Safety

2018 Executive Insights: Surety Bonding

Industry experts share their insight on surety bonding considerations.
November 2, 2018
Topics
Safety

How can a construction company mitigate risk when getting ready to apply for a surety bond?

Michael P. Cifone
Senior Vice President, Surety Underwriting
Hudson Insurance Group

On a daily basis, construction companies are confronted with risks associated with their labor force, subcontractors, contract terms, weather and unforeseen conditions. The ideal surety candidate has the ability to identify risks and manage them effectively. Once a risk is identified, the contractor has the option to avoid, eliminate, reduce or accept it.

The surety understands the risks surrounding the construction industry. When contractors are looking for surety support, they should demonstrate their knowledge of the risks and their plan to manage these risks. A long-range plan provides a good starting point for the contractor to address issues related to growth initiatives, succession planning, training and mentoring, and equipment and financing needs.

The daily risks associated with onerous contract terms, labor shortages, subcontractor defaults and equipment failures are best mitigated by a contractor with the proper management team operating with a practical long-range plan.

Henry W. Nozko, Jr.
President, Surety Underwriting
ACSTAR Insurance Company

Unforeseen project conditions can blow up a project’s cost. Estimating errors and omissions in drawings and contract documents could lead to cost overruns. Natural disasters and defective materials or equipment can crush the success of a project. Labor stoppages from work disputes or jurisdictional disputes can eradicate estimated profits. Funding shortfalls and litigious owners could kill a project. It is impossible for a contractor to control all of these factors; however, through risk mitigation, successful outcomes are greatly enhanced.

Vigorously renegotiate onerous contract terms and conditions. Secure insurance coverage for a particular project exposure in addition to simply purchasing required insurance. Confirm that adequate project financing has been secured. Negotiate extensions to labor agreements where the absence of such could give rise to work stoppages. Require bonds from critical subcontractors and suppliers. Research the litigation history of your customers.

What top qualities should a construction company look for in a surety bond producer?

Mike Sanders
Senior Vice President, Underwriting
Old Republic Surety Company

The individual a contractor selects as its agent for surety bonds has a tremendous impact on the contractor’s ability to obtain the most beneficial surety bonding program possible. Look for a bond agent who:

  • understands the contractor’s business, goals and plans for the future;
  • asks a lot of probing questions;
  • gives you their undivided attention and really listens to your story;
  • will respectfully challenge scenarios relative to both their business operations and to the surety bonding process;
  • can access multiple surety companies to more effectively choose the company and the underwriter that best fits their surety needs; and
  • finds value in building the relationship between the contractor and the underwriter.

An agent demonstrating these traits will be most effective in presenting a contractor to a surety underwriter in the most favorable manner.

What clauses should bond producers and construction companies be on the lookout for in contracts?

Bogda M. Clarke
Associate Vice President, Surety Claims
Nationwide

Heightened risks from onerous contract provisions pose a threat to subcontractors from project delays wholly unrelated to their work. If the subcontractor has agreed to broad language obligating it to meet the project schedule as it may be revised and updated, coupled with “no damage for delay” language and clauses allowing the general contractor to supplement the subcontractor’s workforce, the subcontractor’s risks may skyrocket.

A general contractor that has fallen behind in its work may seek to avoid its own liquidated damages exposure through contract provisions allowing for schedule compression and acceleration, causing inefficiencies to subcontractors and back-charge exposure to the subcontractor. Consequential damage exposure, without limitation in the subcontract, also may be unreasonably high.

Subcontractors must not agree to clauses that unfairly expose their companies to ruinous consequences for project delays and disruptions for which they may not have been responsible.

Brian Smith
Contract Underwriting Officer
Liberty Mutual Surety

Contract provisions important to a contractor’s risk assessment include liquidated/consequential damagers, default, payment terms, change orders, no damage for delay, final payment, warranties and hold harmless/indemnity. Key questions include:

  • Are liquidated damages reasonable or capped? Is there a mutual waiver of consequential damages?
  • Is there reasonable time to cure? Does the termination for default provision provide adequate notice to the contractor and surety?
  • Is payment contingent upon receipt of financing?
  • Are change order procedures clearly defined?
  • In addition to time extensions, is the contractor compensated for job costs that were unforeseeable or due to owner delays?
  • Does receipt of final payment waive all claims?
  • Can extended warranties pass through to suppliers/manufacturers?

