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Surety Bonds at Work

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Contents

Surety Provides Working Capital . . . . . . . . . . . . . . . . 2

Surety Guarantees Bank Loans . . . . . . . . . . . . . 4

Surety Provides TechnicalAssistance. . . . . . . . . . . . . . 5

Surety Replaces Contractor . . . . . . . . . . . . . 8

Surety Completes the Project . . . . . . . . . . . . 10

Surety Saves Project fromSubcontractor Failure . . . . 11

Surety Mediation PreventsDefault . . . . . . . . . . . . . . . 13

The Cost of Not Bonding . . . . . . . . . . . . . . 15

Note: Some contract amounts in the

following case studies have been adjusted

to reflect current contract dollars.

Surety Bonds: Seeing Projects to Completion

Construction represents 10% of the U.S. Gross Domestic

Product according to the U.S. Census Bureau. This $845 billion

industry comprises nearly 650,000 construction companies

and 5.7 million workers. With unparalleled competition in recent years,

less predictable profit margins, and increased preferences by project

owners for fixed price contracts and design-build project delivery, con-

struction is a risky business.

Completion is the goal of everyone involved in a construction proj-

ect. Although the purpose of a surety bond is to assure a qualified con-

tractor capable of completing the project, contractors do experience

problems, and default does occur. Fortunately, surety bonds protect pri-

vate and public owners from the enormous costs of contractor default.

Surety companies pay millions of dollars in claims each year and pro-

vide financial and technical assistance to contractors so you get what

you contracted for—a completed project.

The surety industry plays an important role in the construction indus-

try’s success. The following case studies illustrate the many ways surety

companies assure project completion.

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Sureties’ Chemistry With Contractor &Owner Results in Completed Project

A $38.7 million renovation of a 250,000 sq.ft.Bloomingdale’s department store into universityclassrooms was just one of many ongoing projectsfor a major national contractor. The new facilityincluded a main chemistry classroom building, alarge glass enclosed concourse, and a parkinggarage—each with its own completion deadline.

The classrooms were top priority—they neededto be completed for the start of the semester inJanuary. By July, the project was 61% complete,on time, and on budget. In September, however,the contractor filed for bankruptcy protection.Several subcontractors reduced to skeleton crews

or left the site completely, and work was at a nearstandstill. When a major subcontractor supplyingand installing exterior panels was not paid, heceased work, and the project stopped completely.

The co-surety companies got involved early inthe bankruptcy proceedings with debtor-in-possession financing. Through a quick infusion ofmajor funding to the contractor and commit-ments to the major subcontractors to pay forcompleted and future work, the subcontractorsremobilized quickly. In addition, the contractorworked out a staged occupancy plan with theowner and accelerated the schedule.

The surety companies maintained a presenceat the job site, implementing incentives to keepcritical project personnel on the job. The class-rooms were finished in January and the concoursewas completed for the owner’s planned galaopening party in April.

According to the university architect, “Ourentire organization was a bit anxious about thecompletion of this important facility afterlearning of the unfortunate bankruptcy filingby the contractor. However, we wereextremely pleased with the prompt and pro-fessional action taken by [the surety compa-nies], which allowed the project to maintainits momentum by retaining the existing and

effective management team of constructionprofessionals. In all candor, it was a seamless

transition which was undetectable to thoseunaware of the circumstances.”

Surety Provides Working Capital

Surety companies may provide financial assistance directly to a bonded contractor,

which enables the contractor to continue its work program, pay subcontractors and

suppliers, and keep the project moving forward. This assistance may be provided at the

contractor’s request without the involvement of the project owner and may occur with-

out formal declaration of default.

This handsome apartment building is a comfortable home forseveral Decatur, Georgia families because the surety fulfilled its end of a Contract Bond. The problem: the contractor ran upagainst financial difficulties in the construction. The answer: thesurety came through with financial and engineering assistance.

Contract price:$50,404

Contribution:$36,443

Home Sweet Home

Surety Claims Legacies

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Surety Stands by Its Contractor

Shortly after its initial public offering, a largegeneral contractor encountered financial difficul-ties. The contractor had significant losses on twoprojects and expected a $2 million loss on hotelprojects that were behind schedule. In addition,the contractor’s core clients, major retailers, cutback expansion plans that fostered the construc-tion company’s growth. As a result, the contractorcut staff 40% to lower operating costs.

To keep the contractor afloat, the suretiesoffered financial assistance. The majority owners ofthe construction company entered a joint controland escrow agreement that allowed the sureties tofund the completion of contracts and pay vendorsin exchange for an interest in the constructioncompany’s two million shares of stock. The con-tractor completed its work and pursued an aggres-sive marketing campaign. Within two years, thecompany’s sales were $54.5 million.

The construction company owner said that thefirm is “gratified by the surety’s assistance andobvious display of confidence in our experiencedconstruction team.”

Exploding Pilings Cause Contractor Headache

A $43 million bridge contract was over budget,and the contractor had given up any hope of aprofit. With the job 95% complete, the bridge pil-ings began exploding—along with the contrac-tor’s hopes of completing the project.

