Surety Bonds &General Contractors

Name of EventOrganizationDate

AgendaI Construction Risk

II Bonds; A Brief Introduction

III How to Establish and Maintain a Strong Surety Relationship

IV What’s New in Surety Bonds?

V E-Bonding

VI A Few Points to Ponder

I – Construction Risk

“Then You Shall be his Surety”

William Shakespeare

Merchant of Venice

Construction Risk 2015

Construction Risk = Risk of Contractor Failure.The number and severity of contractor failures

increased in recent years.Recent Challenges:

Reduction of available work; oversaturated market = tighter margins

Onerous contract conditions. Downloading of risk

Paradigm Shift: AFP’s, P3’s

Construction Risk 2015From 2010-14, the Surety industry paid out almost

$800 million in claims; more than all of the previous decade.

2013 a year to forget: Loss ratio; 52% - industry unprofitable Premiums flat after two years of decline Across all lines and all sectors of the country

2014 showed improvement with lower loss ratios and premium growth … but….

2015 ? Impact of Oil Prices in western Canada and political and economic instability

Construction in Canada 2015Canada the new construction “mecca”.

Ongoing commitment to infrastructure Federal commitment $48B over 10 years.

By 2020 Canada to be world’s 5th largest construction market (9th in 2010)

Increased foreign investment from depressed areas (e.g. Europe)

Larger and longer projectsChallenges to small and mid-sized contractors

Protect Against Construction Risk

Surety BondsPerformance BondsLabour & Material Payment Bonds

Liquid Security Irrevocable Letters of CreditCash/Negotiable instruments on Deposit

Default Insurance Products

II – Surety Bonds What are They?

How do they Work?

Surety is not Insurance

Surety is not Insurance

INSURANCE 2 party agreement;

Insured & InsurerPremiums actuarially

determined Losses anticipatedNo recourse against

insured in the event of loss

SURETY 3 party agreement;

Principal, Surety & Obligee

Premiums only a service charge

No losses anticipatedRecourse against the

Principal via indemnity agreement

Surety Bonds: 2 Essential Services

Prequalification:Assurance that the bonded contractor is

qualified for the job for which they are contracted.

Security:Financial Protection in the event that the

bonded contractor should default on its obligation.

PrequalificationSurety Company’s Standard Minimum Checklist:

Good character

Experience matching contract requirements

Financial strength

Excellent credit history

Established banking relationship

Line of credit

Necessary equipment

Standard Construction Bonds

Prequalification

Prequalification LetterBid BondConsent of Surety

Security

Performance BondLabour & Material Payment BondRenewable Multi-Year Bonds (service contracts)

Prequalification LetterNot a bond but a letter from 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 refer 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 contractprovide the required security

Typically required in the amount of 10% of tenderif contractor defaults, surety pays the difference

between successful bid and second bidderTender must be accepted within time frame set out in

tender documentsseven months to file suit

Consent of SuretyNot 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 BondsGuarantees Contractor will perform contract in

accordance with its terms & conditions.Contractor must be in default and the default must

be declaredOwner must perform their obligations 4 options available to Surety:

Remedy the defaultComplete the ContractArrange for new contractor to completeTender Payment

Two years to file suit

Labour &Material Payment BondsGuarantee that the contractor will pay all direct

subcontractors, suppliers for materials and services provided to bonded project.

Obligee is trustee on behalf of the claimantsClaimant must have a direct contract with the

PrincipalClaimants may only claim for goods and services

supplied to the bonded jobClaim must be filed within 120 days of the last day

worked or the date material shippedOne year to file suit

III – Surety Bonds How to Establish &

Maintain a Strong Surety Relationship

Who Obtains the Bond? Project Owner is not responsible for obtaining

the required bonding or other contract security.

Owner only has to include bonding requirement in tender documents or contract specifications

The contractor obtains the bondingSelects a professional surety bond broker or

agent who assists in submitting case to a surety underwriting company

How is a Bond Obtained?Contractor Submits Financial

Statements and other background information to Surety

Participates in prequalification process: an in-depth look at contractor’s business operations and financial structure.

Surety’s Financial AnalysisBalance Sheet

Working Capital / Net WorthRatio AnalysesReceivable/Payables aging analysisWork on hand; profitability, maturity, trending

Income StatementProfitabilityRevenueTrend Analysis; 3 to 5 years

Cash Flow AnalysisAccountant’s Opinion/Explanatory Notes

What Else does a Surety Need?Complete details on Affiliated / Related

Companies; ownership, financial information, etc.

Detailed Work on Hand SchedulesAged Listing of Receivables and PayablesOrganization Chart of Key EmployeesDetailed Resumes of Principal & EmployeesBusiness Plan & Contingency PlansSubcontractor & Supplier References

What Else does a Surety Need?Details of construction operations; areas of

expertise, list of key projects, key people, etc.Letters of Recommendations from OwnersEvidence and details of a Line of Credit from a

Financial InstitutionDetails of business continuity plans in the event

of death or incapacity of owners/key peopleReports on Similar Completed Projects

Owner, contract price, date completed, profit earned

The Care & Feeding of Sureties

(four tips)1. Establish a relationship with a

professional broker (SAC can help).

2. If you’re declined, FIND OUT WHY!! Many problems can be solved.

3. Work With The Bonding Company; it is truly a relationship

4. There IS competition among sureties.

IV – New & Improved… What’s the

Latest in the World of Surety Bonds?

SAC Performance BondSAC consultations with Owners & Contractors;

More “certainty” in the claims process.More responsiveness to a claimMore frequent and effective communication

between sureties and owners.

New “enhanced” performance bond provides construction buyers with more timely &responsive claim service.

Has been used by owners across the country and will be adopted by CCDC as the new standard.

