Surety Bonds What s New in the World of Construction Security I Construction Risk

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1 Surety Bonds What s New in the World of I Construction Risk 10:45 11:30 1

2 Then You Shall be his Surety William Shakespeare Merchant of Venice Construction Risk 2015 Construction Risk = Risk of Contractor Failure. The number and severity of contractor failures increased in recent years. Recent Challenges: Reduction of available work; oversaturated market = tighter margins Onerous contract conditions. Downloading of risk Paradigm Shift: AFP s, P3 s 10:45 11:30 2

3 Construction Risk 2015 From , the Surety industry paid out almost $800 million in claims; more than all of the previous decade a year to forget: Loss ratio; 52% - industry unprofitable Premiums flat after two years of decline Across all lines and all sectors of the country 2014 & first half of 2015 showed improvement lower loss ratios and premium growth but. 2015? Impact of Oil Prices in western Canada and political and economic instability Construction in Canada 2015 Canada the new construction mecca. Ongoing commitment to infrastructure Federal commitment $48B over 10 years. By 2020 Canada to be world s 5 th largest construction market (9 th in 2010) Increased foreign investment from depressed areas (e.g. Europe) Larger and longer projects Challenges to small and mid-sized contractors 10:45 11:30 3

4 Protect Against Construction Risk Surety Bonds Performance Bonds Labour & Material Payment Bonds Liquid Security Irrevocable Letters of Credit Cash/Negotiable instruments on Deposit Default Insurance Products Why Contractors Fail Unqualified Contractors; the lowest irresponsible bidder Insolvency of Contractor Contractor default for non-financial reasons: Over Extension Inability to complete Incapacity of Key people Unpaid subs and suppliers resulting in liens Warranty problems 10:45 11:30 4

5 II Surety Bonds What are They? How do they Work? Surety is not Insurance 10:45 11:30 5

6 Surety is not Insurance INSURANCE 2 party agreement; Insured & Insurer Premiums actuarially determined Losses anticipated No recourse against insured in the event of loss SURETY 3 party agreement; Principal, Surety & Obligee Premiums only a service charge No losses anticipated Recourse against the Principal via indemnity agreement Surety Bonds: 2 Essential Services Prequalification: Assurance that the bonded contractor is qualified for the job for which they are contracted. Security: Financial Protection in the event that the bonded contractor should default on its obligation. 10:45 11:30 6

7 Prequalification Ongoing, Thorough & Value Added Intensive: Ongoing Comprehensive: Value Added Standard Construction Bonds Prequalification Prequalification Letter Bid Bond Consent of Surety Security Performance Bond Labour & Material Payment Bond 10:45 11:30 7

8 Standard Construction Bonds Prequalification Prequalification Letter Letter to owner confirming bondability ; non-binding Bid Bond Protection should low bidder refuse to enter into contract. Pays Difference between the low bid and 2 nd bidder Consent of Surety Letter to owner where surety agrees to provide the required bonds; this one is binding. Standard Construction Bonds Security Performance Bond Guarantees Contractor will perform Contract in accordance with terms and conditions. Contractor must be in default Provides owner with completed job; not just cash Labour & Material Payment Bond Guarantees that trades and suppliers will be paid for goods and services provided. Must have a direct contract with bonded contractor. 10:45 11:30 8

9 III Surety Bonds Myths & Misconceptions Myths & Misconceptions Myth #1: Sureties Don t Respond to Claims. A surety bond will provide: Professional prequalification to weed out unqualified contractors. True performance security; i.e. provides owners with a completed project in the event of default. Payment protection to subs and suppliers. A surety bond will not provide: Cash-on-demand. There MUST be a default. Dispute resolution. A magic lamp. Protection beyond the scope of the contract. 10:45 11:30 9

