Chapter 5 Surety Bonds Flashcards by Chandra Marchand

Surety

State of being sure, certain or secure

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Suretyship

A guarantee of performance made by one person for another

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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

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3 areas underwriters use to base credit appraisal

Character
Capacity
Capital

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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

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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

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4 categories of surety bonds

Contract Bonds
Judicial Bonds
License and Permit Bonds
Miscellaneous Bonds

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Contract Bonds

Guarantee certain obligations of contract
Most commonly used in construction field

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Who does not use the bond form but develops their own form specific to their needs

Hydro companies
Oil companies
Crown corporations
Municipalities

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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

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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

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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)

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Types of Construction Bonds

Bid Bond
Performance Bond
Labour & Material Payment Bond
Maintenance Bond

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Bid Bond

Contract involves large project
Furnished to the owner ( oblige) of project and not in force until contractors tender is accepted

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2 methods bid bonds are made

Bid bond
Certified cheque

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Surety’s consent
AKA Consent of surety
Agreement Bond
Bid letter

Letter that assures the owners that the principal was the successful bidder

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Reasons why contractors may default on Bid Bond

Error in judgement
Mistakes in arithmetic

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What is required when a bid is forfeited

An offer must be made and rejected in writing

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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