When the State Highway Department stoppedall payments to the contractor, including a largeearned sum, the surety was called in to investigate.The surety advanced $4.5 million to the contractorand arranged analysis of why the pilings explodedin order to correct the problem. Because the suretywas notified in a timely manner, it was able to pre-vent contractor default. This assistance:

� kept the contractor from bankruptcy;

� completed the bridge promptly for public use;

� saved the owner from the delay of re-biddingthe contract; and

� assured payments to subcontractors who wereon the verge of bankruptcy themselves.

Firm Falls Apart, Surety Sends Rescue Team

The president and vice president of a highway-contracting firm were killed in an airplane crash.The heirs brought in a new management teamwho managed 21 contracts worth $109.5 million.Within a short time the formerly successful opera-tion was in financial difficulty. With $27 million inwork remaining, the firm owed $8 million to sub-contractors and suppliers and had no cash flow.The surety brought in two recently retired suc-cessful highway contractors who determined thatthe company was a good organization. Undertheir direction, the company liquidated an equip-ment repair plant and set up effective costaccounting methods. The surety infused $6.8 mil-lion into the contractor’s company, including $1.7million to complete a non-bonded project toavoid jeopardizing the bonded projects.

Flood of Work Nearly Drowns Contractor

Building a hurricane and tidalflood barrier to protect a commer-cial and industrial section of townwould ordinarily be a piece ofcake for this experienced highwayand bridge contractor. However,after contract modifications andequipment delivery delays causeda $25 million deficit, the contractor turned to hissurety for help. Compounding the problem wasthe contractor’s excessive overhead, inadequateplanning, and insufficient long-term financing.

The surety company’s investigation confirmedthat the contractor was performing quality workand could complete the project with support fromthe surety. Rather than re-bid the contract, face adelay in completion, and subject the area to expo-sure in the event of a catastrophic storm, thesurety quickly decided to finance the contractor.

The surety continued to provide financial assis-tance over a 10-year period. During that time, thecontractor performed federal, state, and municipalcontracts in excess of $410.6 million. Prompt inter-vention by the surety prevented a serious defaultand saved the project owners substantial sums bymaintaining competitive bidding in the state andcontributing to its economic development.

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Pollution Control Project Exhausts Funds

A city awarded an $82 million contract as amassive pollution control effort to a joint ventureof three contractors, two of which were large,experienced firms with tunneling expertise. As thework progressed the joint venture experiencednumerous unforeseen problems and conditionsthat resulted in a significant cost increase. Thethree contractors contributed corporate assets,but the operating fund was exhausted.

The contractors’ sureties analyzed the situation,using an internationally known tunnel expert toestablish completion costs. The sureties evaluatedthe financial position of each joint venture andthe ability of each to contribute talent and labor.The joint venture requested financial assistance tocomplete the project.

The sureties guaranteed a $6.8 million revolv-ing loan. With adequate financing, the projectcontinued with no interruption of work, nochanges in method of payments, and no inter-vention by the city.

Caught Between a Rock and a Hard Place

A $26.5 million contract with the U.S. ArmyCorps of Engineers called for the construction of aport facility for another nation as part of a foreignaid package. The contractor was required to exca-vate rock from a specified area and then constructa pier and protective area with this rock. The con-tractor was also required to dredge a channel andcreate a harbor.

When the area didn’t yield the right type ofrock, the Corps told the contractor to find it else-where. This proved to be a costly and fruitlesssearch. The Corps then agreed to accept rock of

less density and weight. However, this increasedthe contractor’s cost so substantially that all hiscosts and bank credit was soon exhausted. On theverge of default, the contractor sought financialassistance from the co-sureties.

The co-sureties paid off loans, and arranged aguaranteed line of credit for the contractor, whoborrowed $19 million to complete the contract.The total cost exceeded $53 million, but withcontinued bonding and new profitable work, thecontractor survived and continued in business.

Embezzlement Leaves Contractor Short

Employee embezzlement left a contractor, whohad a healthy workload of more than $56.7 mil-lion, with little working capital. Banks stoppedcredit and called in their loans. The contractorfaced default on several large federal contracts invarious stages of completion.

The surety spent $11.8 million to pay out-standing bills, assisted the contractor with guar-anteed bank loans, and avoided default on alljobs—including several urgent NASA and militarycontracts. Because of the surety’s involvement,the work continued without delay.

Non-bonded Jobs Cause Near Default

A general building contractor suffered seriouslosses on non-bonded shopping center contractswhen the owners became insolvent. This impairedthe contractor’s working capital and bank creditso drastically that he was on the verge of default-ing on several bonded contracts. The contractorcontacted the surety, who arranged a $2 millionguaranteed loan. The contractor completed allwork without incident and the owners were neverfully aware of the contractor’s financial dilemma.

Surety Guarantees Bank Loans

When the surety becomes aware of a contractor’s financial difficulties, it may guar-

antee a line of bank credit. This assures a steady flow of materials to the work site and

payments to subcontractors.

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Surety Speeds Rush Hour Traffic

Rush hour commutes are frustrating enough,but when a major artery is undergoing construc-tion, it can be intolerable. When con-struction is delayed due to contractorfailure, it’s torture.

