Efficiency Bonds: The Way To Avoid Collateral

Efficiency Bonds: The Way To Avoid Collateral

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

Why is the bonding company taking cash from me when they can see I am in a weak money position? I want it to efficiently perform the new project.
You don't pay me interest on the money? Why not?
When the job is half completed, you'll not release a part of the collateral?
You will not launch the collateral upon acceptance / completion of the contract?
You will not launch the collateral till the warranty period ends?
Etc. Loads of aggravating phone calls and emails.
With all this aggravation ahead, why do some bonding corporations require collateral? The reason is to protect themselves within the event of a bond claim.
When a contract surety loss occurs, the claims division hopes to have two relyable resources for financial recovery:

The unpaid balance of the contract goes to the surety as they complete the work
The surety sues the applicant / firm and its owners to recover the loss
Collateral requirements come up when the surety desires to have certainty. If a problem develops, they do not need to discover that the client has no money left, or they declared bankruptcy... or left the country. If they are to write the bond, they want a assured way of having monetary recovery.
Bearing in mind that collateral is a dear worth to pay for a bond, let's look at an alternate approach that helps the surety, however would not take a big bite out of the contractor!

"Retainage" is money the project owner hold back (retains) to assure the ultimate completion of the project and payment of associated bills. If the retainage is 10%, the contractor receives 90% of the funds they're owed as the job progresses. On the end, the contract owner / obligee will still be holding 10% to keep the contractor focused on reaching total, satisfactory completion. In this manner, the retainage cash protects each the obligee and the surety - making a bond claim less likely.

"Surety Consent to Release of Final Payment" is a voluntary procedure obligees could 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 however the contractor might find annoying to correct. The Surety Consent is one other way for the bonding company the keep away from a claim. "Fix this problem or we is not going to conform to release your ultimate payment."

How can these two helpful instruments be incorporated to ensure they'll help the surety, and therefore exchange the need for collateral?

The answer is to add a condition to the bond (necessary compliance required by the obligee) stating that there may be no release or reduction of retainage or closing payment without the prior written consent of the surety. Now the bonding company is assured to have a financial resource available and the amount is known in advance - just like collateral. However the contractor didn't have to drain the corporate bank account to accomplish it: Win-win!

What if the contract phrases do not provide for a retainage procedure? One may be added by contract amendment. If Funds Control (an escrow agent) is in use to handle the contract disbursements, a retainage procedure could be added to the funds management agreement.

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Présentation

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