Provides more responsive services to owners by…..

SAC Performance BondPre-Demand Conference to allow surety and owner

to prevent problems from turning into a default. Timelines for Surety’s Response:

5 days to acknowledge a response & request info.21 days (from receipt of information) for surety to

respond to owner with their response.Emergency Remedial Work: Allows Owner to

address urgent issues (e.g. safety) under the bond.Post-Demand Conference: Mechanism to minimize or

eliminate work stoppages while surety investigates.Contact Coordinates: Contact information for all

parties to facilitate notices and communication.

Surety Bonds & P3 ProjectsComprehensive performance & financial security

against construction default on mega-P3 projects.Sufficient capacity for mega-projects.Broad and flexible protection packages which include:

Professional surety prequalficationSpecialty P3 bonds designed by member sureties:

Provide liquid / cash on demand protection. Built-in “fast-track” dispute resolution Early Response; surety involved pre-default.

Protection for trades & suppliers via the payment bond.Called for on Infrastructure Ontario Build-Finance and

Design-Build-Finance projects.

Renewable Multi-Year BondsOnly applicable to service contracts; e.g. Waste

Management, Snow Removal, etc. Initial Term is open. Renewal Terms are typically

1 year periods can be extended to two.Surety issues an annual Renewal Certificate.Failure to renew the Bond is not a ‘default’ under

the Contract or the Bond 2-year suit limitation – runs from earlier of expiry

of latest bonded ‘Term’ or date default declaredCan be modified to address O&M components of

P3’s

Headstart Performance BondTMCreated by The Guarantee Co of N.A. to protect GCs

from sub default (competitive alternative to SDI)Industry Solution: available for use by other sureties.Flexibility: Obligee given two mitigation options:

o Traditional Option: Surety investigates and implements solution (as in standard bond); or,

o Headstart Option: Obligee implements its own solution upon surety’s acceptance of Obligee’s completion proposal.

Responsiveness:o First dollar protection(no deductible or co-payment).o Surety will respond in 3 days from receipt of Claims letter.o Standard claims notice and mitigation agreement.

Electronic Delivery of BondsE-Commerce: the buzzword of the new

millennium; every aspect of commercial activityDelivery of bonds via internet technology.Advantages:

Accuracy / built-in safeguardsEase & economy of transmissionSmaller “Carbon Footprint”

SAC can provide assistance to owners as they move to automated tenders and bonds.

V – e-Bonding

Did someone mention “paperless” ??!!!

Issues and Challenges

Commercial

Legal

Technological

SAC’s Efforts to Address the Issues & Challenges

Electronic Delivery of Bonds

Commercial Issues & Challenges

SAC encourages and promotes electronic delivery of surety bonds.

Don’t Act on your own. Will only work with industry buy-in.

Flexibility; evaluate; establish criteria and standards, leave it to others to find a way to meet them..

Electronic equivalent of a courier.

Legal Issues & ChallengesPIPEDA passed by parliament in 2000.

Umbrella legislationEach jurisdiction followed with its own

legislation over the next two yearsChallenge: What about seals?Deed vs Contract - “Deemed” sealed, overt

act of sealing will constitute seal equivalent. Verbiage not sufficient.

Friedmann Equity vs Final Note – Supreme Court of Canada

Technological Issues & ChallengesTechnology is in place; systems have been

developed and marketed in Canada and U.S.

All systems are NOT created equal; different focus; different capabilities

Criteria:Integrity of content;Secure accessVerifiable / enforceable

SAC & e-BondingPublications on SAC website:

Designing Electronic Pathways Together.Vendors Guideline. Criteria checklist.

Position Paper: Surety Bonds in a Digital World.

Working with owners and vendors:Mock Tender – Defense ConstructionDevelopment of template language for

inclusion in tender documents.

Six e-Tendering Tips for Owners

1) Consult Consult Consult: Without Buy-in from other stakeholders, the advantages can be squandered.

2) Don’t Reinvent the Wheel: Learn from what’s been done. Are you in the software development business?

3) Insist on Verifiability… whatever the approach, know that the bond is valid and enforceable.

4) … But be Flexible About Everything Else: Allow vendors to find ways to meet the criteria and standards you set.

5) It’s Up to You: Initiative has to come from owners and end-users. SAC can provide guidance but only you can start the journey

6) Take the Time to Get it Right: Pilot projects; Phase-in implementation. Allow for time to work out the kinks and for the industry time to adjust. Mock Tenders.

Six e-Tendering Tips for Owners

VI – Surety Bonds

A few Points to Ponder

A few Points to PonderPoint #1: Bonds: Benefits to General Contractors

Eliminate unqualified competition; critical in tough times when too much capacity in the marketplace.

Non-intrusive; do not tie up liquidity or borrowing power (in contrast to letters of credit)

Respond only upon actual default; protect contractors from arbitrary action by project owner

Can provide assistance (technical or financial) should contractor encounter difficulties on bonded project

A few Points to PonderPoint #2: Bonds a “Barrier” to small contractors?

Barrier? Bonding companies need to write bonds.Sometimes a time problem – for contractors without a

bond company 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 a barrier to unqualified contractors

A few Points to PonderPoint #3: Advantages of bonding subcontractors and suppliers

Provides unintrusive and complete first dollar protection against subcontractor default

Surety Prequalification process ensures better quality of subcontractor/supplier working on your project.

Can expand your own bonding capacity.

Nominal cost for total protectionHeadstart alternative to SDI provides full first dollar

protection without deductibles or co-payment.

SURETY ONLINE LEARNING CENTREThe 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 UsPhone: 905-677-1353

Fax: 905-677-3345

email:surety@suretycanada.com

or visit our www.suretycanada.com website: