The Unseen Value of Subcontract Bonds
In 1974, The Surety Association of America (now known as The Surety & Fidelity Association of America) published a booklet entitled “Contract Bonds: The Unseen Services of a Surety.” That year, 1974, was one year after I entered the surety industry, which makes the math easy for Pipeline readers to determine how long I have been involved this industry. Our archives in Washington had a copy of the pamphlet, and it makes fascinating and relevant reading today. This, my second Pipeline article, will focus on the unseen advantages of subcontractor bonds.
I believe that the surety and construction industries are in an unprecedented environment when it comes to subcontractor risk. In the building trades, prime contractors are self-performing less and less of the construction. This increases the subcontractor risk to the prime contractors as they are taking projects with low profit margins. The amount of available work is increasing in most states as we have exited the Financial Recession that hit the construction industry particularly hard. The balance sheets of many subcontractors were damaged during that period. Their work programs have now increased while they are operating with less working capital and equity than previously. Many subcontractors lost key employees during the downturn, and many of those workers have not, and will not, return. This fact combines with negative aspects of an aging workforce with a woeful lack of training for workers to replace the soon-to-be-retiring laborers and skilled craftsmen. The rise in longer, larger and more complex projects increases the risk exposure from subcontractor failure.
In 2015, the Associated General Contractors of America asked me to serve as moderator for a panel on prequalifying subcontractors that was presented at its annual Risk Management Conference. I was joined by a NASBP member who spoke on the benefit of bonding subcontractors and by a major advocate for the use of subcontractor default insurance. I mentioned that some general contractors would conduct their own prequalification process and then essentially “go naked” and use such techniques as joint check arrangements, funds administration and contract terms and conditions to mitigate the risk. The AGC had requested that the panel do a balanced and nuanced presentation. I am not under any such constraints as I write for the Pipeline. I believe as strongly as ever that a professional bond producer and an experienced underwriter are uniquely positioned to prequalify a subcontractor. They are likely to have greater access to historical and performance information. Their experience allows them to judge with more accuracy the nature and risk of a proposed project with work the subcontractor has done previously. They may also have access to assets through their indemnity agreements that can assist in the successful completion of the job. Finally, a key element with surety underwriting is that it is not “one and done” prequalification. It is a dynamic, rather than static, process. The producer and underwriter are more likely to spot adverse trends from too rapid growth, expansion into new markets areas and/or taking work with questionable prime contractors, owners or architects.
Additional unseen advantages of subcontract bonds come into play when a subcontractor runs into difficulty in spite of the due diligence done in the prequalification process. The possibilities outlined in the 1974 pamphlet are as helpful today as they were decades ago. For example, if a subcontractor exhausts his working capital or bank credit, but still has the capability and character to complete the project, the surety can, and often has, advanced money to assist the subcontractor. The surety may also guarantee a bank loan. During the mid-1980s, I was involved with a contractor who was technically insolvent, and the surety guaranteed a seven-figure bank loan. Obligees on their projects never knew that there were financial problems. The contractor repaid the loan and is still bonded by the same surety today. I have recently seen cases where a surety has made it possible for the general contractor to release retainage early while the payment and performance bonds remained in full force and effect. When material suppliers are reluctant to sell to a distressed subcontractor, the existence of a payment bond can persuade the supplier to keep the critical flow of materials going.
When a subcontractor takes a job that is beyond his expertise, the surety can assist in providing additional technical and engineering support to work through the problem. A similar situation can arise with the death of an owner or key personnel. The surety can supplement with the talent needed to complete the job or work program. The surety can keep the project moving in the worst possible scenario of a bankruptcy. In the case of the bankruptcy of a major Texas mechanical subcontractor, the surety responded quickly to meet with the labor unions and kept the work forces on the job. The surety brought in supervisors, and not a single day of work was missed. In today’s tight labor markets, the surety’s ability to keep the original labor on the job makes it possible to deliver the project on time. Such an achievement pays tremendous dividends to the prime contractor as he seeks additional work with the same owner.
The fact that many of the services provided by subcontract bonds are unseen does not lessen their importance. A subcontractor benefits from the discipline required in the prequalification process and then in the ongoing underwriting process over time. They can become better businessmen and managers. General contractors benefit from the protection of their profits on projects and from timely completion of projects due to a surety keeping laborers on the job and suppliers continuing to furnish materials. In summary, the use of subcontract bonds is smart business. It is NASBP’s responsibility to continue to deliver that message.
Howard Cowan is Principal of Acrisure, LLC dba Cowan-Hill Bond Agency in Lubbock, TX. He can be reached at firstname.lastname@example.org.