protection of the project owner. Surety consent may be required for this, too. The owner will not release this money unless all the loose ends are resolved, referred to as a “punch list.”
• Bond “overrun” premium – normally the surety is automatically required to cover additions to the contract amount. Therefore, they are entitled to an additional premium for such exposure. If not collected during the life of the project, this would be a clean-up item at the end. Sometimes a refund is issued for an “underrun” (net contract reduction.)

Bonus question: Why do some underwriters require premium payment in advance for Performance and Payment Bonds?

Answer: Unlike insurance, surety obligations (P&P bonds) are not cancellable. Therefore, if the underwriter doesn’t get paid the bond premium, they are still “on” the risk!

Conclusion

Surety underwriters strive to bond reputable, capable companies. But there is no avoiding the financial aspects that pop up during the life of all bonded projects.