Chapter 5 Flashcards
How are surety companies similar to banking institutions?
They are both asked to extend credit. Surety extends credit in case principal fails to perform their duties.
Outline 8 common characteristics of surety bonds.
3 party contract - Principal, obligee and surety
Principal liable to surety
No losses expected
Indeterminate length, can not be canceled
Maybe statutory or non statutory
Bond limits/penalty
Bond premium
Must be in writing
Provide 3 examples of risks that owners of construction projects are faced with.
Low bidders do not sign the construction contract forcing to re-tender job.
Contractor doesn’t complete the job at the agreed price, or fails during the job.
Contractor does not pay subcontractors or material suppliers.
What are 3 considerations of general contractors when determining whether or not to request bonding from subcontractors?
Contractor may have long term relationship or no relationship with subcontractors
Contract with the project owner may require subcontractors to be bonded.
The cost of the job
Size and value of the subcontract
Large differences in low bidding subcontractors may worry a contractor, resulting in a request for the subcontractor to obtain bonding.
Whether general contractor is willing to assume the price of a bond or take the risk.
With respect to Bid Bonds:
What is the Consent of Surety?
Why would a contractor default on bid bonds?
If a default occurs, what is a typical bond penalty, and what kinds of expenses may be incurred by a Surety when a contractor defaults?
- A letter written by a Surety and delivered under their seal stating the principle is eligible for further binding with the Surety.
- They made an error in judgment on the scope of the project. They made a mathematical error.
- A specific dollar amount equivalent to the percentage required in the bid. Cost to re-tender the job. Pay the difference in bids between defaulting contractor and subsequent contractor bid.
What are 5 examples of involuntary default under a Performance Bond?
Bankruptcy/insolvency
Incompetence/lack of technical ability
Bank refusal to grant additional extension of credit.
Delay in construction
Failure of subcontractors where no bonding exists.
Identify 3 business benefits of a labor and material payment bond.
Reduce cost of construction.
Eliminates or reduces delay in construction.
Frees up credit with access to additional credit.
What are 3 concerns of sureties that make issuing a maintenance bond difficult?
The longer the time period, the greater chance of defects becoming apparent.
Determining causes of defects become more difficult.
Judgment awarded tend to increase the vulnerability of contractors to claims - contractors are being held to higher standards by courts.
The qualifications of Contractors for Surety Bonds is taken seriously. Why would an underwriter require a bank letter of reference?
Sureties want to know the average account balances carried as well as the amounts of any lines of credit currently in use.
Commentary on the general operation of the account and length of time the contractor has dealt with the bank shows their level of stability.
Sureties would like to see what types of security is held on their lines of credit.
The calculation of a Contractor’s working capital represents…
The amount available to pay operating expenses until payment is received for outstanding jobs.
Describe 2 methods used to report income on contractors financial statements. Identify which is most desirable to surety underwriters.
Completed contract method- reports income or losses on projects only when completed. This may distort year end financial statements because work underway will not be reflected.
Percentage of completion method- reports income or loss on projects as a percentage of completion. This allows for a true reporting of financial condition of a contractor at their financial year end.
Percentage of completion is preferred
Once bonding limits are established, Surety underwriters review each request for bonding. What are 3 factors considered in this process?
Type of work involved in the contract.
Location of the project in relation to contractors usual work area.
Size of job and amount of bonding requested.
Contract completion date considered in conjunction with work in progress.
Provide an example of guarantees provided by license and permit bonds.
Compliance guarantee bonds guarantee principal will abide by laws affecting their business.
This bond may be required by government to ensure taxes collected on goods or services rendered are submitted to the government.
Custom and Excise bond
This bond is required of a plaintiff who did not get the remedy they sought and would like their case to be heard by higher court
Appeal bond