10 Myths & Misconceptions Myth #1: Sureties Don t Pay Claims. Also. Owner must have fulfilled its contract obligations L & M Claimants must comply with the terms of the bond and be prepared to document claim Problems or questions? Contact the Surety Association of Canada Phone: Fax: sness@surety-canada.com Myth #2: A 50% Bond only provide 50% Protection 50 percent bond gives you 100 percent protection up to the bond amount Example: Myths & Misconceptions Contract Price = $ 1 million 50 % Performance bond ($500,000) Contract is 50% complete Surety arranges completion for $ 700,000 Surety s loss is??? 10:45 11:30 10

11 Myths & Misconceptions Myth #3: Bonds are a Barrier (especially to small contractors). Barrier? Bonding companies need to write bonds. Sometimes a time problem for contractors without a bond company it takes time to establish a facility. Some sureties will ONLY bond small contractors, others have small contractor divisions Small firms will secure bonding for jobs within their realm of expertise Bonds are a barrier to unqualified contractors IV Surety Bonds What Happens when a Contractor Defaults? 10:45 11:30 11

12 Before a Default is Declared Surety has extensive experience with contracts and solving construction problems. Surety has intimate knowledge of contractor and its operation Can provide informal assistance to solve problems that can lead to a default Will convene meeting or teleconference among the parties to address problems. Assist in formalizing solutions. Claims When A Contractor Defaults: Surety will promptly acknowledge notice of default and being to gather information. Surety will begin an investigation as soon as possible. Surety will conclude the investigation as soon as possible. If requested by owner, surety will provide periodic written updates on investigation status and best estimates as to completion date. 10:45 11:30 12

13 Claims During and After the Investigation: Surety will cooperate with the owner to protect work from damage or deterioration. Surety will work with the owner to: Identify and implement a solution. Minimize delays, keep the job going and protect the rights of all parties. Pay valid labour and material payment bond claims as promptly as possible to ensure continuity of subs and suppliers. How can the Project Owner Help Comply with bond & contract terms! (e.g. proper notifications, payments and certifications) Communicate: keep surety appraised of problems and provide default notice promptly. Cooperate: Ensure surety has access to knowledgeable staff and relevant documents. Keep expectations realistic. 10:45 11:30 13

14 V Surety Bonds Unseen Services to Owners & Lenders Unseen Services of Surety Bonds A surety can provide assistance and default prevention services to owners & lenders by: Facilitating the resolution of construction performance issues that could lead to default Providing management and business assistance to assist contractors with administrative issues. Providing financial assistance to financially distressed contractors Providing technical/engineering expertise if required 10:45 11:30 14

15 Unseen Services of Surety Bonds Confederation Bridge New Brunswick to PEI Confederation Bridge Fixed Link from PEI to mainland 12.9 km 3 ½ year project; cost of $800 million. Opened June Performance & Payment Bonds provided by a three member co-surety pool. Owner: Public Works Canada Contractor: Strait Crossing Development Inc; a private consortium of four companies. Senior Partner: Morrison Knudsen Inc. of Boise Idaho 35% share. 10:45 11:30 15

16 Confederation Bridge Morrison Knudsen; Established 1932, $2.86 billion in sales 1996 MK files for Chapter 11 bankruptcy protection; threatens survival or project. Sureties act quickly; arrange to finance MK through to completion to allow for the company to be sold. Default prevented and project completed on time. NOT ONE DAY OF WORK WAS MISSED. The local community, the general public unaware of any problems VI - Other Forms of Contract Security 10:45 11:30 16

17 Liquid Security (LOC s) Yield cash; not performance Provide no prequalification assurance Available in smaller; perhaps insufficient amounts (5% to 10%) Deplete a contractor s borrowing power and can bring on the very problem they seek to avoid No dedicated protection for subs or suppliers Work well for financial risks Subcontractor Default Insurance (SDI) Introduced in 1996 to protect very large general contractors from subcontractor default. Indemnity product compensates for loss incurred Significant deductibles and co-payment Insured should have in house construction administration experience and strong cash flow. Does a good job at providing the protection for which it was designed; i.e. protecting large G.C. s against construction default. NOT designed to protect owners from risks associated with default of prime contractor. 10:45 11:30 17