An $18.4 million constructioncontract in Leon County, Floridacalled for the widening of a majorroadway from four lanes to eight atthe busiest intersection in the City ofTallahassee. The contract called for the construc-tion of a fly-over bridge, access ramps, improve-ments to several feeder roads, and access pointsto dozens of businesses.

When the contractor faced financial difficulties,the surety company worked closely with him tomaintain normal business operations. The suretycompany’s claims team was comprised of aregional claims manager and claims representa-tive, home office accountants, an engineer, andexternal consultants. The surety also retained aconsulting firm familiar with contractor default.The consulting firm reviewed all project paymentsto subcontractors and suppliers and providedtechnical assistance on the day-to-day operations.

The surety kept a firm hand on the pulse of theproject with frequent visits by the surety’sConstruction Services Manager—an engineer bytraining. The team of professionals workedtogether to review the contract, analyze the infor-mation, and develop a plan to complete the proj-ect. Their vast experience provided the essentialelements necessary to address many circumstancesthat arose during the project’s completion.

The surety entered into a financial assistanceagreement with the contractor to facilitate projectcompletion. In accordance with this agreement,

the project owner deposited all con-tract payments into a checkingaccount held jointly by the contractorand surety. The account was con-trolled by the surety to ensure allcontract funds were used for the pay-ment of labor and materials used onthe project.

To keep operations running smoothly and thepublic informed of progress, the surety and thecounty hired a public relations firm to keepmotorists informed of construction updates, traf-fic rerouting, and access restrictions.

The project continued without interruptionand was completed ahead of schedule. TheCounty Board of Commissioners expressed itsappreciation to the surety for its role in the timelycompletion of the road project. The Board stated,“[The surety] has proven its resourcefulness anddedication to efficient and smooth running opera-tions,” and completion was a result of “[thesurety’s] quest for excellence and proven service.”

Surety Bond Saves Penn State Season

Which was more difficult toaccomplish? Finishing construc-tion on the 15,000-seat BryceJordan Center at Penn StateUniversity in time for the NittanyLions’ long-awaited Big Ten bas-ketball showdown againstIndiana? Or...Penn State winningthat game against a formidablefoe—then Hoosier Coach Bobby Knight?

Surety Provides Technical Assistance

The professional expertise of the surety company and surety bond producer can min-

imize problems and losses on a project. Many sureties employ professional engineers,

accountants, and other technical staff or advisors who can help a contractor succeed.

As it turned out, neither was insurmountable,despite some preseason predictions to the con-trary. “[The Bryce Jordan Center] isn’t going to beready for [Penn State’s home opener] unless youbring in some construction people from Mars,” saidKnight, noting the significant amount of unfinishedwork on a visit to State College, Pennsylvania in thesummer of 1995. “There’s no American construc-tion company that will get that done.”

Penn State “doesn’t have the depth to chal-lenge for the Big Ten Championship,” said severalleague prognosticators before the season started.

So much for crystal balls. The Bryce JordanCenter was indeed ready for Penn State’s surpris-ing 82–68 victory over Indiana and it was alsoavailable for the 76–61 win over Minnesota 16days earlier. In fact, the Nittany Lions liked theirnew home so much they finished second in theBig Ten standings and won an NCAA Champion-ship series berth.

What behind-the-scenes forces enabled thespeedy completion of the athletic complex whenbad weather and financial difficulties of the gen-eral contractor threatened to delay its debut?

The situation at Penn State is an example of acontract surety bond working to perfection.Finishing construction on the Center on timeseemed impossible after severe weather problems

wreaked havoc on the construction schedule. Theproject was only 28 percent complete in February1995 while 68 percent of the scheduled time hadelapsed. The construction company, whichhelped build the Houston Astrodome and othersports arenas, was close to shutting down theproject because of financial difficulties.

With the 1995–96 basketball season less than ayear away, a shutdown was unacceptable to allparties. The surety recognized the importance ofmaintaining continuity on the job and arrangedfor the contractor’s management team to workwith a new contractor.

“Their managers were vital,” said the newcompany’s Project Executive. “They knew thedrawings, submittals, and the process. We couldnever have accomplished this without the fullcooperation of officials from the two constructioncompanies, Penn State, and the surety.”

Due to the surety’s intervention and support,the schedule was reworked and additional sub-contractors and general contractors were hired to carry out various aspects of the job that hadbeen done by the original contractor alone. The number of craft workers grew from 310 to 590working two shifts for six and seven days a week.

A combination of prompt intervention, com-mitment of resources, and considerable financialsupport from the surety company got the projectback on track and the doors to the arena open intime for an uninterrupted string of Penn Statehome victories.

To Students’ Dismay, School Completed on Time

A contractor specializing in school con-struction had six projects underway whenthe school district declared him in default ona junior high school. This school was desper-ately needed by the fast-growing school dis-

trict. Unfortunately, the contractor was on thebrink of collapse and the default was the final

straw.

The surety, however, felt that with financial andtechnical assistance, the contractor could com-plete all six projects. An engineering and account-ing survey revealed cash flow problems so the

The construction of this hospital at Decatur, Alabamashowed signs of financial consumption and almost died ofthe illness. The surety provided the cure with engineers andmoney, and the work went on to completion without anyinterruption.

