Surety Bonds &Construction Risk

Transcription

1 Government of the Northwest Territories Project Management Conference Yellowknife Surety Bonds &Construction Risk November 21, 2017

2 Objectives for Today To explain the surety bonding process in the context of cradle to grave project planning and delivery. SAC s objectives: 1. To provide an overview of how surety works in Canada and why. 2. To relate the surety process to the risks of larger projects. 3. To learn from you about your perceptions and experience with surety bonding and other forms of contract risk management

3 Inscription found in the Temple of Apollo in Delphi Greece 3 24 November 2017

4 I THE SURETY INDUSTRY Surety Companies SAC members write 95% + of all bonds in Canada There are hundreds of sureties listed on OSFI s website roster fewer than 20 are SAC members and they write almost all the bonds Surety Brokers Look for SAC member brokers they are dedicated to providing superior service

5 I Construction Risk

6 Construction Risk - what we mean Construction Risk = Risk of Contractor Failure. Ongoing global economic uncertainty. Surety Challenge: Uncertainty = more risk Economic factors now seem to be in a permanent state of flux (e.g.) resource development drives much of the economy but volatility in every resource sector is the new normal (minerals; oil; gas) The number and severity of contractor failures continues to be a concern across the country

7 Construction in Canada 2017 Canada will still have strong construction spending: Federal infrastructure commitment stretching over 10 yrs. Saskatchewan remains committed to infrastructure spending Canada was to go to 5 th from 9 th largest construction market how times change! foreign investment was the key; going elsewhere now Larger and longer projects are a lasting legacy: Challenges to small and mid-sized contractors Challenges regionally how to protect local contractors without violating trade agreements (like NWPA)

8 Why Contractors Fail some things don t change 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

9 Construction Risk Recent History From , the Surety industry paid out almost $1B in claims; more than the previous 10 yrs a year to forget: Loss ratio = 52% - industry unprofitable; premiums flat after two years of decline; affects all regions 2014 and 2015 record years: DWP (direct written premium) closing $580M, loss ratio drops 30%+ 2017: a more positive trend; slight increase in DWP and loss ratio now around 10% (abnormally low). Note: The surety industry hitting new all-time highs for the value of contracts underwritten - $75B+

10 Options to Protect Against Construction Risk: Surety Bonds Performance Bonds Labour & Material Payment Bonds Liquid Security Irrevocable Letters of Credit Cash/Negotiable instruments on Deposit Subcontractor Default Insurance (SDI)

11 II Surety Bonds What are They? How do they Work?

12 Surety is not Insurance

13 Surety is not Insurance INSURANCE Losses anticipated 2 party agreement; Insured & Insurer Premiums actuarially determined No recourse against insured in the event of loss SURETY No losses anticipated 3 party agreement; Principal, Surety & Obligee Premiums only a service charge Recourse against the Principal via indemnity agreement

14 Surety Bonds: 3 Essential Services Prequalification: Assurance that the bonded contractor is qualified for the job for which they are contracted. Ongoing monitoring (and hidden services): Sureties monitor bonded contractors continuously and can provide assistance if needed ($, technical support, accounting, etc.) Security: Financial Protection in the event that the bonded contractor should default on its obligation.

15 Prequalification Intensive Ongoing Comprehensive Value Added

16 Capital Capacity Character

17 Information a Surety Needs Organization Structure Key Employee Resumes Business Plan Backlog Report Financial Statements References Contractors Profile (Underwriting Requirements) Bank Information

18 What is a Surety Facility? After undergoing a thorough process of investigation and discovery, qualified contractors are provided a Surety Facility The facility is typically provided and reviewed annually; and monitored quarterly or more often Its parameters are set out in aggregate and individual job limits (e.g.) the surety will back the contractor For a total (aggregate) amount of work at any one time To a maximum job (contract) size of x dollars

19 Surety prequalification isn t superficial (Site visit) 24 19

20 Standard Construction Bonds Before Contract Award Prequalification Prequalification Letter Bid Bond Consent of Surety After Contract Award Contract Security Performance Bond (Covers normal contracts, spanning 1-2 year construction period.) Renewable Multi-Year Bonds (For longer term service contracts, like snow-clearing or refuse collection/recycling.) Labour & Material Payment Bond

21 Prequalification Letter Not a bond but a letter from a bonding company to the project owner confirming bondability. Used during the pre-tender phase; (i.e.) before contract terms, scope or pricing details are known. Non-binding surety and principal reserve the right to review the details before firm commitment. Typically refers to the project at hand. SAC standard form available on SAC website.

