ConstructionPro Week, Volume: 3 - Issue: 23 - 06/06/2014

Are Bonds of Any Value to the Bonded Contractor?

By Bruce Jervis

 

Contractors are frequently required to furnish payment and performance bonds. It is mandatory on most public projects and common on private projects. The bonds guarantee the contractor’s payment of its debts and performance of the work. When a project owner requires bonds, the owner is the “obligee,” the recipient of the guarantee. When a prime contractor requires a subcontractor to furnish bonds, the prime is the oblige.

 

Corporate sureties go to great lengths to mitigate their risk when issuing bonds. If the bonded contractor defaults, triggering the bond obligation, the surety has almost unfettered discretion in dealing with the situation. Bonded contractors (and frequently their individual owners) are then liable for indemnifying, or reimbursing, sureties for all expenditures.

 

The strength of a corporate surety’s position was illustrated in a recent case. When two subcontractors filed claims against a contractor’s payment bond, the surety demanded the contractor post collateral equal to the amount of the claims and the cost of defending the claims. The contractor failed to post the collateral. The surety, without the participation or consent of the contractor, negotiated settlements with the subcontractors and sued the contractor for all costs and expenditures. The contractor cried foul, but to no avail. A federal appeals court ruled that the surety had acted within the terms of the bond agreements.

 

Given this all-too-familiar scenario, are bonds of any value or protection to bonded contractors? Bonds protect obligees against contractor default. Sureties go to great length to protect themselves as much as possible against bond losses, usually at the contractor’s expense. But, for the bonded contractor itself, are payment and performance bonds anything more than a necessary cost of doing business? I welcome your comments.

 

COMMENTS

There are two things I can think of right away that could be of value to the contractor issuing bonds.

They could get more favorable credit from suppliers and bonds can reduce competition especially from unqualified contractors who may give ridiculous bids.

Of course the Sureties protect themselves. They are simply putting up a financial guarantee for their client so that the client doesn't have to post huge amounts of collateral to the owner or GC. Just ask the smaller contractors who used to have to provide cashier's checks to bid TxDot work in years past.
Posted by: Steve Schutze - Friday, June 06, 2014 10:30 AM


As a business owner for the past 13 years, and having successfully won many government, state, municipal, and private contacts all requiring the bonding mentioned above, I would say cost of doing business.

The principles behind the bonding are understandable, but are primarily for the client and almost useless to the contractor having to provide them. They are also another expense that a contractor has to finance up front and hope to get paid back on time and not months later. We contractors are already financing most of the projects for the client. By financing I mean we are providing the design & engineering, equipment, material, labor, bonding, permitting and expenses up front and billing for draws or work completed later. Every project we have worked on in 13 years has never been paid on time per contract terms, sometimes days & weeks late but most of the times far longer. Thus the term financing a project.

Since financing projects is really what a contractor does when they are awarded a contract that they bonded, the bond itself becomes almost useless to them. The majority of the bonding should be for the contractor not the client. The contractors that are not being paid for completed contract terms or are having to wait months outside agreed payment terms are far more than clients getting "stiffed or burned" by a bonded contractor. Depending on the many numbers available the national average is over 80% of contractors are slow paid, not paid at all, or settling for less than agreed to terms just to get paid. This gets us to the absurd portion of bonding, try to use the same bond you paid for to get the contract and protect the client from you, to collect the money owed to you from the client not paying you per bonded contract terms. Goodluck!

Mr. Schutze has two valid points, but from my experience they have not benefited us in any form. We see just as many ridiculous bids from bonded or bond-able contractors, and contractors that are not bond-able are not even a factor. Getting more favorable credit because of bonding only comes after being in business for quite some time. When I first started this company 13 years ago, my personal credit & property owned allowed for my credit lines with suppliers and bonding companies. Then after many years in business and my D&B rating that came primarily from the suppliers, & having already pulled several bonds, did we get better bonding rates.
Posted by: Mike West - Friday, June 06, 2014 12:36 PM


We are contractors specializing in Historic Restoration and do many projects with a portion or all of the funding through state or federal grants, which require bonding. In almost all cases, the bond does absolutely nothing to benefit either the project owner or the contractor. To the project owner, they provide a false sense of security, as the bonding companies "pre-qualify" the contractors, but in fact, their system of qualifying a contractor for bonding is no different than what a bank does for a loan applicant. In the end, they show that the contractor is able to repay the value of the bond, should it be called, but they determine nothing about the contractor's qualifications to complete the project. The requirement for bonding significantly drives up the bids, as many otherwise qualified contractors are excluded from bidding by the lack of a bond.

As to the contractor, this is just another cost, just another hurdle, and a significant one at that.

Furthermore, last year I did a bonded project as a sub and discovered part way through the project that the bonding agent was under a 20 count federal indictment for various alleged acts of fraud, even while he continued to issue bonds for government projects!

So who's bonding the bonding companies??
Posted by: Tom Pahl, Heritage Building and Design - Friday, June 06, 2014 1:01 PM


Well said by all of you. This bonding issue is designed to protect the owner who is suppose to be paying for the project. He is paying for that protection when he requires it. It doesn't help the subcontractor, but may help the General Contractor in the event his sub encounters a problem during the course of a project. The other side of this is it usually requires a company with a fairly large overhead to meet the bonding requirements as they are looking at the companies total net worth in determining the amount of risk they are willing to assume depending on the size of the job. Here is one example of why? If you hired a small business man and he started a 9 month project for you and sometime during the course of the project he came down with cancer and died or got into a plane wreck or got shot accidentally on a hunting trip or many other unforeseen tragedies this life can throw at you, at least the general is not left standing on the curb with his hand out to finish a project with un recoverable expenses. So with that said, I can see the need as long as the customer realizes they are ultimately the ones paying for the bond in the long run. You simply add it to the cost of the job. Unfortunately the little guy pays more for the bond because he doesn't have the clout the big guy does, but he should not have the overhead expense the big guy has either.
Posted by: Mark Foree - Friday, June 06, 2014 2:54 PM


Hmmmm. Maybe time to consider going into the bonding business. Or time for the NAHB or AGC to provide a fair bonding system beneficial, or at least not damaging, to contractors.
Posted by: Gary R. Collins, AIA - Friday, June 06, 2014 3:00 PM


One more comment: in order to get 1M liability insurance, I don't have to pledge my home and assets against a potential claim...it's insurance, not a loan. But for bonding (in CT) that's exactly the drill, as though I'm taking out a loan equal to the value of the project. If that's how it is to go, why is it a part of the insurance industry and not banking?

A better way would be for bonding to be an insurance, available to those who pay the premium and calculated as a risk in the same way. Somewhere deep inside this business, something stinks, IMHO.
Posted by: Tom Pahl. Heritage Building and Design - Friday, June 06, 2014 9:15 PM


Bonds cannot be done as insurance mostly because insurers do not cover the conducting of business per se as a risk. Also, bonds are a three-party contract that guarantee performance (something insurers will not do).
Posted by: Brian DeBruin - Saturday, June 07, 2014 7:46 AM


Also, if you can't collect money owed to you from the client not paying you per bonded contract terms, the client is in breach of contract. This is a bad position for the client to be in as the bond then becomes useless to the client because the client has obligations in the bond to perform their side of the contract (e.g., payment terms). This doesn't help the contractor in collectiong but it is a significant incentive.
Posted by: Brian DeBruin - Saturday, June 07, 2014 8:00 AM


 









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