Contract Price:$72,357


The Healing Touch


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surety infused $3 million. The surety alsoemployed a construction engineer and projectsuperintendent. To the students’ dismay, theirjunior high school opened on time that fall. Thesurety’s financial and technical assistance enabledthe contractor to avoid bankruptcy and pay sub-contractors and suppliers. With the exception oftown officials, the school district was unaware ofthe contractor’s difficulties.

Surety Sends Team to Prison

A construction firm began work on an $8 mil-lion prison project in the southeastern UnitedStates. Initially, work proceeded on schedule.Soon, however, the contractor encountered diffi-culties with the project’s specifications and draw-ings, which needed clarifications from the owner’sproject management team.

Progess slowed as the owner took increasinglylonger periods to respond to the contractor’sRequests For Information (RFI) and change orderrequests. Tensions mounted, the work slowed to agrinding halt, and the project quickly fell behindschedule. Several months later, the owner’s projectmanagement team still had not addressed many ofthe construction issues critical to project completion.

As the project slowed, so did payment to thecontractor. To compound the contractor’s cashflow problems, he was unable to collect a largereceivable on an unrelated non-bonded job. Thecontractor turned to his surety for assistance withcompleting the bonded prison job.

The surety dispatched a claims team to the jobsite. After conducting an inspection of the con-struction site and financial review of the contrac-tor, they resolved immediate cash problems byadvancing $500,000 to pay subcontractors andsuppliers. They also appointed an on-site con-struction representative who monitored the con-tractor’s work and helped the contractor and theowner’s project management team resolve theoutstanding RFI and change orders.

Finally, the surety supplemented the contractor’sproject management team with six additional engi-neers and job superintendents. This enhanced thecontractor’s coordination of the work and the proj-

ect proceeded at an accelerated pace. The surety’sexpenses were approximately $1 million, and theproject was completed successfully.

Surety Bails Out Sewer & Water Contractor

Life was good for a large sewer, water, andtunneling contractor. He had completed $34 mil-lion in projects with an aggregate workload of$68 million. He had bid 600 jobs in the last twoyears. Then his bank line of credit dried up, andmore problems followed. Two projects worth$30.8 million had unusually high start-up costs.Labor problems on another project resulted intwo years of substantial losses. More than $1.7million in retainage was tied up in litigation fortwo years and he expected an additional $2.7million in retainage to be frozen as well. What’s acontractor to do? Call the surety.

The surety:

� Analyzed the bids on a $30.8 million projectthat had just begun;

� Investigated the status of retainage litigation;

� Appraised the contractor’s equipment and recommended that some be sold;

� Analyzed the contractor’s organization fromfield supervisors to top management;

� Developed a cash flow projection based onanticipated completion of all work in progress;

� Worked with the banks to develop a paymentschedule for equipment loans; and

� Arranged bank credit for additional workingcapital up to $4.5 million (the contractor even-tually used $3.3 million).The surety got the contractor back on track

before the contractor’s problems affected the proj-ect, which protected the contractor’s reputationand standing in the industry. Seventy-five employ-ees and more than 400 material suppliers and sub-contractors were paid. The contracts werecompleted without disruption and the owners andengineers were unaware of the surety’s involve-ment. Although the contractor’s retainageremained frozen, the surety’s assistance was discon-tinued three months ahead of the projected date.

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Paying the Bond Premium is Cheaper than the Alternative

A well-established, family-owned contractingcompany had 16 bonded projects underway.When the State of California began licensing con-tractors, this company received the second licenseissued, but even contractors that have been inbusiness for years can run into trouble. In this case,the last surviving family member had sold the com-

pany to five employees six years earlier.

The contractor was working on abonded $20 million school buildingproject that had significant cost over-runs. It was the beginning of a hugefinancial strain on the company, whichstarted spreading to the contractor’sother projects.

The company defaulted on fourprojects: three senior citizen homesand one low-income community reha-bilitation center. The default was a seri-

ous situation because manypeople would not be able tooccupy their new living facilities.Furthermore, delays could resultin a substantial loss in fundingfrom the U.S. Department ofHousing and Urban Development(HUD) and tax credits.

The surety acted swiftly by hir-ing a replacement contractor with an excellenttrack record on HUD projects. A special team wasassembled to handle the complex federal andstate documentation required to keep the job ontrack and in compliance with HUD regulations.

The original subcontractors, laborers, and sup-pliers were retained and paid for completed work.The surety satisfied all the liens on the projectsand all necessary paperwork moved throughchannels without delay. The work was completedon time with no loss of tax credits or specialfinancing. Most importantly, residents were ableto occupy the premises in time to satisfy agencydeadlines.

The owner was protected from financial lossand four important projects were finished ontime. Without a bond, the loss to the owner onthese four bonded projects would have been$1.86 million dollars. The premium on the bondthat protected the owner from that expense wasonly $129,290.

Owner to Surety, “Job Well Done”

A California specialty contractor with a longhistory of successful projects faced financial disas-ter after the managing shareholder of this family-owned business suffered a stroke. Aninexperienced son-in-law took over but wasunable to manage the company successfully.

