How to navigate 'the 3 Cs' of construction bonding

{"version":"0.3.0","atoms":[],"cards":[],"markups":[["a",["href","http:\/\/www.eci.build\/","target","_new"]],["a",["href","https:\/\/www.travelers.com\/business-insurance\/surety-bonds\/index.aspx","target","_new"]],["a",["href","http:\/\/www.swlaw.com\/","target","_new"]],["em"],["a",["href","http:\/\/www.constructiondive.com\/","target","_new"]]],"sections":[[1,"p",[[0,[],0,"\u0022Payment and performance bonds required.\u0022 Those words can signal a giant dead end for some contractors who would like to bid on public work or large private projects but haven\u0027t yet waded into the bonding world. However, the bonding process doesn\u0027t have to be mysterious or sweat-inducing as long as companies are equipped with the right information."]]],[1,"p",[[0,[],0,"The most common types of construction bonds are performance and payment bonds, which are kinds of surety bonds. A payment bond guarantees the owner that the contractor will pay all the supplier and subcontractor bills associated with the project, and the performance bond is the owner\u2019s assurance the project will be completed in a timely manner and with high quality."]]],[1,"p",[[0,[],0,"Those who have bumped into bonding requirements on past jobs might have seen a \u0022bid bond\u0022 requirement. This is a bond that guarantees the owner that the contractor will be able to meet the requirements of the contract for the amount of the submitted bid. But if a company has bonding capability for performance and payment bonds, these aren\u2019t usually a problem to secure."]]],[1,"h3",[[0,[],0,"Surety, but not insurance"]]],[1,"p",[[0,[],0,"But before delving into what surety bonds are, let\u2019s first address what they are not. Even though surety bonds are obtained from an insurance company, they are not insurance."]]],[1,"p",[[0,[],0,"\u0022I think a lot of the reason it gets confused with insurance is our delivery method,\u0022 Bill Reidinger, senior vice president of surety at Assurance, told Construction Dive. \u0022It\u0027s through insurance agencies, but it\u0027s really a credit instrument that\u2019s provided by an insurance company.\u0022"]]],[1,"p",[[0,[],0,"With general liability insurance, for example, if there is a valid claim against a policy, the insurance company will pay it. The repercussions might be a more expensive policy with increased premiums, but the insurance company absorbs the lion\u0027s share of the cost. That isn\u0027t the case with performance and payment bonds. Any claims the surety pays become the contractor\u2019s responsibility to pay in full. If the company can\u2019t pay, then the surety will seek reimbursement from the principals of the company."]]],[1,"p",[[0,[],0,"\u0022They\u0027re a financial partner,\u0022 Mary Devolt, chief financial officer of "],[0,[0],1,"Englewood Construction"],[0,[],0,", told Construction Dive. \u0022They\u2019re putting skin in the game.\u0022"]]],[1,"p",[[0,[],0,"This partnership is why the process to obtain payment and performance bonds can be so rigorous. Reidinger said that because these types of bonds can be likened to a line of credit, the qualification process is similar to the experience of trying to obtain a bank loan."]]],[1,"h3",[[0,[],0,"Three Cs of bonding"]]],[1,"p",[[0,[],0,"Bob Raney, executive vice president of construction services, bond and specialty insurance at "],[0,[1],1,"Travelers"],[0,[],0,", said financial considerations, like how much money someone has in the bank and credit history, are important in the bond qualification process; but so is someone\u0027s project history."]]],[1,"p",[[0,[],0,"\u0022Bonding can be wrapped up with the three Cs \u2014 character, capacity and capital,\u0022 Raney told Construction Dive."]]],[1,"p",[[0,[],0,"An examination of the \u0022character\u0022 element looks at a contractor\u2019s proven project track record, which means the surety will be on the lookout for prior contract defaults and evidence that the company has met its prior contract obligations, Raney said."]]],[1,"p",[[0,[],0,"The \u0022capacity\u0022 portion of the equation reviews contractor resources. This is where the surety determines if a contractor has the skill, experience, employees and equipment to perform the work."]]],[1,"p",[[0,[],0,"\u0022Capital,\u0022 according to Raney, means how the contractor\u2019s balance sheet looks, as well as credit history, cash flow and working capital."]]],[1,"h3",[[0,[],0,"Be prepared for scrutiny"]]],[1,"p",[[0,[],0,"Devolt said the financial aspect of the surety company\u2019s review can often be the most time-consuming part, which is why contractors need to start building a relationship with a surety as early as possible and start practicing some serious financial housekeeping."]]],[1,"p",[[0,[],0,"\u0022Clean up your internal and reporting systems, make sure your (financial) ratios look good and start forming that relationship before you all of a sudden decide you want to go after a $20 million bond,\u0022 Devolt said."]]],[1,"p",[[0,[],0,"In addition, Devolt said contractors shouldn\u0027t be be surprised by the extent of detail the surety will want to see. She said smaller companies might have in the past gotten away with a simple compilation of their books to demonstrate financial strength, \u0022but maybe now they need to have a review or maybe they need to have an audit. It just depends on their level.