Surety Bonds For Projects
October 15, 2019
Sometimes referred to as Payment Bonds, Surety Bonds are posted by a contractor to guarantee that its subcontractors, material suppliers and other vendors will be paid-in-full. Surety Bonds are required on most large projects. Surety Bonds are typically issued by an insurance carrier or bank and are normally required in conjunction with Performance Bonds.
Performance Bonds, also known as Contract Bonds, are commonly used in construction and development of real property or in re-roofing/rehabilitation projects. They assure that the project for which the Bond is posted will be completed if the contractor fails to complete the contract. Also, if a dispute arises among parties to a contract in which the contractor and owner cannot reach a resolution, the owner may make a claim on the contractor’s Performance Bond. In extreme cases, the company providing the bond (the Surety) takes over and completes the project using another contractor. In the case of a contractor becoming insolvent, some sureties have extended credit to the contractor to complete the project after which the contractor is bound to re-pay the Surety. In many cases, the Surety requires owners of a contracting company to provide personal guarantees to the Surety before issuing the bond. These personal guarantees place the owners’ personal assets at risk of being seized in the event the contractor becomes insolvent or otherwise fails to honor its contractual obligations.
In 1999, our firm, as well as more than a dozen other subcontractors, were subjected to a general contractor declaring insolvency during the construction of a large high school project in Atlanta. Fortunately, the general contractor had been required to put up Payment and Performance Bonds at the beginning of the project. After numerous delays caused by the general contractor, as well as countless instances of failing to properly schedule the work of its subcontractors, the owner and the subcontractors filed claims against the existing Surety Bonds. Following this action, the general contractor demobilized and left the site with the project only 40% complete, months behind schedule and owing millions for materials and the completed work of the subcontractors.
After the claims were filed, the Surety brought in a new general contractor to complete the remaining work. We scheduled and attended a meeting with the new general contractor and the Surety. The results of the meeting were:
- The Surety issued our firm payment for the backlog of our unpaid invoices to the original general contractor.
- We agreed to complete the roofing work after the new general contractor performed a pre-work inspection to confirm all leading trades’ work was in-place to allow our firm to complete the roofing and related work.
- We agreed to mitigate the claimed damages to our material stored on-site once we were able to ensure that they had not been exposed to weather and that they were properly protected with water-tight tarps until we would need them.
One of the most important strategies to employ in such an unfortunate situation is to establish a positive working relationship with the Surety and the new general contractor. As president of the company, I took over direct responsibility for daily project management, including initiating the positive working relationship and level of communication and trust needed for a situation that was stressful to all parties and stakeholders. Any effort to play hardball with the Surety or the new general contractor would have been counterproductive and led to a rocky relationship for the remainder of the job. Some subcontractors tried the hardball approach and regretted it. In the end, we were allowed to proceed with our work, quickly completed our contractual obligations and were paid-in-full.
In retrospect, the calamities experienced by the owner and subcontractors of this project were the result of the contract being awarded to the lowest bidder that could provide the required Surety Bonds, with no regard to whether that contractor was qualified to actually fulfill the contract.
There were two primary contributors that led to these negative effects for the owner, the taxpayers and other project stakeholders. The first was the owners’ failure to properly and fully prequalify bidders on the project. A thorough vetting of the failed general contractor would have led to the contractor being disqualified from bidding on the project in the first place. The second stop-gap that should have prevented this situation was that the Surety failed to properly assess the risk in issuing Surety Bonds to this general contractor. The Surety’s underwriters failed to perform a proper assessment of the general contractor’s financials and adequate due diligence of the contractor’s history on past projects of similar complexity. A thorough assessment of these risk factors would have red-flagged the contractor’s application for the project’s Payment and Performance Bonds and prevented them from being awarded this contract in the first place.