Steve Dorenkamp
Vice President, Claims Manager
Merchants Bonding Company

Our advice is: Always read your contract and, where appropriate, seek the input of your surety to help you avoid onerous bond language.
Here’s a quick list of clauses to be aware of:

  • Damage clauses, including liquidated, actual, consequential and efficiency;
  • subcontract flow-down provisions;
  • indemnification clauses;
  • environmental indemnification clauses;
  • differing site condition clauses;
  • warranty, venue and jurisdiction provisions;
  • attorney fee provisions; and
  • statute of limitation waivers.

In each of these cases, the goal is to limit the risk to what a contractor and its surety should truly be responsible for and not force them to take on unnecessary risks. Your professional surety agent and surety underwriter should be able to assist you with identifying onerous contract language, allowing you to modify it and right-size your risk.

What clauses should bond producers and construction companies be on the lookout for in contracts?

Carl G. Castellano
Vice President, Contract Surety
Philadelphia Insurance Companies

Cardinal rule No. 1: Read the contract and associated documents. Clauses, such as those outlined below, will be favorable for one party but not favorable for others. Beware of:

  • Sole discretion to default/terminate;
  • Cross default language;
  • Consequential damages in general and especially if unspecified and uncapped;
  • Indemnity, particularly those in which the indemnitor assumes obligation for damages caused by indemnitee;
  • Unreasonable liquidated damages;
  • Pay if paid clauses, where enforceable;
  • Long-term warranties, which continue to be the obligation of the contractor instead of a manufacturer;
  • Expanding coverage to such areas as personal injuries and copyright infringements; and
  • If the project is bonded, clauses that could cause greater loss to a surety.

How should a construction company prepare for its first meeting with a surety bond producer?

Robert E. Shaw
President
Skillings Shaw & Associates

The first meeting is about the bond producer and contractor learning more about each other’s goals, businesses and history, as well as identifying steps to meet the contractor’s business surety goals.

Bring all information, statements and reports, such as financial statements, résumés of key employees, trade references, recommendations and other pertinent documents requested by the bond producer.

The producer will explain for whom he or she works, how surety companies underwrite bonds, how bond rates work, how to request a bond, the importance of a good accountant, why bond underwriters care about construction accounting and bank support, the general surety marketplace, and how producers can coach contractors to attain higher levels of surety capacity.

He or she will explain how bonds are underwritten based on character (of the contractor), capacity (the expertise and experience of a contractor to handle a project) and capital (the financial strength of the contractor and its indemnitors).

Why is it important for contractors to choose a law firm experienced in surety bonding?

Michael C. Zisa
Partner
Peckar & Abramson

When a contractor selects a law firm to defend or prosecute a claim against a performance or payment bond, it is essential to select a firm that not only understands the complexities of construction law but also has a true understanding of the legal and practical issues affecting sureties.

I regularly see well-seasoned construction lawyers who miss significant opportunities for their clients because they do not understand or appreciate the intricacies of surety law.

They do not understand the terms of the performance or payment bond and how those terms impact the contractor’s and surety’s right and obligations, which can result in costly consequences.

How are surety bond companies keeping up with increased demand within the construction industry?

Richard Barnett
Senior Vice President, Surety Director
Chubb Insurance

Investing in people remains a top priority. Contractors should make sure they are working with a seasoned surety that is not only deep in talent, but also consistently hires and trains new entrants.

Similarly, contracts and bond forms are getting more complex, particularly for large or privately financed projects. These require experienced and responsive legal resources to identify the inherent risks and potential solutions.

The surety industry is not immune to the need to improve efficiencies through technology. Best-in-class sureties are regularly investing in their platforms to enhance real-time access to information and timely decision-making.

With a growing and changing market, face-to-face interaction is as important as ever. A surety needs to be available to its clients to clearly understand their needs as well as their strategy to address risk.

Finally, there is no substitute for working hard and smart. Demands are great on contractors, requiring heavy investments of time and pursuit costs.

