Construction Project Management introduces you to Project Initiation and Planning. Industry experts join Columbia University professor, Ibrahim Odeh, to give an overview of the construction industry. Professor Odeh teaches the fundamentals of the Project Development Cycle while guest lecturers discuss Lean Project Delivery method and Lean Design Behaviors. Technological advances, such as Building Information Modeling, will be introduced with real world examples of the uses of BIM during the Lifecycle of the Project. The course concludes with Professor Odeh discussing the importance of project planning and scheduling and an opportunity to develop a Work Breakdown Structure.
Purchasing a Surety Bond
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En provenance du cours de Columbia University
Construction Project Management
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Project Delivery
Professor Odeh introduces the fundamentals of the Project Development Cycle. Phillip White, a lawyer with the international firm Dentons, provides insight into Contract Types. William J. McConnell, CEO of the Vertex Companies, reviews the basics of surety bonding and Tim McManus, Vice President of Capital Projects and Infrastructure Projects at McKinsey and Company, discusses Project Delivery Methods and Surety Bonds.
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Ibrahim Odeh, Ph.D., MBAInstructor, Department of Civil Engineering and Engineering Mechanics, Columbia University
Director of Research and Founder, Global Leaders in Construction Management
How does a contractor purchase a surety bond?
It doesn't go to Liberty Mutual or Travelers or Zurich or Chubb and say,
I would like a surety bond please for $10 million.
Distribution is similar to insurance.
Regulation and distribution is very similar.
State insurance departments regulate sureties on a state level.
And distribution through out the country is done through brokers.
So, there needs to be, if you're a contractor and you're looking to
set up a surety line or surety credit facility, you have to go to a broker
that specializes in contract surety bonds and you need to work with him or her.
And he or she will facilitate the process and there's brokers,
it’s all they do, it's all they've done for years, and years, and
years, and they're very qualified and they're very good at what they do.
Because that's a lot of moving parts.
So in order to set up a surely facility if your contractor,
you have to do many things.
It's kind of like getting a mortgage on your house where you're providing
paper work that fills up a room.
Last five years of tax returns and financial statements and organizational
reviews and references and credit history and list of backing relationships.
There's a lot of moving parts at the early stages of setting up a bonding line.
The financial review, typically performed by the sureties,
include a review of the income statements.
Whether your revenue is more than your expenses over a given time period or
time periods.
You'll look at monthly, yearly, the last five years.
Balance sheet might be the most important asset, that'll show what your assets are.
It'll show what your debt load is.
And one important thing in construction is cash flow, particularly in public work.
Where a lot of times equipment required, so you are gonna have debt
load based on equipment purchases and capital expenditures.
And there needs to be the paperwork, the income statements,
and the balance sheet, and the cash flow statements need to establish
that the company has the wherewithal to complete this line of work.
And it has the ability to complete it and G&A expenses is incredibly important.
What that is, is what's a company's overhead?
And sureties will look at, what is your overhead compared to industry?
So if you are a large contractor, your overhead should be, hypothetically, 16%.
If it's at 30%, that'll raise a red flag.
And say boy, this company's overhead's a little too high.
What if they all of a sudden don't get the revenue that they need?
And that could be a big problem.
And that could cause problems in the future.
So you want to be lean and mean as a contractor.
But you also want to have the infrastructure in order to manage
problems, and handle the work and manage the work and collect your money, etc.
And then whip schedules really tell the story on how our contractor is doing,
that's work in progress schedules.
And that'll show all active projects and it'll show the original bid was,
what the anticipated profits were, and what the actual profits are trending at.
And in many instances you'll see, if a contractor's in trouble,
if he's got 30 projects, it's not gonna be on all 30 projects.
It might be a major issue on two projects.
And that'll detect what problems the contractor's having.
And then let's say that this is during an underwriting process still.
They'll wanna know the surety, likely wanna know,
what is the issue with these two projects?
And if there's a good explanation, that helps.
And contractors, hopefully, learn from their mistakes, etc.
Sureties always mention the three Cs of underwriting.
Capital, capacity and character.
