Chapter 5 Flashcards
Describe the three “C’s” of credit appraisals and outline factors considered for each.
i) Character – This involves studying company’s management performance
ii) Capacity – This involves reviewing company’s past job performance
iii) Capital – This involves reviewing company’s financial ability to finish work on hand as well as job for which bonding was requested
How are surety companies similar to banks?
Sureties are similar to banks because they are being asked to lend credit.
Define the three parties of surety agreements.
i) Surety – Organization who undertakes to pay money or to do any other act in event that his principal fails therein
ii) Obligee – Is the party to whom someone else is obligated under a contract
iii) Principal – Organization or person primarily liable
What are three characteristics of the promise made by sureties?
i) Promise made to oblige, not principal
ii) Secondary obligation occurring when principal defaults
iii) Obligation of surety to oblige happens as soon as principal defaults
Explain the following characteristic of a surety bond: No losses expected
Surety companies base fees on belief that they will not incur any losses. When principal does default, surety believes they have adequate back-up positions to cover guarantee to obligee.
Explain the following characteristic of surety bond: Indeterminate length and non cancelable
Surety bonds cannot be canceled by surety company once issued. Surety bonds stay in effect as long as principal has not completed their obligations.
Explain the following characteristic of surety bond: Bond limit or penalty
This indicates amount guarantee surety is providing to obligee.
Explain the following characteristic of surety bond: Bond premium
This indicates amount surety charges for bonds issued on their behalf. Premium is not an accurate term for surety bonds because sureties do not expect losses.
Explain the following characteristic of surety bond: Written contract
Surety bonds must be written and signed, under seal, by both surety and principal.
What are five examples of differences between surety contracts and insurance contracts.
i) Surety contracts are three party agreements, insurance contracts are two party agreements
ii) Sureties do not expect losses, insurers do expect losses
iii) Principals must pay sureties back when they default, insureds do not have to pay back insurer when claims are made
iv) Sureties charge fees, insurers charge premiums
v) Surety contract must be written, insurance coverage may be provided orally
State four types of bonds common in the construction industry.
i) Bid Bonds
ii) Performance Bonds
iii) Labour and Material Payment Bonds
iv) Maintenance Bonds
Provide three examples of risks faced by owners of construction projects.
i) Low bidder does not sign construction contract
ii) Contractor does not complete job at agreed price or fails during job
iii) Contractor does not pay subcontractors or material suppliers
Identify four considerations of general contractors when determining whether or not to request bonding from subcontractors.
i) Contract with project owner may require subcontractors to be bonded
ii) Contractor may be long-term relationship or have no relationship with subcontractors
iii) Size of subcontract may influence contractor to request subcontractors to be bonded
iv) Large differences in low bidding subcontractor may worry contractor, resulting in request to subcontractor to provide bonds
What are three methods of deposit available to contractors when bidding on a new job?
i) Bid Bonds
ii) Certified cheques
iii) Surety’s consent
What two things, owners are assured, when deposits from contractors take the form of bid bonds?
i) Principal was investigated by surety and therefore prequalified
ii) Because of significant penalties of default, principal bid is in good faith
What are two guarantees owners receive when deposits take the form of bid bonds?
i) Principal will sign construction contract at agreed price
ii) Principal will be able to provide follow-up surety bonds for project
What is “consent of surety”?
This is a letter written by surety and signed under their seal indicating principal will be provided follow-up bonding on project.
What are three disadvantages of certified cheques as a form of bid deposit?
i) Amounts equal to certified cheque are frozen, thereby limiting contractor’s cash flow
ii) When certified cheques are used it is assumed contractor cannot qualify for bid bonds, therefore unable to provide follow-up bonding for project
iii) Bid Bonds are only valid for 60 days after tendering deadline. This time limit does not apply to certified cheques
Why would contractors default on bid bonds?
i) Error in judgment on project scope
ii) Mistake in arithmetic on project pricing
What are two expenses sureties may incur when contractors default on bid bonds?
i) Pay any retendering costs and delay costs to project owner
ii) Pay any difference in bid form subsequent contractor and defaulting contractor’s bid
What are two guarantees provided by performance bonds?
i) Principal will perform contract within conditions and terms of contract
ii) Principal will provide maintenance on work for one year after completion
What limit is usually requested on performance bonds?
50% of tendered price is usual limit on performance bonds.
Can changes to the bonded project be made, and if so, to what extent?
Changes are allowed to projects once underway. Sureties will only extend guarantees to project increases up to 10% of tendered price. Increases above 10% must be approved by surety.
What are two types of defaults under performance bonds?
i) Voluntary default
ii) Involuntary default
What are four examples of involuntary default?
i) Bankruptcy
ii) Lack of technical ability to perform contract
iii) Lack of additional credit needed to maintain accounts payable
iv) Delays in construction
What are two examples of voluntary default?
i) Large errors made in project cost
ii) Lack of current assets to pay current liabilities
What two actions could sureties take when contractors default under a performance bond?
i) Finance defaulting contractor to allow completion of project
ii) Collect bids from other contractors for project completion and present to obligee
Describe the guarantee provided by a labour and material payment bond.
Surety guarantees that principal will pay all sub-trades and material suppliers.
What are three business benefits of labour and material payment bonds?
i) Construction costs are lower
ii) Access to labour and materials is faster
iii) Credit not needed for this project can be used in other projects
When would a maintenance bond be required?
Obligees will request maintenance bonds when one year maintenance period provided by performance bonds is inadequate.
Describe guarantees of maintenance bonds.
Maintenance bonds guarantee that principal will come back and repair flaws in job for term of maintenance bond.
What are three concerns of sureties that make issuing a maintenance bond difficult?
i) When long maintenance periods are provided, more flaws will become apparent
ii) With long maintenance periods, parties responsible for flaws becomes more difficult
iii) Courts are demanding higher and higher standards from contractors
Outline information sureties require in the following area: Financial strength of owners
Personal financial statements of all shareholders will be requested.
Outline information sureties require in the following area: Corporate structure
Corporation, individual or partnership of principal will be identified
Outline information sureties require in the following area: Key personnel resumes
Skills, education, and experience of senior employees should be described.
Outline information sureties require in the following area: Banking information
Bank Letter of Reference will be required indicating size of line of credit, repayment history and overall banking experience.
Outline information sureties require in the following area: Accounting information
Financial statements from past three to five years will be required.
Outline information sureties require in the following area: Completed work record
Five year history of previous projects, including all contract information will be required.
Outline information sureties require in the following area: Work in Progress record
Financial status and list of work currently underway will be required.
What are three items in financial statements important to surety underwriters?
i) Working capital
ii) Net worth
iii) Profitability
Describe three factors which affect working capital.
i) Labour and material ratio will affect working capital. Labour must be paid regularly, however material suppliers often will wait for payment for up to 30 or 60 days into future
ii) Subcontract work will affect working capital because subcontractors often will not be paid until general contractor is paid by project owner
iii) Customer paying habits will affect working capital because general contractors may have paid project expenses prior to payment from project owner
Describe how net worth is calculated.
Assets minus liabilities.
Describe two methods used to report income on contractor’s financial statements and identify which is most desirable to surety underwriters.
i) Completed contract method reports income or loss on projects only when completed. This may distort year end financial statements because work underway will not be reflected.
ii) 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 contractor at their financial year-end.
When issuing bonds limits to contractors, what two limits will be provided?
i) Per job limit
ii) Work in progress limit
Describe three types of guarantees contractors provide sureties.
i) Indemnity agreements are when shareholders pledge personnel assets in event of default
ii) Third party indemnities are guarantees provided by individuals or other corporations on behalf of principal
iii) Collateral security is cash or letters of credit
Once bonding limits have been established, surety underwriters will review each request for bonding. What are four factors considered in this process?
i) Type of work involved in contract
ii) Location of project in relation to contractors usual work area
iii) Size of job and amount of bonding requested
iv) Contract completion date considered in conjunction with work in progess
Describe an example of guarantees provided by license and permit bonds.
Compliance guarantee bonds guarantee principal will abide by laws affecting their business.
What is the guarantee provided by Administration and Executors bonds?
This bond guarantees that principal will perform responsibility in compliance with law of deceased persons estate.
What are three responsibilities of administrators and executors?
i) Collecting assets and protecting them from loss
ii) Pay all debts incurred by deceased
iii) Provide court with all accounting records necessary transactions
Describe “guardian”.
This is someone who is charged in a will to look after affairs of minors and is approved by courts.
What guarantee is provided by Trustee in Bankruptcy bonds?
This bond guarantees that trustee will execute duties in compliance with Bankruptcy Act.
Describe the guarantee provided by Custom and Excise bonds.
This bond guarantees that principal will pay taxes collected on behalf of government are paid to government.
Describe why Injunction Bonds are needed and what they guarantee.
These bonds are needed to guarantee payment of court costs and delay expenses to land owner when injunctions affect their property.