Finances were in serious disarray, and past duefederal tax and bank loan obligations totaled sev-eral hundred thousand dollars. As a result, thecontractor voluntarily defaulted on six bondedprojects, of which four were not completed. Morethan 85 subcontractors and suppliers filed claimsagainst the payment bond.

Surety Replaces Contractor

There are times when a contractor cannot complete a project—whether due to unfore-

seen changes in the job, economic conditions, or other reasons that cause a contractor

to default. When this happens, the surety may bring in a replacement contractor to fin-

ish the job.

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Because of timely investigation and interven-tion, the surety worked with the project’s ownersto replace the contractor on one project and tookover and completed work on two other projects.The surety also paid the penal sum of the bondon another project that had barely begun.

One project owner wrote, “[The completioncontractor under the takeover agreement] hascompleted all of the work required and all of theadditional warranty and corrective work that wasnecessary to satisfactorily complete the project.Your cooperation and professionalism in handlingthis contract has been appreciated.”

Surety Digs in to Relet Work

An excavation contractor in the southeast hadeight projects in progress when infighting amongthe company’s stockholders began. The disputeresulted in substantial operating losses and ulti-mately the contractor was forced to dissolve thebusiness.

The contractor withdrew work forces from allbonded and unbonded projects and called thesurety for assistance. The surety quickly investi-gated and arranged meetings with the eightowners within 72 hours of the contractor with-drawing forces. Within three weeks, the suretysuccessfully relet all eight uncompleted projects,tendering four new contractors and tak-ing over the balance of the work andsubcontracting to a completioncontractor.

The surety sustained a $2.5million loss after reletting all ofthe projects and satisfying allof the outstanding labor andmaterial payment bondclaims.

What Else Is Your Contractor Doing?

Surety companies and bond producers have aunique perspective of the contractor’s businessbecause they investigate the contractor’s entirebusiness operation, including bonded and non-bonded contracts. While a contractor may be per-forming adequately on your project, it may befailing on another.

With no warning, a contractor on a wastewatertreatment plant in Leesburg, Virginia, declareditself in default on two projects for the plant total-ing $16 million. According to town officials, thecontractor had been doing excellent work.However, the contractor experienced problemson an unrelated project that affected its entirebusiness.

The surety company proposed a new contractwith a new company organized by the principalsof the old construction company and bonded thenew corporation. Since existing personnel wereused, the surety company had the project up andrunning with only a two-month delay, which wascritical to ensure continued funding on the proj-ect. One town official noted, “This was thesmoothest transition in a default I have everseen.”

This attractive California hospital had plenty of construction woes.The contractor became hopelessly involved financially and had todefault. Finding someone to replace him was a problem.Thesewere war days and the construction industry was in chaos becauseof the extensive build-up for the projected invasion of Japan. Thesurety once again came through handsomely as surety and withits finances completed the building.



Home Sweet Home


Handsome Is WhenHandsome’s Done

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Surety Steps into Contractor’s Shoes

When the contractor on a $30 million studentactivity center for a prominent southeastern uni-versity became overwhelmed with problems andsetbacks, the surety company made sure the proj-ect proceeded as scheduled.

The initial schedule called for completion intwo years. However, subcontractor financial prob-lems and performance defects, architect/engineerdesign and supervision deficiency, a lack of skilledlabor and materials due to various concurrentprojects, and adverse weather caused substantial,unforeseeable delays. After two years, the projectwas nowhere near completion, so the ownerdeclared the contractor in default and turnedover project completion to the surety company.

The surety company hired a new constructionmanager, but retained the project staff of theoriginal contractor. The owner extended the com-pletion date. The surety company authorizedovertime, including work on weekends. Due tocontinued problems with the architect/engineerand certain subcontractors, a substantial amountof corrective work was necessary to complete theproject to the owner’s satisfaction.

The project was finished in time for the fallsemester, just four months past the extensiondate. The surety company experienced an eight-figure loss, but the owner received the end prod-uct it was looking for. The vice president forbusiness and finance wrote, “The surety company]handled a bad situation as professionally and ablyas we believe possible. I especially appreciate yourseeing that the project was fully completed to thehigh standards of our original expectations. Weare very proud of the facility and aware that itsquality reflects in large measure your interveninghand. We never felt abandoned.”

Surety’s Quick Thinking Keeps Subs Paid and On the Job

A contractor hired by a local government toconstruct a municipal building abandoned theproject with 75% of the structure completed. Theowner declared the contractor in default andcalled upon the surety for completion. In order tomeet its obligations and minimize loss, the suretyhired a construction management consultant.

The surety needed to respond quickly since thebuilding would suffer extensive damage if not fin-ished before winter. The partially completedbuilding had neither heat nor insulation. Thesurety and management consultant visited thejob site to determine its condition, quality of workalready completed, and the new projected com-pletion date. After reviewing all available options,the surety decided to expedite the project byusing the original 28 subcontractors and 12 spe-cialty suppliers who were already familiar with theproject.

The surety hired a field superintendent to mon-itor the project on a weekly basis and reportprogress to the construction management con-sultant and the surety. Additionally, the surety andarchitect reviewed payment claims and convincedthe project owner to pay subcontractors and sup-pliers for completed work. Within four weeks afterthe subs returned, the municipality obtained aSubstantial Completion Certificate followed by afull Certificate of Occupancy four weeks later.