Michael Groman
Vice President, International
CNA Surety

On a pure capacity point of view, the availability of capital has been robust given the continued run of excellent industry results. Many established sureties have continued to leverage more of their own internal capital, and that of the reinsurers, by taking higher net retentions and placing higher excess of loss limits on top, translating into higher program capacity. Some sureties have adapted to the growth challenges by flattening their organizational oversight and moving more authority to the field.

Alternative surety solutions, such as expedited dispute resolution clauses and partial liquidity bonds, have grown in usage as contractors and sureties strive to meet the requirements of owners and lenders in the new public-private partnership models.

Lastly, more established sureties are going above and beyond the extension of surety credit by providing legal review to help avoid onerous contract terms, providing benchmarking tools for clients, and sharing their claims team insights on best practices.

Brad Gibson
Vice President, Surety
Marsh & McLennan Agency

The surety industry as a whole managed to weather the recession fairly well and losses fell significantly short of expectations. The profitability of the product has paved the way for an influx of capital and resources into the industry, which has made it possible for existing sureties to increase capacity.

Surety capacity is readily available from sureties, often at multiples of what they could accommodate just a few years ago.

Smaller sureties that cannot compete on large bond programs have adapted by offering up “bonded only” programs. A strong construction market yielding better profit margins has allowed sureties to extend more credit than they once would for a given balance sheet.

Underwriters are becoming more adept to get past the numbers to underwrite individual projects that create a stretch. Overall, an unprecedented amount of surety capacity is available to accommodate the growing demand. An open and proactive approach to communication with your surety is the key to accessing it.

What advice do you have for contractors considering making a claim on a surety bond?

Michael Bomba
Director & Counsel, Contract Documents & Risk Management
AIA Contract Documents

A payment bond is separate from the contractor’s agreement for the project and it often includes separate obligations the contractor must satisfy when a contractor is considering making a claim. Accordingly, a contractor should be aware of the terms of the bond at the outset of the project and thereafter be careful to ensure that it satisfies all the conditions in the bond. A failure to meet all the required conditions could result in the surety not being obligated to make a payment.

Particular attention should be given to the bond’s notice requirements. If a contractor fails to provide notice to the surety of a claim on the bond within the time period required, the contractor could lose its right to payment.

Additionally, many payment bonds require the contractor to provide adequate supporting information in order for the surety to consider the claim as proper. Failure to do so also could put the contractor’s claim at risk, or at the very least delay any payment being made by surety.

How should alternative dispute resolution provisions be approached upfront in construction contracts?

Michael A. Marra
Vice President, Construction Division
American Arbitration Association

Construction firms and their lawyers carefully evaluate the business terms in their contracts, but they often reflexively insert a boilerplate arbitration clause. This oversight may jeopardize the inherent benefits of arbitration and could result in a more expensive, disruptive and inefficient proceeding.

Arbitration is a creature of contract, enabling the parties to tailor the process to fit their needs and bypass litigation procedures. If you do not take advantage of this critical distinction, you may be relegated to a more cumbersome and costly proceeding.

It is vital to give upfront consideration to the details of the procedures most suitable to any likely disputes under a contract and not simply hope for the best once hostilities have arisen. Parties to a contract should evaluate their specific project and potential disputes to determine if a simple arbitration clause found in most industry form documents is sufficient for their project or if further customization is needed.

Are you ready for revenue recognition?

Jack Callahan
Partner - Construction Industry Leader
CohnReznick

The new revenue recognition standard is now due for implementation. Despite the long lead time and delays, we find the construction industry is generally not ready.

Construction CFOs must have their game plan in place or risk the consequences of last-minute issues that may be costly, time-consuming and will pull much-needed resources from other areas within their organization.

As you prepare for this year’s financial statement audit, meet with your accountants to discuss the five-step process that needs to be put in place. It’s important to be certain that you are in a position to gather the information needed to make legal, accounting and engineering judgements required to properly support your financial statement assumptions.

Review your accounting software systems to assure that you have the capabilities to assemble the required financial information. Have you addressed key issues, including software, job tracking, contract analysis, point-in-time testing and others?

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