Demystifying surety bonds

Construction projects can take a nasty
turn in a New York minute. A host of
problems can cause a contractor’s business to fail, leaving projects at a standstill.

“It happens all the time,” says Michael
Popick, AIP, Vice President, Gateway
Insurance, Fort Lauderdale. “When a construction project is not bonded and the
subcontractor fails to complete the job, the
projects stalls, delays are massive, and it
costs a lot more money to find somebody
to complete someone else’s job.”

Smart Business spoke with Popick
about how these issues could be mitigated
with a surety bond and why a number of
misconceptions may be stopping project
owners or contractors from obtaining this
important and accessible insurance.

What is a surety bond?

A bond is a three-party instrument
between the surety, the contractor or general contractor, and the project owner or
financial institution. A bond shows that a
hired contractor has the capital and where-withal to finish the project.

Car accident insurance or hurricane
insurance are anticipated losses that get
factored into underwriting and pricing
these policies. But with surety, claims and
losses are not anticipated. We try to underwrite them out, so if somebody doesn’t
qualify for a bond, we’re not going to give
them a bond.

Are surety bonds always required?

Bonds are required under the Miller Act
for public work valued at over $100,000.
The private sector doesn’t have that
requirement, but many times it is used as a
rule of thumb. Public work is responsive to
guidelines and codes, and it usually is managed by administrators, engineers and
architects with experience in contract
supervision. Private work contracts and
specifications vary widely in form, and if
architects and engineers are not involved,
private owners may not be familiar with
construction operations and procedures.

Why do some projects commence without a
surety bond?

The biggest misconception out there is
that you have to sign away your entire life.
That’s not true. Bonding companies don’t
want to get into your personal home, and
the Florida Homestead Act prohibits that.
The main requirement is that you have to
finish the job at all costs. Another misconception is that there is a mountain of paperwork involved. There are some forms that
have to be filled out and some financial
information that has to be generated, but
there’s not an overwhelming amount of
paperwork. It’s really less than the paperwork associated with a small bid.

Are surety bonds accessible?

Most people can qualify for a surety
bond. We go through an application
process and check references, and credit
checks are done to support character. If
you’ve got bankruptcies, then you’re not a
very good credit risk. Bonding is more of a
line of credit than it is insurance, and
you’re borrowing against that line of credit
every time you issue a bond. Right now, the
surety market wants to write more and
more business, and it is doing what was not typical five or six years ago. Some of the
people we write today were not bondable
just two years ago. Now I can get them a
$3 million bond.

What are components of the qualifying
process?

A common term we use in bonding is
called the ‘Three C’s,’ or character, capacity and capital. We look at character to see
what kind of contractor you are. Do you
pay all of your bills? Do you have a lot of
liens against you? Do you finish jobs on
time? Determining your capacity tells us if
you have the capability to do the job. For
example, if you were renovating kitchens
last week, you probably can’t tackle a multimillion dollar project next week. Finally,
a review of capital reveals if your firm is
financially strong enough so that, in the
event of a surprise, you can still pay sub-contractors and suppliers so everyone
stays happy.

What can smooth the application process?

A CPA — plain and simple. Any company
seeking a bond should consider hiring an
accountant that specializes in construction. That can make or break you.
Bookkeepers are not acceptable because
construction accounting has to be done in
a very certain way to optimize your financial statements.

Who pays for the surety bond?

The contractors usually pass the cost of
the surety bond to the general contractor
or the project owner. Depending on the
rate, they might not be able to pass the
entire amount through because the general
contractor will only give a certain point,
but often the entire amount is passed
through to the ultimate owner or whoever
required the surety bond.

MICHAEL POPICK, AIP, is Vice President, Gateway Insurance
Agency, Fort Lauderdale. Reach him at (925) 332-1875 or
[email protected].

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