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Surety Bonds &Construction Risk
Government of the Northwest Territories Project Management Conference Yellowknife
November 21, 2017
Objectives for Today To explain the surety bonding process in the context of ‘cradle to grave’ project planning and delivery. SAC’s objectives:
1. To provide an overview of how surety works in Canada – and why.
2. To relate the surety process to the risks of larger projects.
3. To learn from you about your perceptions and experience with surety bonding – and other forms of contract risk management
24 November 2017 3
Inscription found in the Temple of Apollo in Delphi Greece
I – THE SURETY INDUSTRY Surety Companies • SAC members write 95% + of all bonds in
Canada – There are hundreds of sureties listed on
OSFI’s website roster – fewer than 20 are SAC members and they write almost all the bonds
Surety Brokers • Look for SAC member brokers – they are
dedicated to providing superior service
I – Construction Risk
Construction Risk - what we mean Construction Risk = Risk of Contractor Failure. Ongoing global economic uncertainty. Surety Challenge: Uncertainty = more risk Economic factors now seem to be in a
permanent state of flux (e.g.) resource development drives much of the economy but volatility in every resource sector is the new normal (minerals; oil; gas)
The number and severity of contractor failures continues to be a concern across the country
Construction in Canada 2017 Canada will still have strong construction spending: Federal infrastructure commitment stretching over 10 yrs. Saskatchewan remains committed to infrastructure
spending 2015 - Canada was to go to 5th from 9th largest construction
market…how times change! foreign investment was the key; going elsewhere now
Larger and longer projects are a lasting legacy: Challenges to small and mid-sized contractors Challenges regionally – how to protect local contractors
without violating trade agreements (like NWPA)
Unqualified Contractors; the lowest “irresponsible” bidder
Insolvency of Contractor
Contractor default for non-financial reasons: Over Extension Inability to complete Incapacity of key people
Unpaid subs and suppliers resulting in liens
Warranty problems
Why Contractors Fail – some things don’t change
Construction Risk – Recent History From 2011-16, the Surety industry paid out almost $1B
in claims; more than the previous 10 yrs. 2013 a year to forget: Loss ratio = 52% - industry unprofitable; premiums flat
after two years of decline; affects all regions 2014 and 2015 record years: DWP (direct written
premium) closing $580M, loss ratio drops 30%+ 2017: a more positive trend; slight increase in DWP
and loss ratio now around 10% (abnormally low).
Note: The surety industry hitting new all-time highs for the value of contracts underwritten - $75B+
Options to Protect Against Construction Risk: Surety Bonds Performance Bonds Labour & Material Payment Bonds
Liquid Security Irrevocable Letters of Credit Cash/Negotiable instruments on Deposit
Subcontractor Default Insurance (SDI)
II – Surety Bonds What are They?
How do they Work?
Surety is not Insurance
Surety is not Insurance
INSURANCE Losses anticipated 2 party agreement;
Insured & Insurer Premiums actuarially
determined No recourse against
insured in the event of loss
SURETY No losses anticipated 3 party agreement;
Principal, Surety & Obligee
Premiums only a service charge
Recourse against the Principal via indemnity agreement
Surety Bonds: 3 Essential Services Prequalification:
Assurance that the bonded contractor is qualified for the job for which they are contracted.
Ongoing monitoring (and hidden services): Sureties monitor bonded contractors
continuously and can provide assistance if needed ($, technical support, accounting, etc.)
Security: Financial Protection in the event that the bonded
contractor should default on its obligation.
Prequalification
Intensive
Ongoing
Comprehensive
Value Added
Capital
Capacity
Character
Information a Surety Needs
Organization Structure
Key Employee Resumes Business Plan
Backlog Report
Financial Statements References
Contractors Profile
Bank Information (Underwriting Requirements)
What is a Surety ‘Facility’? After undergoing a thorough process of investigation
and discovery, qualified contractors are provided a Surety Facility
The facility is typically provided and reviewed annually; and monitored quarterly or more often Its parameters are set out in aggregate and
individual job limits (e.g.) the surety will back the contractor For a total (aggregate) amount of work at any one
time To a maximum job (contract) size of ‘x’ dollars
Surety pre-qualification isn’t superficial… (Site visit)
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Standard Construction Bonds Before Contract Award – Prequalification Prequalification Letter Bid Bond Consent of Surety
After Contract Award – Contract Security Performance Bond (Covers normal contracts,
spanning 1-2 year construction period.) • Renewable Multi-Year Bonds (For longer term
service contracts, like snow-clearing or refuse collection/recycling.)