18 The CDI for Owners Non-Solution Large general contractors approaching owners and lenders with a cost savings proposal. Sign on to G.C. s CDI policy better protection, more cost effective better management of subcontractors, etc. Save the bond premium. The SDI for Owners Non-Solution What they don t tell you. CDI is NOT an alternative to Surety Bonds OWNERS NOT PROTECTED FROM G.C. DEFAULT Owners have limited or no access to CDI benefits Endorsement only responds when G.C. is insolvent. Contracts with unpaid trades are unenforceable If Prime Contractor should default: No Protection Cost Savings are minimal or non-existent. CDI protects Contractors; NOT Owners 10:45 11:30 18

19 Waiving Final Bonds Owners Save the bond premium by calling for bid security and waiving requirements for final bonds. Penny-wise; Pound Insane. Contractor failure can bring catastrophic consequences if not adequately managed. Contractor failures on the rise as the economy continues to struggle. NO contractor; large or small is immune to financial and economic forces Morrison Knudsen: from Fortune 500 to Chapter 11 in two years. VII Other Stuff 10:45 11:30 19

20 SAC Performance Bond SAC consultations with Owners & Contractors; More certainty in the claims process. More responsiveness to a claim More frequent and effective communication between sureties and owners. New enhanced performance bond provides construction buyers with more timely &responsive claim service. Has been used by owners across the country and will be adopted by CCDC as the new standard. Provides more responsive services to owners by.. SAC Performance Bond Pre-Demand Conference to allow surety and owner to prevent problems from turning into a default. Timelines for Surety s Response: 5 days to acknowledge a response & request info. 21 days (from receipt of information) for surety to respond to owner with their response. Emergency Remedial Work: Allows Owner to address urgent issues(e.g. safety) under the bond. Post-Demand Conference: Mechanism to minimize or eliminate work stoppages while surety investigates. Contact Coordinates: Contact information for all parties to facilitate notices and communication. 10:45 11:30 20

21 Surety Bonds & P3 Projects Comprehensive performance & financial security against construction default on mega-p3 projects. Sufficient capacity for mega-projects. Broad and flexible protection packages which include: Professional surety prequalfication Specialty P3 bonds designed by member sureties: Provide liquid / cash on demand protection. Built-in fast-track dispute resolution Early Response; surety involved pre-default. Protection for trades & suppliers via the payment bond. Called for on Infrastructure Ontario Build-Finance and Design-Build-Finance projects. e-procurement & e-bonding Consult Consult Consult: Industry buy-in and engagement is critical Don t Reinvent the Wheel: are you a software developer? Insist on Verifiability: a true ebond; responsive vendor Scanned pdf??? Take the Time to get it right: Not difficult just different; Lead time to allow industry to adjust; Mock Tenders SAC can Assist: Vendor evaluations Visit SAC Website 10:45 11:30 21

22 Headstart Performance Bond TM Created by The Guarantee Co of N.A. to protect GCs from sub default (competitive alternative to SDI) Industry Solution: available for use by other sureties. Flexibility: Obligee given two mitigation options: o Traditional Option: Surety investigates and implements solution (as in standard bond); or, o HeadtstartOption: Obligee implements its own solution upon surety s acceptance of Obligee s completion proposal. Responsiveness: o First dollar protection(no deductible or co-payment). o Surety will respond in 3 days from receipt of Claims letter. o Standard claims notice and mitigation agreement. SURETY ONLINE LEARNING CENTRE The Surety Online Learning Centre accessible from SAC website; Five learning modules that introduce the basics of surety bonds and the suretyship process Learn at your own pace. Ideal for review or for colleagues who can t attend a live information session. It s FREE 10:45 11:30 22

23 Contact Us Phone: or visit our website: (west) (H.O. Toronto) 10:45 11:30 23