Subcontractor Bonding: What General Contractors and Subcontractors Need to Know

With project owners and general contractors becoming more risk averse, bonding subcontracts has become more prevalent than ever. Decades ago, many sureties viewed bonding subcontractors as more risky than bonding prime contractors.

Today, most sureties do an excellent job of mitigating their exposure to the unique risks within the subcontract market. As a result, there is increased surety appetite and capacity to bond subcontractors.

While subcontracts contain unique risks, the surety looks for the same basic qualities in a subcontractor as they do in a prime contractor: capacity, capital and character. The surety pays close attention to receivables and will want to see an aging schedule. It is helpful if the subcontractor has experience working for the general contractor and has established a good relationship.

Why Are Subcontractor Bonds Required?
Unlike prime contracts, bonds typically are not required for subcontracts by law on public works. Instead, each general contractor decides whether to require their subcontractors to bond. Prudent general contractors understand the importance of transferring the risk of subcontractor failure by establishing a subcontractor bond policy. The general rule of thumb is a subcontract exceeding $100,000 will require a bond; however, a general contractor can make this threshold smaller or larger, depending on the scope of the subcontractor’s work and the type of project. Chances are, subcontractors doing more than $100,000 on public work will eventually encounter a bond requirement.

Bid vs. Negotiated
Because subcontracts are usually negotiated, general contractors seldom require bid bonds. Instead, the general contractor may require a bond prequalification letter from its surety that states the subcontractor’s current bond capacity. However, there is a growing trend for large general contractors to require bid bonds. A subcontractor must be fully prequalified by the surety before obtaining either a bond letter or a bid bond.

The Devil is in the Details
General contractors try to shift as much project risk to their subcontractors as possible. Typically, the general contractor uses its own, customized subcontracts and bond forms. The surety will require the subcontractor to provide a copy of the subcontract and bond forms prior to approving the bond. The surety wants to make sure there are no unduly onerous terms and conditions for the subcontractor–and to them, by extension.

Here are a few examples of common subcontract clauses that sureties consider onerous.

Extended discovery period.
A general contractor should make a bond claim reasonably soon after it is discovered. An extended discovery period clause allows the general contractor to wait several years before filing bond claims or lawsuits against the subcontractor and its surety. Sureties usually take strong objection to this condition.
No notice required. Often, subcontracts are amended as the work progresses. The surety may object to a subcontract that does not require the general contractor to notify the surety of contract changes that can significantly increase their liability. Sometimes, the subcontract language even allows the general contractor to default the subcontractor without notice. This can leave the door wide open for an unscrupulous general contractor to default and replace the subcontractor without giving the subcontractor and its surety a chance to cure the problem. If given proper notification, the surety can be helpful in defusing contentious disputes that might otherwise result in costly litigation.
Pass-through liquidated damages. On large, high-profile projects, the liquidated damages assessed by the project owner in the event of a project delay can be substantial. For example, the liquidated damages for a $100 million project might be $50,000 per day. Most boilerplate subcontracts simply pass down the liquidated damages from the prime contract to the subcontractor. The surety will want to know the specific amount of liquidated damages and how much time the subcontractor is given to complete the work. Sureties will object to contract wording that allows the subcontractor to be charged with all the liquidated damages, regardless of who is responsible for the delay. The liquidated damages should be allocated proportionally to the amount of fault the subcontractor bears.
Pay when paid. This clause has gained wide acceptance in recent years. It legally allows the general contractor to only pay the subcontractor after they have received payment from the project owner.
Pay if paid. This is a newer twist to the pay when paid clause that allows the general contractor to be only legally liable to pay the subcontractor if the project owner pays the general contractor. The subcontractor is given legal remedies if this clause is enforced; however, specific actions must be taken that will require assistance from a good construction attorney. This is an especially dangerous condition for the subcontractor and may be difficult to bond.

Eager to take on new work, subcontractors often make the mistake of signing subcontracts without fully understanding the ramifications of its terms and conditions. Smaller subcontractors often view seeking legal advice as cost prohibitive. It is far less expensive to have an attorney review and negotiate a subcontract’s wording than it is to hire the attorney after construction starts and a dispute erupts into a costly, protracted legal fight. Most general contractors are willing to modify or even eliminate objectionable conditions.

Bond Before Starting Work

Sometimes, the general contractor allows the subcontract to begin work without the bond in place. It may be tempting for the subcontractor to start the job and worry about the bond later, but it is never a good idea. If the bond is required in the subcontract, it will be enforced eventually. Once the work starts, the surety will demand written confirmation from the general contractor that the there are no pre-existing performance or payment issues on the job. General contractors tend to recoil against this, often sending the request to their legal department. Meanwhile, the bond approval is kept in limbo, with the general contractor and surety locked in a stalemate. The general contractor may lose patience and refuse to pay the subcontractor. They can even default and replace the subcontractor for failure to provide the bond.

With a growing number of general contractors requiring subcontractor bonds, it is important for subcontractors to be prepared. To be successful, a subcontractor must enter into a subcontract with equal measures of enthusiasm and caution.


Filed under: Construction,Surety Monthly — Jillian Bender-Cormier @ 10:49 pm October 26, 2015

Construction Material Prices Plunge in September

Prices for inputs to construction industries plunged 1.6 percent in September after shedding 0.9 percent in August, the Bureau of Labor Statistics reported today. Year-over-year prices were down 5.3 percent for the month, the largest yearly decrease since October of 2009. Inputs to nonresidential construction prices also declined, losing 1.6 percent for the month and 6 percent for the year. Only three of the 11 key input prices expanded on a monthly basis in September, while six experienced double-digit year-over-year declines, according to analysis by Associated Builders and Contractors.

“The global economy has continued to soften in recent weeks, with additional concerns directed at formerly fast-growing nations like China, Brazil and Russia,” said ABC Chief Economist Anirban Basu. “Europe continues to muddle along and the Canadian economy remains relatively flat. All of this has conspired to weaken demand for global commodities even as supply of many inputs continues to be elevated.

“For much of September, there was a belief among some that the Federal Reserve would raise short-term interest rates during that month,” said Basu. “That belief helped keep the dollar strong, which also helped to keep commodity prices low. When the Fed made the decision not to raise rates, the dollar weakened a bit, allowing oil prices to edge higher. The implication is that October PPI is unlikely to be as deflationary as September.”

Only three key input prices rose in September:
• Plumbing fixtures and fittings expanded 0.1 percent from August and are up 1.1 percent from September 2014.
• Prices for concrete products expanded 0.7 percent in September and are up 3 percent from the same time last year.
• Crude petroleum prices expanded 2.3 percent in September but are down 54.3 percent from the same time last year.
The key input prices that fell or remained flat are:
• Crude energy materials prices dipped 1 percent in September and are down 39.9 percent from the same time last year.
• Fabricated structural metal product prices fell 0.l percent for the month and are down 0.6 percent on the year.
• Iron and steel prices fell 1.1 percent for the month and 18.8 percent for the year.
• Prices for steel mill products fell 0.8 percent from last month and 14.9 percent from last year.
• Nonferrous wire and cable prices are down 0.8 percent in September and 7.8 percent from the same time last year.
• Softwood lumber prices fell 3.8 percent on a monthly basis and 12.2 percent on a yearly basis.
• Prepared asphalt, tar roofing and siding declined 1.9 percent for the month but expanded 2.5 percent from the same time last year.
• Natural gas prices fell 7.5 percent on a monthly basis and are down 35.8 percent from the same time last year.

Filed under: Construction,Surety Monthly — Jillian Bender-Cormier @ 10:37 pm