ALTERNATIVE TO BONDING PRIVATE WORK
A commercial venture is a big risk for an owner. A lender may not have the flexibility of approving a General Contractor, unless the General Contractor can Bond the project.
What is a bond? A bond is nothing more than an Insurance Policy the GC provides, that assures the owner and lender that the Contracted GC will complete the project, and, that the GC will pay his bills to his Trade Contractors, and material men.
If the GC does fail, the owner “Calls In The 100% payment and performance Bond” The Bonding company becomes the new contractor for the duration of the project. The first thing that happens is that the Bonding Company, who is not a contractor stops any and all work on the site, and remains stopped, for a minimum period of (90) days to see if any new invoices have come in. Once past the Lien Rights of Trade Contractors, and Material Men, the bonding company Re-Bids the project out to new Trade Contractors, and material men.
It is possible that work will be stopped 6 months, or 9 months, or even 12 months while the bonding company comes up with a project plan that is in the bonding company’s best interests and will minimize the loss to the bonding company as much as they can before starting work.
Let’s say your GC Failed when 75% of the work was completed, and 75% of the money was spent. Let’s say your job is $5,000,000.00. There is $1,250,000.00 left to spend. As owner, you have already spent $3,750,000.00.
The bonding company is not responsible for the owner’s construction loan interest. As an owner if your construction loan is $5,000,000.00, and you’ve already spent $3,750,000.00 and are paying interest on that at 10%, that translates to a monthly interest cost of $31,250.00. While the bonding company stops for (90) days, then works on a new project completion plan, and limits their loss for up to a total of (6) months, in which case, the owner is still responsible for the interest in dollars, that’s $187,500.00 more dollars in Sit Empty Interest. Say that is a (12) month delay, that’s just double or $375,000.00.
As an owner, chances are, you have not accounted for $375,000.00 in additional cost to the development, just in interest. But, now, as an owner you have 3 months, 6 months, 9 month or even 12 months of not using the development you bonded, as work has been stopped. You also have that same length of time of not collecting rents. $375,000.00 additional out, and (6) months of not being able to collect rents.
So, just how does this bond help to protect the owner and lender? Even if everything goes perfectly and the General Contractor does finish, finish on time. The General Contractor does pay for the bond out of his pocket, but, he also bills the owner for it. So, does the contractor actually pay for the bond? No, it’s a pass-through cost. Not only does the contractor not really pay for the bond, when it’s required, that goes into the contractors General Conditions, and, the owner pays for it, but, Since the Contractor has taken out the bond, put the beneficiary as the lender, he charges you the owner profit to do so.
On a perfect job, as owner, you will pay between 1 ½% up to 3% back to the contractor for taking out this insurance policy, but you will also pay somewhere between 6%, and 10% profit to the contractor, or whatever his fee for the job happens to be.
Sometimes, mainly in Public Work, School Work, and work where a governmental agency is the owner, a bond may be necessary. Most Church Projects, private schools, require a bond. That is the Public, Government’s way of qualifying the General Contractor. If he can pay for your insurance policy, then he is qualified as a builder. Because it’s no longer the General Contractor who is responsible. The General Contractor’s Bonding Agent, is responsible.
By and large, Contractors have done this to themselves by getting money from a project, and rather than pay their bills to Trade Contractors, and Materialmen, they spend the money on some other purpose. Then, you the owner, and you the lender are left holding an empty bag. Not a good position to be in.
There are (2) methods of providing assurances to the owner, and the lender that the money is going where the money is supposed to go.
- Provide in the agreement between the owner, and the contractor, that periodical payments, typically presented by the 25th of each month for payment on the 10th of the following months, whereby the contractor makes those “Draw Requests” to the Owner, who in turn forwards them to a paid Title Company. The Title company in turn pays directly to the Concrete Company, the Electrician, the Plumber, and of course the General Contractor. The Trade Contractor is required to submit a “Pre-Payment” lien waiver, that declares “IF” the (Amount of invoice less retainage) is paid, then that company is current. Then that company is required to exchange an Unconditional Progress Payment lien wavier in exchange for the actual check. The GC does this for the Title Company and submits these lien waivers before each draw, and after each draw, so the big fear that Owner and Lender have, is no longer a reason to need an insurance policy/bond. That money never goes into the Contractor’s Bank Account to mis-use in the first place.
- There are, and have been a growing industry service known as Independent 3rd Party Financial Project Manager. That Service is hired by the lender, and serves the lender. The contractor submits the draws to the Owner, who in turn sends it to the lender, who in turn sends it to the Financial Project Manager. This 3rd Party, in physically inspects the work against a Trade Contractor’s invoice. For example if the Trade Contractor turns in, that he is 35% complete with the Parking Lot, the Financial Project Manager, goes to job site, and confirms it’s 35%, or, if it’s only 30% the Trade Contractor is notified to re-do his invoice for the 30%. Either way, the Trade Contractor is paid directly by the Financial Project Manager. The contractor get’s his monthly check, and the Trade Contractors and material men get their check without risk of over-payment, or money into the Contractors account to start with.
- Neither these service, or payment types are the friend of the Contractor. They work for the lender/owner. This requires extensive reporting and justification on the Contractor’s part, and the Trade Contractors part. But, is the lesser of (2) evils, bonding vs Third Party Financial Management.
- The Financial Project Manager does not report to the GC. The Financial Project Manager serves at the pleasure of the lender and owner. Overall the cost of the service is less than even the lowest bonding rate of .015. It actually accomplishes what a Bond is intended to accomplish, yet if the Bond/Insurance Policy is called upon, which is rare, the work does not have to stop.
- No method, 100% payment and performance bonding, Title Company, or Financial Project Manager, offer any assurance that a General Contractor won’t go bankrupt while in the service of an owner. It’s just a better mouse trap.
- Tetra Tech, a nation wide Engineering Firm, with Financial Engineering Services to compliment it’s physical Engineering services is one such Financial Project Manager.
- FAS is another. FAS has only (1) office in San Antonio.
- There are others.
While use of a Title Company, or a full Financial Project Manager is not the best option for every job. It is proving to be the most affective in Private Construction and Development over the past (10) years, and most affective when the project is not owned by a governmental agency in the up to $15,000,000.00 cost range.
For more information, contact your Title Company, or Financial Project Manager, and consider the advantages before requiring a bond.
Joe Lansdown, MBS, CCM