\u0022"]]],[1,"p",[[0,[],0,"Devolt said that no matter the company size, contractors should expect scrutiny. Since the Great Recession, owners and their lenders are looking for that extra security a bond provides, she noted. In addition to most public projects where payment and performance bonds are required, Englewood\u2019s private owners are increasingly demanding them as a risk management tool. As a result, Devolt said Englewood has bonded approximately $16 million in 2015, a substantial uptick from previous years."]]],[1,"p",[[0,[],0,"Reidenger said, \u0022I think everyone was just a little bit on edge after the economic downturn and the collapse of many of the construction firms that they were doing business with.\u0022"]]],[1,"h3",[[0,[],0,"Exploring alternatives"]]],[1,"p",[[0,[],0,"Given such a demanding qualification process and the relative high cost of surety bonds, it\u0027s no wonder some owners and contractors are exploring alternatives. For general contractors, a suitable alternative might be a letter of credit from their bank to the owner. In fact, Reidinger said, surety bonds are an American invention, and letters of credit are commonplace internationally."]]],[1,"p",[[0,[],0,"Reidinger said that when a contractor provides an owner a letter of credit, usually 10%-25% of the contract amount, the owner \u0022has the ability to pick up the phone and draw down on the letter of credit, and the bank has to send them cash.\u0022"]]],[1,"p",[[0,[],0,"\u0022The problem with that approach,\u0022 he added, \u0022is it puts a financial strain on the contractor. He loses the ability to borrow money for working capital because of funds set aside for the letter of credit.\u0022"]]],[1,"h3",[[0,[],0,"Bonding concerns during work"]]],[1,"p",[[0,[],0,"After the initial bonding process is settled and work is underway, bonding questions are far from over. Projects bring the possibilities of disputed change orders, weather delays, antagonist relationships between a project manager and the owner\u0027s rep, and countless troubling scenarios. "]]],[1,"p",[[0,[],0,"For example, if a contractor hasn\u0027t paid a few subcontractors for extra work they did because they\u0027re waiting for the owner to pay them, then the subs \u2014 who have already complained about payment to the owner\u2019s rep \u2014 are now grumbling about filing a claim against the project payment bond. And the owner is talking breach of contract because the subcontractors won\u2019t do any more work unless they get paid."]]],[1,"p",[[0,[],0,"Attorney Mark Johnson, a partner at "],[0,[2],1,"Snell \u0026 Wilmer"],[0,[],0,", said it\u0027s smart to put into the project contract a clause that says upper-level management will get involved in the negotiation of disputes."]]],[1,"p",[[0,[],0,"\u0022You\u0027d be surprised how many times in a project the dispute really boils down to a personality dispute between the owner\u0027s onsite project personnel and the contractor\u0027s onsite personnel,\u0022 Johnson told Construction Dive. \u0022They butt heads every day for months and months on end, and they get themselves locked into positions, and sometimes they\u2019re lost in the jungle and not looking at the big picture.\u0022"]]],[1,"p",[[0,[],0,"Johnson said parties to private projects have the luxury of being able to come up with their own dispute resolution \u0022as long as they\u0027re both willing to comply with it.\u0022 The options on a public project, he said, are statutorily dictated, and the parties often have little leeway when it comes to the available ways to work things out."]]],[1,"p",[[0,[],0,"However, Johnson added, if the parties can manage to keep the contractor out of default and on the project, \u0022it\u0027s going to be cheaper for all parties.\u0022"]]],[1,"p",[[0,[],0,"Nevertheless, if the owner or a sub does file a claim against either the payment or performance bond, Reidinger said companies shouldn\u0027t expect a quick fix."]]],[1,"p",[[0,[],0,"\u0022It would probably go to litigation before the bonding company would step in and start writing checks,\u0022 Reidinger said. \u0022It would have to go down the path of dispute resolution before they would get involved at all, even on the payment side of it.\u0022"]]],[1,"p",[[0,[],0,"He added, \u0022While (the surety) guarantees run to the owner and suppliers and subs and lien holders on the job, their real business partner is the contractor that they provided the bonds for... At the end of the day, if the contractor loses the dispute resolution and cannot make the financial restitution it needs to, then (the surety) will be there to respond.\u0022"]]],[1,"h3",[[0,[],0,"Advice for companies seeking a bond for the first time"]]],[1,"p",[[0,[],0,"So given the complexities of obtaining surety bonds and the possibilities for serious financial consequences if things take a turn for the worse, what advice would the experts give someone who is thinking about going for it anyway?"]]],[1,"p",[[0,[],0,"Devolt said her best piece of advice is for a contractor to turn to trusted advisors, such as attorneys or bankers, who are familiar with surety bonds."]]],[1,"p",[[0,[],0,"\u0022They need to understand the industry,\u0022 she said."]]],[1,"p",[[0,[],0,"Reidinger said it\u2019s critical that whoever the contractor reaches out to be well-versed in the industry and be able to advise on how to not only grow bonding capacity, but how to grow the company as well. "]]],[1,"p",[[0,[],0,"\u0022It\u2019s very important that they\u2019re working with a person who understands the business and is able to help them reach their goals,\u0022 he said."]]],[1,"p",[[0,[3],0,"This article originally ran on "],[0,[4],1,"Construction Dive"],[0,[],1," as part of The Dotted Line series."]]]]}