Because of the surety’s prompt investigationand assessment of the situation, the owner coop-erated in paying subs and suppliers, thus keepingthem on the project. Cost to complete the projectwas $356,034.

Surety Completes the Project

One of a surety’s options is to take over completion of the project. The surety gener-

ally negotiates a formal takeover agreement with the owner. This option may be used

when the project is substantially complete or key contractor personnel and subcon-

tractors are crucial to project completion.

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Surety Keeps Job Moving Without Key Subcontractor

A subcontractor sustained losses on a numberof bonded contracts and didn’t have the cashflow to handle job costs on a $24 million subcon-tract for the installation of reinforcing steel andconcrete at a large building complex, eventhough the prime contractor furnished the con-crete and reinforcing steel.

The surety advanced funds for payroll and criti-cal bills to keep the job moving. When it becameapparent that the subcontractor still could notcontinue, the surety arranged for the prime con-tractor to employ the subcontractor’s work forcewhile it found a new subcontractor. The suretyand prime contractor jointly arranged contractterms with the new subcontractor and the suretypurchased heavy equipment to avoid disruptionof the work schedule. The new subcontractorstarted operations after a brief one-week shut-down and mobilization period.

The owner was aware that a key subcontractorhad defaulted and observed the subsequentevents, but did not in any way participate in thearrangements. The architect for the owner esti-mated that throughout the default and reletperiod, less than three days production was lost.The new subcontractor made up for lost time andcompleted the project on schedule. The owner’srepresentatives expressed appreciation to all par-ties for the smooth transition.

The surety paid $4 million in completion costsand $3 million to subcontractors and for correc-tion of defective work.

Surety Gives Green Light for TrafficControl System

The Virginia Department of Transportation(VDOT) needed a sophisticated traffic manage-ment system on a bridge. The prime contractorhired a subcontractor to design and install thesystem. Unfortunately, the system was seriouslyflawed and never performed to the specificationsmandated by VDOT. Since the traffic signalingsystem was a major component of the contract,VDOT filed a claim against the prime contractorand the performance bond.

The surety supported the contractor in anexhaustive investigation of the problem. Withsupport from the surety, the contractor tried tocorrect the technical problems, but despite itsbest efforts, was unable to provide a workabletraffic system. The contractor could not afford thecost of remedial work or the cost of outrightreplacement. VDOT declared the contractor indefault and called upon the surety to correct theproblems and complete the contract.

Surety Saves Project from Subcontractor Failure

Subcontractors are vital to project completion. A subcontractor who is unqualified or

has not been paid can affect your project. Surety companies pay hundreds of millions

of dollars in losses each year—much of it to subcontractors.

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The surety promptly solicited proposals fromother contractors with expertise in the very tech-nical field of traffic management systems. Eventhe lowest responsive bid to replace the defectivesystems with workable ones required hundred ofthousands of dollars in excess of remaining con-tract balances. The surety honored its obligationsand provided a check to VDOT for the excesscompletion costs and tendered an acceptablecontractor to complete the contract to VDOT’ssatisfaction.

Performance Bond Insulates Contractor & Owner

Owners can help the prime contractor managerisk by requiring performance bonds from sub-contractors. When a subcontractor is a significantpart of the job or a specialized contractor that isdifficult to replace, bonding is a cost-effective wayto limit the exposure.

On a $500,000 insulation contract for a hospi-tal project, the owner required the subcontractorto be bonded. With no notice and only 40% ofthe project complete, the subcontractor ceasedwork, filed for bankruptcy, and disappeared.

The surety company contacted subcontractors,obtained bids, and tendered the completing sub-contractor to the general contractor, picking upthe difference between the contract price and thecontract balances without delaying job progress.The general contractor was “very satisfied as wellas surprised with the response of the surety com-pany in replacing the original contractor and min-imizing disruption to the project.”

Panels Crack, but Bonds Hold Fast

A mason was subcontracted to install decora-tive limestone panels fastened to concrete blockand pre-cast concrete panel exterior walls on afour-story savings and loan building. One stipulation was that the grout mixture had to be approved by the architect prior to com-mencing work.

The mason completed the work and paid hislabor, but failed to submit the grout mixture tothe architect. The mixture he selected containedingredients that expanded in the presence oflimestone and water. Within a year of completion,the panels began to crack around the hangers.Eventually, more than 70% of the panels had tobe repaired or replaced.

The subcontractor was financially unable to dothe repairs as required by the warranty. Becausethe subcontractor was bonded on the project, thesurety company paid $465,000 for additionalwarranty work on what was originally a $600,000project.

Plumbing Contractor Finances Go Down the Drain

A plumbing and HVAC contractor in theMidwest sustained substantial operating lossesafter diverting funds into a general contractingbusiness. As a result, the contractor’s bank can-celled the lines of credit and refused to approveany more loans.

The surety quickly conducted an investigationof the contractor’s financial condition and electedto provide interim financial assistance while evalu-ating alternatives. The plumbing and HVAC opera-tions were merged with another entity thatassumed completion of all the contractor’s work.As work progressed, the surety continued to pro-vide financial support. The surety and the contrac-tor sent voluntary default letters along with thetender agreements to each of the owners toensure a seamless flow of work. All of the ownersaccepted the tender agreements and all of thecontracts were completed on time and on budget.