Labour & Material Payment Bond
Prequalification Letter Not a bond but a letter from a bonding company to
the project owner confirming “bondability”.
Used during the pre-tender phase; (i.e.) before contract terms, scope or pricing details are known.
Non-binding – surety and principal reserve the right to review the details before firm commitment.
Typically refers to the project at hand.
SAC standard form available on SAC website.
Bid Bonds protection from the “lowest irresponsible bidder”
provide assurance that contractor will: enter into the contract provide the required security
typically required in the amount of 10% of tender
if contractor defaults, surety pays the difference between successful bid and second bidder
tender must be accepted within time frame set out in tender documents
seven months to file suit
Consent of Surety Not a bond at all; a letter of commitment from the
Surety to the Obligee to execute performance and/or payment bonds No penal sum set out; payment not an option
Typically, bonds must be required within 30 days
following award No standard (CCDC) form in existence, many
variations in wording
Performance Bonds Guarantees that the Contractor will perform the
contract in accordance with its terms & conditions. To claim on the bond: Contractor must be in default and the default must be
declared Owner must perform their obligations 4 options available to Surety: Remedy the default Complete the Contract Arrange for new contractor to complete Tender Payment
Two years to file suit
Labour &Material Payment Bonds Guarantee that the contractor will pay all direct
subcontractors, suppliers for materials and services provided to bonded project. (Note: “Broad form” bonds are becoming common and protect two tiers) Obligee is trustee on behalf of the claimants Claimant must have written contract with the Principal
(or the Principal’s direct sub-contractor for broad forms) Claimants may only claim for goods and services
supplied to the bonded job Claim must be filed within 120 days of the last day
worked or the date material shipped One year to file suit
Make sure to ask for the L&M Payment Bond!
It’s better when trades and suppliers are paid – especially on publicly funded jobs
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SAC supports CCDC Documents Successful Track Record: legal precedents
have been established – this clarity provides more certainty (less litigation, reduced costs).
Fairness: balance the needs of all parties to the construction process – as all sectors are represented on the
Explicitness: clearly states the rights and obligations of the Principal, Obligee and Surety
Note: The latest CCDC bond forms (the first since 2002) should be released later this year
III – Surety Myths & Misconceptions
Myth #2: A 50% Bonds only provide 50% Protection 50 percent bond gives you 100 percent protection up to the bond amount
Example:
Contract Price = $ 1 million 50 % Performance bond ($500,000) Contract is 50% complete Surety arranges completion for $ 700,000 Surety’s loss is ???
Myths & Misconceptions
Myth #3: Bonds are a “Barrier” (especially to small contractors).
Barrier? Bonding companies need to write bonds.
Sometimes a time problem – for contractors without a surety it takes time to establish a facility.
Some sureties will only bond small contractors, others have small contractor divisions
Small firms will secure bonding for jobs within their realm of expertise
Bonds are only a barrier to unqualified contractors
Myths & Misconceptions
IV – Surety Bonds What Happens when a
Contractor Defaults?
Keep the Surety informed!
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Before a Default is Declared Surety has extensive experience with contracts
and solving construction problems.
Surety has intimate knowledge of the contractor and its operation
Can provide informal assistance to solve problems that can lead to a default
Will convene meeting or teleconference among the parties to address problems.
Assist in formalizing solutions.
Claims When A Contractor Defaults:
Surety will promptly acknowledge notice of default and begin to gather information.
Surety will commence the investigation as soon as possible.
Surety will conclude the investigation as soon as possible.
If requested by the owner, surety will provide periodic written updates on investigation status and best estimates as to completion date.
During and After the Investigation:
Surety will cooperate with the owner to protect work from damage or deterioration.
