Chapter 5

Question 1

Describe the three “C’s” of credit appraisals and outline factors considered for each.

Answer 1

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

Question 2

How are surety companies similar to banks?

Answer 2

Sureties are similar to banks because they are being asked to lend credit.

Question 3

Define the three parties of surety agreements.

Answer 3

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

Question 4

What are three characteristics of the promise made by sureties?

Answer 4

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

Question 5

Explain the following characteristic of a surety bond: No losses expected

Answer 5

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.

Question 6

Explain the following characteristic of surety bond: Indeterminate length and non cancelable

Answer 6

Surety bonds cannot be canceled by surety company once issued. Surety bonds stay in effect as long as principal has not completed their obligations.

Question 7

Explain the following characteristic of surety bond: Bond limit or penalty

Answer 7

This indicates amount guarantee surety is providing to obligee.

Question 8

Explain the following characteristic of surety bond: Bond premium

Answer 8

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.

Question 9

Explain the following characteristic of surety bond: Written contract

Answer 9

Surety bonds must be written and signed, under seal, by both surety and principal.

Question 10

What are five examples of differences between surety contracts and insurance contracts.

Answer 10

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

Question 11

State four types of bonds common in the construction industry.

Answer 11

i) Bid Bonds
ii) Performance Bonds
iii) Labour and Material Payment Bonds
iv) Maintenance Bonds

Question 12

Provide three examples of risks faced by owners of construction projects.

Answer 12

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

Question 13

Identify four considerations of general contractors when determining whether or not to request bonding from subcontractors.

Answer 13

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

Question 14

What are three methods of deposit available to contractors when bidding on a new job?

Answer 14

i) Bid Bonds
ii) Certified cheques
iii) Surety’s consent

Question 15

What two things, owners are assured, when deposits from contractors take the form of bid bonds?

Answer 15

i) Principal was investigated by surety and therefore prequalified
ii) Because of significant penalties of default, principal bid is in good faith

Question 16

What are two guarantees owners receive when deposits take the form of bid bonds?

Answer 16

i) Principal will sign construction contract at agreed price
ii) Principal will be able to provide follow-up surety bonds for project

Question 17

What is “consent of surety”?

Answer 17

This is a letter written by surety and signed under their seal indicating principal will be provided follow-up bonding on project.

Question 18

What are three disadvantages of certified cheques as a form of bid deposit?

Answer 18

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

Question 19

Why would contractors default on bid bonds?

Answer 19

i) Error in judgment on project scope
ii) Mistake in arithmetic on project pricing

Question 20

What are two expenses sureties may incur when contractors default on bid bonds?

Answer 20

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

Question 21

What are two guarantees provided by performance bonds?

Answer 21

i) Principal will perform contract within conditions and terms of contract
ii) Principal will provide maintenance on work for one year after completion

Question 22

What limit is usually requested on performance bonds?

Answer 22

50% of tendered price is usual limit on performance bonds.

Question 23

Can changes to the bonded project be made, and if so, to what extent?

Answer 23

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.

Question 24

What are two types of defaults under performance bonds?

Answer 24

i) Voluntary default
ii) Involuntary default

Question 25

What are four examples of involuntary default?

Answer 25

i) Bankruptcy ii) Lack of technical ability to perform contract iii) Lack of additional credit needed to maintain accounts payable iv) Delays in construction

Question 26

What are two examples of voluntary default?

Answer 26

i) Large errors made in project cost ii) Lack of current assets to pay current liabilities

Question 27

What two actions could sureties take when contractors default under a performance bond?

Answer 27

i) Finance defaulting contractor to allow completion of project ii) Collect bids from other contractors for project completion and present to obligee

Question 28

Describe the guarantee provided by a labour and material payment bond.

Answer 28

Surety guarantees that principal will pay all sub-trades and material suppliers.

Question 29

What are three business benefits of labour and material payment bonds?

Answer 29

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

Question 30

When would a maintenance bond be required?

Answer 30

Obligees will request maintenance bonds when one year maintenance period provided by performance bonds is inadequate.

Question 31

Describe guarantees of maintenance bonds.

Answer 31

Maintenance bonds guarantee that principal will come back and repair flaws in job for term of maintenance bond.

Question 32

What are three concerns of sureties that make issuing a maintenance bond difficult?

Answer 32

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

Question 33

Outline information sureties require in the following area: Financial strength of owners

Answer 33

Personal financial statements of all shareholders will be requested.

Question 34

Outline information sureties require in the following area: Corporate structure

Answer 34

Corporation, individual or partnership of principal will be identified

Question 35

Outline information sureties require in the following area: Key personnel resumes

Answer 35

Skills, education, and experience of senior employees should be described.

Question 36

Outline information sureties require in the following area: Banking information

Answer 36

Bank Letter of Reference will be required indicating size of line of credit, repayment history and overall banking experience.

Question 37

Outline information sureties require in the following area: Accounting information

Answer 37

Financial statements from past three to five years will be required.

Question 38

Outline information sureties require in the following area: Completed work record

Answer 38

Five year history of previous projects, including all contract information will be required.

Question 39

Outline information sureties require in the following area: Work in Progress record

Answer 39

Financial status and list of work currently underway will be required.

Question 40

What are three items in financial statements important to surety underwriters?

Answer 40

i) Working capital ii) Net worth iii) Profitability

Question 41

Describe three factors which affect working capital.

Answer 41

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

Question 42

Describe how net worth is calculated.

Answer 42

Assets minus liabilities.

Question 43

Describe two methods used to report income on contractor’s financial statements and identify which is most desirable to surety underwriters.

Answer 43

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.

Question 44

When issuing bonds limits to contractors, what two limits will be provided?

Answer 44

i) Per job limit ii) Work in progress limit

Question 45

Describe three types of guarantees contractors provide sureties.

Answer 45

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

Question 46

Once bonding limits have been established, surety underwriters will review each request for bonding. What are four factors considered in this process?

Answer 46

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

Question 47

Describe an example of guarantees provided by license and permit bonds.

Answer 47

Compliance guarantee bonds guarantee principal will abide by laws affecting their business.

Question 48

What is the guarantee provided by Administration and Executors bonds?

Answer 48

This bond guarantees that principal will perform responsibility in compliance with law of deceased persons estate.

Question 49

What are three responsibilities of administrators and executors?

Answer 49

i) Collecting assets and protecting them from loss ii) Pay all debts incurred by deceased iii) Provide court with all accounting records necessary transactions

Question 50

Describe “guardian”.

Answer 50

This is someone who is charged in a will to look after affairs of minors and is approved by courts.

Question 51

What guarantee is provided by Trustee in Bankruptcy bonds?

Answer 51

This bond guarantees that trustee will execute duties in compliance with Bankruptcy Act.

Question 52

Describe the guarantee provided by Custom and Excise bonds.

Answer 52

This bond guarantees that principal will pay taxes collected on behalf of government are paid to government.

Question 53

Describe why Injunction Bonds are needed and what they guarantee.

Answer 53

These bonds are needed to guarantee payment of court costs and delay expenses to land owner when injunctions affect their property.