The surety sustained a net $900,000 loss. The successor contractor continues to operateprofitably.

13

Surety Company Keeps the Peace

A hostile work environment invariably leads toproblems on the job. Because the surety companyis a third-party participant in the completion ofthe project, it is in a position to help smooth rela-tions between owners and contractors. When anowner’s project manager did not get along withthe contractor on a $532 million remodeling proj-ect of an historic lodge and garage, the fireworksbegan.

According to the contractor, there were prob-lems from the start, which centered on theowner’s demanding and unreasonable projectmanager. Only two months into the job, the con-tractor asked the surety company for help andadvice after the owner threatened to declare thecontractor in default. The surety company spokewith the contractor, then arranged a meeting atthe job site with the owner and contractor. Whatthe surety company representative witnessed wasthree hours of arguing and finger pointing.

Realizing the situation was out of hand andwork would be delayed without resolution of theproblems, the surety company’s claims represen-tative talked with the owner and contractor to getan understanding of both sides of the issue. A fewdays later, the claims representative went to thejob site and spoke with the contractor’s crew andsubcontractors, the project manager, and theowner.

The surety company objectively addressed thecontractor’s deficiencies in performance andoffered suggestions for improvements. The suretyconvinced the owner to remove the project man-ager from the job and make timely payments tothe contractor. The owner and contractor agreedto follow through on the surety company’s rec-ommendations. The owner and contractor bothacknowledged that things were much improvedand the job was progressing well. Since the suretycompany’s involvement, no performance or pay-ment claims were filed. The owner took posses-sion of the building and the contract wascompleted as scheduled.

The contractor appreciated the surety com-pany’s involvement, saying “It appeared that ourcompany faced termination, but due to theimmediate response by the [Surety Company]Loss Control Team, we were able to interface withthe owner and resolve issues before the projectwent completely bad and any legal action devel-oped. Thank you for your professionalism andstanding behind your product.”

Surety Mediation Prevents Default

When problems occur on a construction project, it’s likely that the relationship

between the owner and contractor is strained. Having a third party, the surety, investi-

gate the problem can often result in a workable solution without declaration of default.

14

Surety Heads Off Litigation with Compromise

A medium-sized general contractor obtained abond for a day care facility at a local junior col-lege. Over the next several months the job pro-ceeded satisfactorily and on schedule.

As the project reached substantial completion,the college submitted its punch list to the con-tractor at the same time the contractor billed thelast progress payment and final retention. Thecontractor objected to several items on the punchlist and refused to correct them. The collegerefused to honor the contractor’s request for pay-ment. The dispute escalated until the collegedeclared a formal default and terminated the con-tractor’s right to proceed with completion of theremaining punch list items.

The owner sent a default termination letter tothe contractor’s surety. The surety promptly metwith the contractor to hear his side of the dispute,then met with representatives of the college andheard their side. The surety then called a meetingof both parties at the day care facility where itsucceeded in establishing a spirit of compromise.The surety reviewed each item on the punch listand facilitated a resolution, thus avoiding expen-sive and protracted litigation.

This contract was fulfilled. It began shortly before the Korean conflict andcalled for a dormitory, a library and music and administration buildingsfor West Virginia Wesleyan College. Unfortunately, the contractordefaulted after the work was 20% completed and left a sad state ofaffairs, as this picture shows. The surety took over at this point and, inspite of extreme material shortages caused by war restrictions, was ablethe complete the original contract to the letter.



War or No War


15

A Contractor’s History Is No Guarantee

When Northland College in Ashland, Wisconsindecided to build the $12 million Larson-JuhlCenter for Science and the Environment, theBoard of Trustees didn’t require performance orpayment bonds.

According to Harold Vanselow, Vice Presidentof Finance and Administration, the college’s Boardof Trustees chose the contractor “because of theirhistory with the college…The company had beenin business for over 100 years and the owner’sgreat-grandfather laid the first stone for the firstbuilding of the college when it was built in1892.” A former owner was at one time a trusteehimself, and the company had successfully per-formed other projects for the college. By allaccounts, it appeared the college made aninformed decision on choosing a contractor.

Vanselow stated that, “The project continuedon schedule and on budget, and the college madeall payments to the general contractor in full, andon time.” It came as quite a surprise when, afterthe project was nearly complete, seven subcon-tractors filed liens totaling nearly $900,000because the contractor hadn’t paid them.

Because the Board of Trustees was so eager todevelop a great science facility, it did not recog-nize the value of a bond. The Board believed the$70,000–$100,000 bond premium could betterbe used on equipment and supplies for the newbuilding. Now the college must find a way to set-tle $900,000 in liens on the completed project.

Realistically, a contractor with a 100-year his-tory of work on college projects who has success-fully completed similar projects for similarcontract amounts, and who had a good reputa-tion with the owner doesn’t sound like much of agamble. But the risk in construction often lies inthe uncontrollable, unpredictable, and unknown.

According to one of the subcontractors on thejob, the contractor was having financial difficultiesbecause of some problem jobs a few years earlier.