Surety will work with the owner to: Identify and implement a solution. Minimize delays, keep the job going and
protect the rights of all parties. Pay valid labour and material payment
bond claims as promptly as possible to ensure continuity of subs and suppliers.
Claims
How the Project Owner can help Comply with bond & contract terms! (e.g.
proper notifications, payments and certifications)
Communicate: keep surety appraised of problems and provide default notice promptly.
Cooperate: Ensure surety has access to knowledgeable staff and relevant documents.
Keep expectations realistic.
By the way…claims are expensive
SAC estimates that an average construction contract loss is on the order of 50% of contract value; and over half that amount is paid out under the L&M Payment bond.
This is based on a study done by BBBG, a major surety claims management company, some years ago
VI - Other Forms of Contract Security
Liquid Security (ILoCs)
Yield cash; not performance
Provide no prequalification assurance
Available in smaller; perhaps insufficient amounts (5% to 10%) Recall, a typical default: 50% of contract value
Upon default – you ‘own the problem’ No surety support to bring in replacement
contractor(s) or to assist with resolving the myriad issues around payment, scheduling, monitoring, etc.
Liquid Security (ILoCs) cont’d…
Some other considerations when using ILoCs:
Deplete a contractor’s borrowing power and can bring on the very problem they seek to avoid
Provide no dedicated payment protection for subs or suppliers This is a growing issue everywhere,
especially for public/quasi-public agencies Can be especially problematic in rural and
remote area
Subcontractor Default Insurance
Introduced in 1996 to protect very large general contractors from subcontractor default. Indemnity product – compensates the GC for loss incurred Significant deductibles and co-payment Only available to the largest GCs (in-house construction
admin experience and strong cash flow) – but even they are new to underwriting NOT designed to protect owners from risks associated
with default of prime contractor Note that one of the largest public procurers in Alberta
has specified that subs must be given the option to post bonds if the GC wants to put the job under SDI (Subguard)
VII – e-Bonding
Did someone mention “paperless” ??!!!
Issues and Challenges Commercial Legal Technological SAC has worked to define and explain the
issues & challenges over the past seven years or more
Electronic Delivery of Bonds
E-Bonding For years e-tendering and e-bonding was the
train that never ‘left the station’
However, this has changed, with e-tendering and e-bonding spreading rapidly in the West, and at the federal level (DCC)
Three e-bonding suppliers are active now: Mobile Bonds, Xenix, and Infinite Source (for users of Bid Central in BC, and CoolNet in AB)
VIII – New & Improved… What’s the Latest in the World
of Surety Bonds?
New Surety Products – The Business Case Surety bonds have been around forever – but they are being asked to respond to new procurement methods and changing needs of owners
The surety industry has a well earned reputation as conservative and cautious Underwriting new and different risks requires new
knowledge and data – which is often lacking
Remember the unique surety value proposition: it always strive to provide true performance security; i.e. providing owners with a completed project in the event of default (including payment protection for subs and suppliers)
The case for new products – cont’d…
As well, there are new realities for owners and contractors (e.g.)
Owners want more control in default situations (schedules, replacement contractors)
Lenders need assurance that big projects won’t be held up due to a default of a key trade or supplier
Some contracts (like road maintenance) need to be much longer – five years or more is common
SAC Code of Best Practices (2016)
Sets out standards of professionalism for a surety’s response to a performance bond claim.
Provides Obligees with a guide to what it can expect when claiming under a performance bond.
Incorporates enhanced process bond form principles: Prompt Resolution Pre- and post-default meetings at the call of the
owner Standards of professional conduct in claims
handling
SURETY ONLINE LEARNING CENTRE The Surety Online Learning Centre accessible from
SAC website; www.suretycanada.com.
Five learning modules that introduce the basics of surety bonds and the suretyship process
Learn at your own pace.
Ideal for review or for colleagues who can’t attend a “live” information session.
It’s FREE
Contact Us Bob Sloat, Director Business Development, Western Canada Phone: 778-995-6585 / 403-612-4070 email: [email protected] or visit our www.suretycanada.com website: