Chapter 5 Study Guide and Checkpoints Flashcards
What is meant by “one goes bond for another”?
Personal Suretyship.
Going bond means to guarantee the PERFORMANCE of another.
Bonding involves the extension of credit to the principal. Discuss the three factors relating to the principal which form the basis of credit appraisal.
What are the 3 Cs?
Character
Capacity
Capital
Character
Review of company’s management performance
Ensure that the principle is of
- good character
- pays bills promptly
- and is of good business reputation
Capacity
Assessment of Principles ability as based on past history.
Surety wants to be satisfied that the principle has the -
- knowledge
- experience
- and labour pool necessary to do the job
Capital
Assessment of Principal’s financial capacity. When large amounts are involved, the financial resources constitute the most important factor in determining whether the principal can obtain a surety guarantee.
State TWO BENEFITS of SURETYSHIP
- Agreeing to provide a surety bond indicates to the principle that the surety is confident in the principles ability to carry out the required task.
- Guarantee that the surety will perform the contract should the principal default serves to provide obligees with the confidence needed to undertake various projects.
First FOUR CHARACTERISTICS common to all surety bonds
- Three party contract - PRINCIPLE, OBLIGEE, SURETY
- PRINCIPLE liable to Surety
- No losses expected
- Of indeterminate length and non-cancellable
Principle liable to surety
- promise made to obligee and not to principle
- secondary obligation arising out of default of principle
- Surety’s duty to pay arises immediately upon default of principle
No losses expected
- prequalification of bond applicants designed to remove risk
Of Indeterminate length and non-cancellable
- Terminate only when Principals Obligations have been fulfilled
The next Four CHARACTERISTICS common to all surety Bonds #5-8
- Statutory or Non-Statutory in form
- Bond Limit (Penalty)
- Bond Premium
- Written Contract
- Statutory or Non-Statutory in form
Statutory or Non-statutory in form =
STATUTORY BOND - Required by municipal ordinance or federal or provincial regulation or statute (i.e. licence and permit bonds)
- Bond Limit (Penalty)
Amount of credit given to the principal by the Surety
- Bond Premium
More appropriately described as a service fee
- Written Contract
Surety contract must be provided in writing and executed under seal of the surety and, unless operating as an individual, the principal.
Contracts of Suretyship are not insurance contracts. Provide some reasons why or how they are different
Insurance Policies be like:
- are two party agreements, not 3
- anticipate losses comin’
- payment of losses is made directly to the insured and insurer is not required to be reimbursed by the insured
- the premium charged is based on current underwriting costs and future claims expenses
- additional limits of insurance can routinely be added by the payment of an additional premium
- are issued for specific periods of time and are cancellable by the insurer during the policy period.
- an oral agreement is just as binding on the parties to the contract as is a written agreement
Identify three risks common to owners when undertaking a construction project without the protection of bonds
RISKS!!
- the inability or refusal of the successful bidder to enter into the contract
- the failure of the contractor to complete the project at the contract price
- the inability of the contractor to pay subcontractors and suppliers
State four factors considered by the general contractor when deciding whether subcontractors should be bonded
- The terms of the contract
- The relationship between the contractor and subtrade
- The value of the subcontract
- The subtrades price in relation to other bidders
- Whether the general contract wishes to pay the costs of the bonds rather than assume the risks associated with not doing so
Four types of contract bonds used by the construction industry
a) BID BOND
b) PERFORMANCE BOND
c) LABOUR AND MATERIAL PAYMENT BOND
d) MAINTENANCE BOND
Lets discuss the guarantees of each shall we:
a) BID BOND
Guarantees:
- The principle can and will enter into a contract to perform the work at the tendered price; and
- The principal can and will provide whatever security is specified to ensure performance of the contract
b) PERFORMANCE BOND
Guarantees:
- the actual performance of the contract in accordance with its specified terms and conditions.
- that faulty work will be corrected and defective materials replaced for a period of one year after completion of performance.
c) LABOUR AND MATERIAL PAYMENT BOND
Guarantees:
- that the sub trades and suppliers will be paid for the work and materials that enter into the project.
d) MAINTENANCE BOND
Guarantees:
- That the principal will fulfill the warranty obligations stated in the contract
Common reasons for defaulting under BID BONDS
- Error in judgement
- Mistakes in Arithmetic
Common reasons for defaulting under PERFORMANCE BONDS
a) INVOLUNTARY DEFAULT - this includes:
- Insolvency
- incompetence
- banks refusal to grant additional extension of credit
- delays resulting from modifications to the contract. failure to receive materials and equipment when needed. bad weather, labour disputes.
- failure of major subcontractors when no bonding in place
b) VOLUNTARY DEFAULT
- Improper estimate of the contract costs
- Cash Flow Problems
a) INVOLUNTARY DEFAULT
a) INVOLUNTARY DEFAULT - this includes:
- Insolvency
- incompetence
- banks refusal to grant additional extension of credit
- delays resulting from modifications to the contract. failure to receive materials and equipment when needed. bad weather, labour disputes.
- failure of major subcontractors when no bonding in place
b) VOLUNTARY DEFAULT
b) VOLUNTARY DEFAULT
- Improper estimate of the contract costs
- Cash Flow Problems
Bond Limit or Penalty of BID BOND
- A specific dollar amount equivalent to the percentage required as a penalty; OR
- a percentage of the contract price with a maximum dollar amount specified.
Bond Limit or Penalty of PERFORMANCE BOND
50 or 100% of Contract Price
Bond Limit or Penalty of LABOR AND MATERIAL PAYMENT BOND
- same limits as PERFORMANCE BOND
Bond Limit or Penalty of MAINTENANCE BOND
- limit required by OBLIGEE as per terms of contract
Where can we find the info needed to determine the level of bonding the contractor can expect to obtain?
In the contractor’s FINANCIAL STATEMENT
Three main items of most interest to surety underwriters when reviewing the contractors Financial Statement
- Working Capital
- Net Worth
- Profitability
If there is a problem in interpreting the financial statements of contractors, surety underwriters agree that it…
… lies in the method used to report income earned on work in progress.
Two reporting Methods used re: Financial Statements
- COMPLETED CONTRACT METHOD
2. PERCENTAGE OF COMPLETION METHOD
- COMPLETED CONTRACT METHOD
the financial statement does not show the job profit or loss until the project is completed or near completion. advantage to principle is that the taxes can be deferred until project is substantially completed.
- PERCENTAGE OF COMPLETION METHOD
The earnings from the work completed are calculated as a percentage of the total contract price. Profit or loss is recognized on a current basis… this allows for a reasonable estimate of the amounts needed to complete the job
Which method provides a more accurate accounting of the contractors current financial position?
percentage-of-completion method
What must contractors do before surety underwriters will agree to issue a bond on their behalf?
Contractors must provide their own GUARANTEES
4 Forms of Contractors Guarantees
The S.C.I.T.
- Indemnity Agreements
- Third Party Indemnities
- Collateral Security
- Subordination Agreements
The 5 Types of Guarantees provided by LICENCE and PERMIT BONDS
C.C. FIG
- Compliance Guarantees
- Financial Guarantees
- Indemnity Guarantees
- Good faith Guarantees
- Credit guarantees
- Compliance Guarantees
Guarantee that principals will comply with those laws that affect them
- Financial Guarantees
Require the surety company to protect the government body that granted the license or permit against monetary damages resulting from the failure of licencees to comply with STATUTES, REGULATIONS, ORDINANCES, or CODES which control their ACTIVITIES
- Indemnity Guarantees
Extend provisions contained in the bonds providing “financial guarantees” to third parties sustaining financial damages.
- Good faith Guarantees
Guarantee that principals will perform in good faith.
- Credit guarantees
Usually required when principals sell property of others. Guarantees that principals will conduct their business affairs in accordance with the best interests of their creditors and will provide an honest accounting of all funds in their possession.
What a client needs to do to open a bond account with a surety
- The surety will want to conduct a credit assessment of the contractor before agreeing to provide it with bonds.
- this will involve an investigation of the character, capacity and capital position of the contractor. the surety company will usually have developed its own survey form to provide the information needed to arrive at a bonding decision.
How do we know the amount of the deposit required under this tender?
It’ll say the % of the total bid on the Tender.
What type of bond is best for a substantial amount?
A bid bond
most common type of performance bond
While 100% bonds are available, a bond for 50% of the contract will usually provide a sufficient guarantee and are, therefore, most common.
a Labour and Material Payment Bond is issued in conjunction with and for the same amount as the…
Performance Bond
if a performance bond includes up to 1 year of maintenance respecting faulty materials or workmanship, is it likely a separate maintenance bond will be required?
It is unlikely, unless the contract has a warranty period beyond the standard one-year term. If a Maintenance Bond is required, the limit of the bond will be stated in the contract between the parties.
if other bonding is required by the successful bidder, indicate why additional documents, if any, should accompany the clients bid.
Generally, when further bonding is required of the successful bidder, a CONSENT OF SURETY will be required to accompany the bid bond.
Suretyship has come to mean:
A Guarantee of PERFORMANCE - made by one person or entity for another
Statutory Bond
One that is required by a municipal ordinance, or federal or provincial regulation or statute. The obligation is a MATTER OF LAW!!!
What is the Canadian COnstruction Documents Committee (CCDC)
The “standard” bond forms used by surety companies have been largely the work of the CCDC
When coverage is issued under the CCDC BID BOND, suits must be started within_______ (time frame) of the date the bond was issued. (if there is a default on the bid bond)
6 Months
Are “Error in judgement” Defensible in the courts?
NO they are indefensible
Are Mistakes in arithmetic defensible in the courts?
YES they are damnit!
When is the Bid Bond forfeited?
When a successful bidder fails to enter into a formal contract.
Why might a SURETY generally require a letter or “Contract Status” report from the owners?
This is in regards to Performance Bonds
This indicates the contractual duties are being performed property and faithfully, and that to the best knowledge of owner, there are no unpaid suppliers, labourers, or liens.
- Protects the Surety from owners who are aware of a work deficiency, insolvency or other fact which might cause the contractor to default.
What is the preferred accounting method for WORK IN PROGRESS?
B) Percentage of completion method