Surety professionals make informed decisionsto prequalify the contractor. They look at thefinancial strength of the contractor, the manage-ment structure and ability, the volume andmakeup of other work the contractor is perform-ing, as well as the character and reputation of thecontractor. Any one of these elements can cause acontractor to fail. This unique relationship with acontractor allows [him/her] to evaluate each ele-ment and guarantee that the contractor can com-plete the job for the owner. Reputation alonedoes not complete contracts and a solid contrac-tor can become an insolvent contractor very rap-idly if one or more of the elements changes. Thesmall fee for prequalification and the surety’sfinancial guarantee of the project are very valu-able products to an owner. The relationship thatan owner has with a contractor is arm’s lengthwhile a surety’s relationship is a day-to-day part-ner. A surety has much greater insight as to a con-tractor’s abilities to perform than any owner couldpossibly have.

The Cost of Not Bonding

No matter how well a contractor is screened and no matter how stable the contrac-

tor’s business is, every project runs the risk of contractor failure. Here’s what happened

when performance and payment bonds were not required.

ALTHOUGH THE

CONTRACTOR

LAID THE FIRST

STONE FOR THE

COLLEGE’S FIRST

BUILDING IN

1892, IT WAS

NO GUARANTEE

OF A LIEN-FREE

PROJECT TODAY.

16

No Payment Bond Hurts Owner,Subcontractors & General Contractor

Two physicians hired a general contractor tobuild a medical facility. Construction began inOctober and was to be finished March 1. ByFebruary, the contractor had already receivedthree draws from the construction loan of almost$245,000. The physicians were surprised whensubcontractors and suppliers began calling inMarch to complain that they had not been paid.They confronted the contractor and decided towrite future checks directly to the subcontractorsand suppliers.

The contractor admitted that he was using thedoctors’ funds to bail out other projects. Hepromised to reimburse them when these projectswent into the black.

The contractor’s “good intentions” were notenough—not for the doctors and not for the dis-trict attorney and the California Supreme Court.The court agreed with the district attorney that itwas irrelevant that, at the time of the wrongfuldiversion, the defendant may have had the purestof intentions and sincerely wanted the project tobe completed and the creditors to be paid. Boththe district attorney and the court cited the strictwording of California Penal Code. The codespecifically calls for completion and payment andthat funds diverted in excess of $25,000 was suffi-cient for a felony conviction. A payment bondwould have protected all parties, even the well-intentioned contractor!

The Cost of Non-Compliance

The failure to obtain surety bonding for a pub-lic project can be a costly oversight, as the mem-bers of a Missouri school board learned. Boardmembers were held personally liable when theyfailed to make sure an architectural firm posted apayment bond on a school renovation project.

The school district had hired the firm for archi-tectural and engineering services which, in turn,hired another company to perform the mechani-cal and electrical work. The school district paidthe architectural firm but it went out of businesswithout paying the mechanical contractor the

$20,145 due. The mechanical contractor suedthe directors of the school board under a statelaw requiring public officials to obtain a pay-ment bond from contractors on publicworks. The directors argued that the servicesdid not constitute “labor” under the law.

The Missouri court sided with the direc-tors, but the State Court of Appeals reversed

the decision. It noted that designers could fileliens for work in the private sector and should

have bond protection on public jobs.

“It was the absolute duty of the directors…torequire a payment bond,” the court said.

The Contract Bond had been arranged between all partiesconcerned. Construction started. Then almost at that precise moment things began to go wrong. Meanwhile,innocent third parties had already provided materials andlabor in good faith. To protect them, the surety stepped inand sustained the loss under the payment feature of itsbond. As a result, the building was finished.



Poor Start…Good Ending


NORTHLAND

COLLEGE’SPLANS FOR

THE LARSON-JUHL CENTER

FOR SCIENCE

AND THE

ENVIRONMENT

For more information about contract surety bonds, please contact the:

Surety Information Office5225 Wisconsin Avenue NW, Suite 600

Washington, DC 20015-2014(202) 686-7463

(202) 686-3656 [email protected]

The information source on contract surety bonds. SIO is supportedby The Surety Association of America and the National Associationof Surety Bond Producers.

The Surety Association of America1101 Connecticut Avenue NW • Suite 800 • Washington, DC 20036

(202) 463-0600 • (202) 463-0606 FAXwww.surety.org • [email protected]

SAA represents 600 companies that collectively underwrite the majority of suretyand fidelity bonds in the United States, and seven foreign affiliates. SAA islicensed as a rating or advisory organization and has been designated by stateinsurance departments as a statistical agent for the reporting of fidelity andsurety experience.

National Association of Surety Bond Producers5225 Wisconsin Avenue NW • Suite 600 • Washington, DC 20015-2014

(202) 686-3700 • (202) 686-3656 FAXwww.nasbp.org • [email protected]

NASBP represents over 5,000 professional surety bond producers and brokers,representing who specialize in surety bonding, provide performance and pay-ments bonds for the construction industry, and issue other types of suretybonds for guaranteeing performance.

surety bonds at work - siosio.org/pdf/sbw.pdf · 2000-08-31 · the financial position of each...

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