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Performance Bonds: How you can Keep away from Collateral

Performance Bonds: How you can Keep away from Collateral

This is a nasty subject. Not because collateral for surety bonds is inherently bad, however because it is a subject of nice angst for contractors and their insurance / bond agents. For instance:

Why is the bonding company taking cash from me after they can see I’m in a weak cash position? I need it to successfully carry out the new project.

You don’t pay me interest on the money? Why not?

When the job is half performed, you will not launch a part of the collateral?

You will not launch the collateral upon acceptance / completion of the contract?

You’ll not release the collateral until the warranty period ends?

Etc. Loads of aggravating phone calls and emails.

With all this aggravation ahead, why do some bonding firms require collateral? The reason is to protect themselves within the occasion of a bond claim.

When a contract surety loss occurs, the claims division hopes to have dependable resources for financial recovery:

The unpaid balance of the contract goes to the surety as they full the work

The surety sues the applicant / company and its owners to recover the loss

Collateral requirements arise when the surety wants to have certainty. If a problem develops, they don’t need to discover that the shopper has no cash left, or they declared bankruptcy… or left the country. If they are to write the bond, they need a assured way of getting financial recovery.

Bearing in mind that collateral is an expensive worth to pay for a bond, let’s look at an alternative approach that helps the surety, however would not take a big bite out of the contractor!

“Retainage” is cash the project owner hold back (retains) to assure the final completion of the project and payment of associated bills. If the retainage is 10%, the contractor receives 90% of the funds they’re owed because the job progresses. On the end, the contract owner / obligee will nonetheless be holding 10% to keep the contractor serious about reaching total, satisfactory completion. In this method, the retainage money protects each the obligee and the surety – making a bond declare less likely.

“Surety Consent to Release of Final Payment” is a voluntary procedure obligees might use as a courtesy to the surety. The final bit of contract funds may be helpful leverage to get the contractor moving for the ultimate contract adjustments. There could also be building cracks, broken glass, faulty lights, painting errors – small stuff that the obligee cares about but the contractor might find annoying to correct. The Surety Consent is one other way for the bonding firm the keep away from a claim. “Fix this problem or we is not going to agree to launch your final payment.”

How can these two useful tools be incorporated to ensure they will assist the surety, and subsequently exchange the necessity for collateral?

The reply is to add a condition to the bond (mandatory compliance required by the obligee) stating that there could also be no release or reduction of retainage or final payment without the prior written consent of the surety. Now the bonding company is assured to have a monetary resource available and the amount is known in advance – just like collateral. But the contractor didn’t have to empty the corporate bank account to accomplish it: Win-win!

What if the contract phrases do not provide for a retainage procedure? One can be added by contract amendment. If Funds Management (an escrow agent) is in use to deal with the contract disbursements, a retainage procedure will be added to the funds control agreement.

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