Keep up with our blog to get helpful information for making the best insurance choices.
Reasons Why Subcontractors Fail
Subcontractor default is a problem that is neither understated nor under-reported. Everyone in the industry is familiar with it and the consequences of the likely, yet always surprising, the situation when a subcontractor goes into default on a project.
Therefore, it is more important now than ever to review why subcontractors fail, and what everyone else should be doing about such failures.
Managerial problems
Inadequate accounting, financial, or project management systems
Management or personnel changes or complications
Business strategy changes
Rapid over-expansion and growth
Poor owner, lead contractor, or project selection
Labor and material problems
Shortage of labor and materials
Unrecovered cost escalations
Tariffs
Uncontrollable factors
The lead contractor on a different job does not pay
Severe weather hindrances
Unexpected economic failures
Difficult contract terms or working environment
Changes in the job site conditions
Death, illness, or departure of necessary employees
Labor shortages or difficulties
Material and equipment shortages or price increases
Financial signs of failure
Tight cash flow
Receivables turning over slowly
Bills are past due
Vendors demand cash on delivery (COD) for supplies and materials
Bank lines of credit are borrowed to the limit and credit
Business plan problems
No contingency plans, goals, or objectives
No road map for future plans
Project management problems
Inadequate project supervision
Inability to find reasonable prices on change orders or inability to collect on change orders
Projects are not completed on time
Projects are moving at a slow pace
One or more projects has a claim
Safety violations on the job site
Poor estimating and job cost reporting
Revenue and profit margins decrease
Operating losses
Loss or reduction of bonding capacity
Contractor bids low to get new work out of desperation
Communication problems
Lots of disputes between the contractor and project owner
Poor communication between management and field workers
Loss of loyal customers
The contractor cannot fulfill contracts – jobs are not done in time or within the established budget
Establish a good relationship with your producer and surety underwriter
Manage growth and control overhead
Communicate with the surety if and when problems arise
Understand contracts and their language
Read bond forms and look for difficult or unmanageable terms and conditions
Verify the surety’s licensing abilities by checking with the state insurance department
Develop a solid relationship with the surety and remain respectful of their decisions and practices
Use a construction-oriented CPA
Have a bank line of credit available to support your business plans
Conserve capital
Adjust your overhead
TOP THREE WAYS TO HANDLE SUBCONTRACTOR FAILURE
The failure of a subcontractor can be sudden and can cause vast problems. Therefore, the question is whether anything can be done about it. Here are the top three ways to protect against subcontractor failure.
Lien rights. Though this one doesn’t apply for those at the top of the chain (general contractors, owners, and lenders), it is still the number one protection measure because of how enormously effective it is for all of the other affected parties. In fact, it is even effective for the defaulting subcontractor, as it can put it in the best position possible to claw its way out of a bankruptcy proceeding. Lien rights protect a company’s right to get paid for work, and more importantly, prevent companies from being placed into the back of a payment line. A subcontractor in the front of the payment line avoids cash problems and is insulated from others defaulting on the project.
Surety bonds. Subcontractors can obtain performance bonds and payment bonds, and it’s common for general contractors, owners, and lenders to require some subcontractors to acquire these bonds. When a subcontractor has these bonds, default is less burdensome because the surety bond will compensate the affected parties for the losses.
Prequalification. Prequalification often is used by top-of-the-chain parties to assess the likelihood of failure by a lower-tiered party (i.e., a subcontractor). It also can be used by lower-tiered parties to assess the problems that might arise by higher-tiered parties. Everyone is affected by default and should do a preliminary analysis to avoid the same. Examining the ability of a subcontractor to deal with the expected cash flow challenges is a necessary evil in today’s construction economy. Also, it serves everyone well to make sure the subcontractor is also taking measures to protect lien rights. If not, the subcontractor is going to be in the back of the payment line, and the result is heightened default risk.
We can help protect you from all the issues that come from subcontractor failure so please give Arnold Insurance a call and get started building your plan against subcontractor failure. 614-863-0455
What is a Surety Bond?
Definition and Benefits of Surety Bonds
A surety bond is simply an agreement between three parties:
Principal: the person who needs the bond
Obligee: the person who is protected by the bond, such as the government entity
Surety: the person who issues the bond
Benefits:
Relieves the project owner of risks of financial loss as a result of liens for unpaid subcontractors and suppliers. They also protect taxpayer money for public projects.
The transition between the construction of the site and permanent financing is smooth because there are no liens.
Surety company can offer assistance such as technical, managerial, and financial – to move the project along and reduce the chance of default (project failure).
Surety company arranges for project completion if the contractor defaults.
Types of Surety Bonds
Bid Bond – provides financial assurance that the bid has been submitted in good faith. The contractor intends to fulfill his/her responsibilities at the price bid and will provide the necessary performance and payment bonds.
Performance Bond – protects the project owner from financial loss if the contractor fails to perform the duties outlined in the contract.
Payment Bond – guarantees that the contractor will pay subcontractors and laborers, and for supplies relating to the project at hand.
Obtaining a Bond
Before a surety can provide assurance that a contractor can perform properly, they must go through the prequalification process. In this process, the surety conducts a review known as underwriting – analyzing the contractor’s business operations and determining their ability to meet current and future contractual obligations. The surety will not issue a bond until they are satisfied that the contractor can fulfill his/her contractual obligations. The surety looks at the items listed on the slide during the prequalification process.
Costs of Bonds
The charge for a bond, or the bond premium, is broken down as such: no charge for the bid bond, 0.5 to 2 percent of the contract amount for the performance bond, and no charge for the payment bond when purchased with the performance bond. In addition, there is a fee for surety’s underwriting services known as the surety bond premium.
Utilize these resources when receiving bids:
U.S. Department of Treasury: www.fiscal.treasury.gov/fsreports/ref/suretyBnd/c570.htm
State Insurance Department: www.naic.org/state_web_map.htm
Surety Information Office: http://sio.org or call 202-686-7463