Capital is what's their financial wherewithal,
which is what we just reviewed.
Are they cash strong?
Do they have assets?
How have they performed over the last five years?
Etc.
Capacity is, does a contractor have the capacity to do the work?
If a contractor is looking for a hundred million dollar bonding line and
it's average project side is $500,000 over the past five years.
They're probably not gonna get a $100 million line,
they might get a $3 million line or $5 million line, but not $100 million,
because they don't have the capacity to complete the work.
Or if a contractor is focused in Southern California, but
wants to open up a regional office and get bonds and do public work in New York City.
That's gonna be scrutinized, because that's a very risky move.
Many contractors aren't successful when they do that.
So that's what the sureties will look at.
Character is very subjective.
It's whether you're trustworthy, can the surety work with you?
Are you honest?
And over the years surety companies meet thousands of contractors and
they know what to look for.
And they wanna build a relationships and they determine whether or
not this contractor has the character that it's looking for, so
it can build a long term partnering relationship.
And that's really what it is, is a surety company is really partnered up
with a contractor, hopefully over a long term that's successful.
What's a general indemnity agreement?
It's a little scary,
I've signed one myself, Texas, one of the larger SAM firms in the country.
And it obligates indemnitors to protect the surety from losses.
So I think I gave instance where you have a $7 million completion cost,
$5 million contract balance, the lost is $2 million.
In that instance they sureties gonna collect through its GIA,
through that contract it's gonna collect, coupled with the bond form.
The losses generally include attorney's fees and consulting fees,
like for techs fees.
And other soft costs.
A lot of times indemnity is sought from
owners of the construction company and their wives.
Courts generally enforce GIAs.
Over the years I have been involved in several disputes where indimnitors
have fought collection and
in 100% of the proceedings, I've been involved with, the GIAs been enforced.
So courts typically understand them and enforce them.
Indemnitors have a duty to deliver collateral
in the event that there's a potential claim.
Sureties will ask that they measure, the surety will measure,
the loss and ask the indemnitors to post collateral that covers that loss,
whether it be a piece property or cash or whatever it may be.
In addition, the sureties have the right
to decide whether any claims against the bond should be paid, settled, or defended.
So let's say there's a claim made against the performance bond and
it is for a million dollars and it's by a sub and it looks to be very proper.
And the surety and its consultants have done a thorough analysis and say, yes,
the money's due.
Well, if the principal says, well I don't like
this particular contractor and well, I don't have any specific defenses.
I just think you shouldn't pay him because he's not a nice guy.
Well, the surety can go ahead and liquidate the claim and pay it.
It has that right.
And the last two, right to books and records and
right to duty to cooperate, that comes right out of the GIA and bond forms.
The books and records review is basically a way for the surety to come in and
take a look at the contractor's records whenever it sees fit.
I mean it's not gonna happen on a daily basis.
But it might happen on an annual basis or
if there's been a number of claims made against the bond, they'll probably,
the surety will probably want to take a look to see where the contractor is at.
The contractor has a duty to cooperate with that.
The sureties understand that it's slightly disruptive to the day to day businesses,
but it's important to take a look at that and they'll do that.
Cost of a bid bond is usually 5 to 20% of the bid.
The penal sum is gonna be the bid.
So, there's no charge
generally if payment performance bonds are also required.
So if it's a 10% bond and let's say the contract's
a million dollars and it's $100,000 penal limit.
So under, if there's a claim made against the bid bond,
the most that would be paid out is $100,000 or the difference between
the first bidder and the second bidder is 50,000 it would be paid 50 or
if it was 150 they'd just pay the penal limit of 100.
Performance bonds are half a percent to 2% of the total contract price, so
if it's a half a percent
of a million dollars that'll be a $5,000 premium.
So larger contractors with larger volumes typically have the lower premiums.
Smaller contractors and sub subcontractors generally
have the higher premiums at the one and a half to 2% level.
And when you're buying the performance bond you're also buying the payment bond,
so you get the two bonds for that price, which based on the protection it offers,
is actually a very reasonable amount.
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