22 Bid Bonds protection from the lowest irresponsible bidder provide assurance that contractor will: enter into the contract provide the required security typically required in the amount of 10% of tender if contractor defaults, surety pays the difference between successful bid and second bidder tender must be accepted within time frame set out in tender documents seven months to file suit

23 Consent of Surety Not a bond at all; a letter of commitment from the Surety to the Obligee to execute performance and/or payment bonds No penal sum set out; payment not an option Typically, bonds must be required within 30 days following award No standard (CCDC) form in existence, many variations in wording

24 Performance Bonds Guarantees that the Contractor will perform the contract in accordance with its terms & conditions. To claim on the bond: Contractor must be in default and the default must be declared Owner must perform their obligations 4 options available to Surety: Remedy the default Complete the Contract Arrange for new contractor to complete Tender Payment Two years to file suit

25 Labour &Material Payment Bonds Guarantee that the contractor will pay all direct subcontractors, suppliers for materials and services provided to bonded project. (Note: Broad form bonds are becoming common and protect two tiers) Obligee is trustee on behalf of the claimants Claimant must have written contract with the Principal (or the Principal s direct sub-contractor for broad forms) Claimants may only claim for goods and services supplied to the bonded job Claim must be filed within 120 days of the last day worked or the date material shipped One year to file suit

26 Make sure to ask for the L&M Payment Bond! It s better when trades and suppliers are paid especially on publicly funded jobs 24 26

27 SAC supports CCDC Documents Successful Track Record: legal precedents have been established this clarity provides more certainty (less litigation, reduced costs). Fairness: balance the needs of all parties to the construction process as all sectors are represented on the Explicitness: clearly states the rights and obligations of the Principal, Obligee and Surety Note: The latest CCDC bond forms (the first since 2002) should be released later this year

28 III Surety Myths & Misconceptions

29 Myth #2: A 50% Bonds 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???

30 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 surety 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 only a barrier to unqualified contractors

31 IV Surety Bonds What Happens when a Contractor Defaults?

32 Keep the Surety informed! 24 36

33 Before a Default is Declared Surety has extensive experience with contracts and solving construction problems. Surety has intimate knowledge of the 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.

34 Claims When A Contractor Defaults: Surety will promptly acknowledge notice of default and begin to gather information. Surety will commence the investigation as soon as possible. Surety will conclude the investigation as soon as possible. If requested by the owner, surety will provide periodic written updates on investigation status and best estimates as to completion date.

35 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.

36 How the Project Owner can 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.

37 By the way claims are expensive SAC estimates that an average construction contract loss is on the order of 50% of contract value; and over half that amount is paid out under the L&M Payment bond. This is based on a study done by BBBG, a major surety claims management company, some years ago

38 VI - Other Forms of Contract Security

39 Liquid Security (ILoCs) Yield cash; not performance Provide no prequalification assurance Available in smaller; perhaps insufficient amounts (5% to 10%) Recall, a typical default: 50% of contract value Upon default you own the problem No surety support to bring in replacement contractor(s) or to assist with resolving the myriad issues around payment, scheduling, monitoring, etc.

40 Liquid Security (ILoCs) cont d Some other considerations when using ILoCs: Deplete a contractor s borrowing power and can bring on the very problem they seek to avoid Provide no dedicated payment protection for subs or suppliers This is a growing issue everywhere, especially for public/quasi-public agencies Can be especially problematic in rural and remote area

41 Subcontractor Default Insurance Introduced in 1996 to protect very large general contractors from subcontractor default. Indemnity product compensates the GC for loss incurred Significant deductibles and co-payment Only available to the largest GCs (in-house construction admin experience and strong cash flow) but even they are new to underwriting NOT designed to protect owners from risks associated with default of prime contractor Note that one of the largest public procurers in Alberta has specified that subs must be given the option to post bonds if the GC wants to put the job under SDI (Subguard)

42 VII e-bonding Did someone mention paperless??!!!

43 Electronic Delivery of Bonds Issues and Challenges Commercial Legal Technological SAC has worked to define and explain the issues & challenges over the past seven years or more

44 E-Bonding For years e-tendering and e-bonding was the train that never left the station However, this has changed, with e-tendering and e-bonding spreading rapidly in the West, and at the federal level (DCC) Three e-bonding suppliers are active now: Mobile Bonds, Xenix, and Infinite Source (for users of Bid Central in BC, and CoolNet in AB)

45 VIII New & Improved What s the Latest in the World of Surety Bonds?

46 New Surety Products The Business Case Surety bonds have been around forever but they are being asked to respond to new procurement methods and changing needs of owners The surety industry has a well earned reputation as conservative and cautious Underwriting new and different risks requires new knowledge and data which is often lacking Remember the unique surety value proposition: it always strive to provide true performance security; i.e. providing owners with a completed project in the event of default (including payment protection for subs and suppliers)

47 The case for new products cont d As well, there are new realities for owners and contractors (e.g.) Owners want more control in default situations (schedules, replacement contractors) Lenders need assurance that big projects won t be held up due to a default of a key trade or supplier Some contracts (like road maintenance) need to be much longer five years or more is common

48 SAC Code of Best Practices (2016) Sets out standards of professionalism for a surety s response to a performance bond claim. Provides Obligees with a guide to what it can expect when claiming under a performance bond. Incorporates enhanced process bond form principles: Prompt Resolution Pre- and post-default meetings at the call of the owner Standards of professional conduct in claims handling

49 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

50 Contact Us Bob Sloat, Director Business Development, Western Canada Phone: / bsloat@suretycanada.com or visit our website: