Chapter 5 Surety Bonds Flashcards
Surety
State of being sure, certain or secure
Suretyship
A guarantee of performance made by one person for another
2 main bonds issued by surety companies
Fidelity Bonds - Protection against dishonest employees
Surety Bonds- An undertaking of one party to become accountable to another party for the performance of a 3rd party
3 areas underwriters use to base credit appraisal
Character
Capacity
Capital
How is suretyship similar to banks
Same process used by banker making loans
Banks don’t lone money to those who don’t make eligibility requirements
Characteristics all Surety Bonds have in common
3 party contract- Principal, Obligee and Surety
Principal liable to surety
No losses expected
undetermined length of time - non -cancellable
Statutory and non-statutory
Bond limit
Bond premium
Written Contract
4 categories of surety bonds
Contract Bonds
Judicial Bonds
License and Permit Bonds
Miscellaneous Bonds
Contract Bonds
Guarantee certain obligations of contract
Most commonly used in construction field
Who does not use the bond form but develops their own form specific to their needs
Hydro companies
Oil companies
Crown corporations
Municipalities
What risk to owners if there is no bonds in place
Refusal or inability of successful bidder to enter contract
Failure of contractor to complete project at contract price
Inability of contractor to pay subcontractors and suppliers
Why do General Contractors need construction bonds
Require bonds to cover all aspects of project
Should develop a relationship with surety company
Failure to secure bonds limits ability to compete for public and private bids or tenders
What factors influence whether general contractors require bonding of subtrades
Terms of contract
Relationship between contractor and subtrade
Value of subcontract
Subtrades price in relation to bidders (if way below may show financial difficulty)
Types of Construction Bonds
Bid Bond
Performance Bond
Labour & Material Payment Bond
Maintenance Bond
Bid Bond
Contract involves large project
Furnished to the owner ( oblige) of project and not in force until contractors tender is accepted
2 methods bid bonds are made
Bid bond
Certified cheque
Surety’s consent
AKA Consent of surety
Agreement Bond
Bid letter
Letter that assures the owners that the principal was the successful bidder
Reasons why contractors may default on Bid Bond
Error in judgement
Mistakes in arithmetic
What is required when a bid is forfeited
An offer must be made and rejected in writing
Penalties for contractor defaulting
Compensate the owner for de-lay and additional costs for the job to be re-tendered
Pay the difference between defaulting contract bid and amount work is contracted
Annual service undertaking fee
Covers cost of investigating applicant
Costs for providing bid bonds and surety letters
Surcharge of $100 may be applied if contractor has over 24 bids
Bid bond service undertaking agreement when established with the Surety
Avoids the need for Principal to use other means of security when submitting tenders to a tight deadline
Performance Bond
Guarantees performance of contract in accordance to specific terms and conditions
Faulty work will be corrected or defected equipment replaced
12 month period
Who does Guarantee of Performance Bond protect
The obligee ( Owner of the project)
Most common bond penalty limit
50% bonds
Some 100% bonds but uncommon
Default under Performance Bond
Insolvency
Incompetence
Bank refusal to extend credit
Failure to receive materials and equipment needed
No subcontracting bonds in place
Improper estimate of costs
Cash flow problems
3 procedures Project owner must follow to make a claim under performance bond
Surety must notify Obligee as required by the bond and within time limit specified
Obligee must satisfy Surety that default occured
Obligee must show the terms of contract between obligee and principal have been observed
2 options surety can take when defaulting
Completion of contract
Obtain a bid for submission to obligee for completion of contract
Rate charged under Performance Bond
Cost per $1000 of worked performed
Labour and Material Bond
Guarantees subtrades and supplied will be paid for the work and materials that enter project
(described as public relations bond )
Important functions of Labour and Material Bond
Reduces cost of construction
Eliminating or reducing delays of construction
Freeing up credit
CCDC - Canadian Construction Document Committee requires claimants to satisfy the following conditions
Direct contractual relationship
Written notice
Time limits - 120 days of last date worked no claims after 1 year
Right of legal action
Project identification
When is a separate maintenance bond required
Contract has an extended warranty beyond standard 1 year
Guarantee given to obligee that principal will fulfill warranty obligations stated in contract
Why are sureties reluctant to provide maintenance guarantees for more then 1 year
Longer the guarantee the greater chance of defects becoming apparent
Determining causes of defects becomes more difficult
Judgement awarded is usually against the contactor
Surety company requires this information when qualifying a contractor
History
Financial strength of owners
Organization chart
Corporate structure
Key personal resumes
Banking information
Accounting information
Surety information
Completed work record
Work in progress record
Receivables and payables
3 areas must meet the expected standards of the Surety company to underwrite the account
Working Capital
Net worth
Profiability
Working Capital
amount of funds available to pay continuing business operating expenses
Net worth
Amount of money remaining after all assets have been liquidated and all liabilities cleared
Profitability
analysis of working capital and net worth
2 different approaches that construction accounting use
Completed contract method - job profit or loss is not recognized on the financial statement
Percentage completion method- preferred accounting method
Earnings from work completed are calculated as a percentage of the total contract price
6 pieces of information shown on the work in progress report
Contract description and location
Contract amount
Percentage completed to date
Amount billed to date
Estimated cost to complete
Estimated date of completion
4 forms of back- up the surety company may require incase of default
Indemnity agreements
Third party indemnities
Collateral Security
Subordination Agreements
2 instances a contractor may not be eligible for bonding
New contractor
Contractor with poor records of performance
Factors included when issuing a bond
Nature of work
Project location
Bond limit required
Completion date
Conditions
Communications
what 2 items does the requirement of licensing provide governments with
Source of revenue
Means of regulating the activities of license holders
Types of businesses that require special legistlation
Insurance
Real estate brokerages
Auctioneers
Automobile dealers
Barbers
Gasfitters, plumbers, electricians
