Name of Event
Organization
Date
Surety Bonds
&Construction Risk
I – Construction Risk
“Then You Shall be his Surety”
William Shakespeare
Merchant of Venice
Construction Risk 2015
Construction Risk = Risk of Contractor Failure.
The number and severity of contractor failures
increased in recent years.
Recent Challenges:
Reduction of available work; oversaturated
market = tighter margins
Onerous contract conditions. Downloading
of risk
Paradigm Shift: AFP’s, P3’s
Construction Risk 2015
 From 2010-14, the Surety industry paid out almost
$800 million in claims; more than all of the
previous decade.
 2013 a year to forget:
 Loss ratio; 52% - industry unprofitable
 Premiums flat after two years of decline
 Across all lines and all sectors of the country
 2014 showed improvement with lower loss ratios
and premium growth … but….
 2015 ? Impact of Oil Prices in western Canada
and political and economic instability
Construction in Canada 2015
Canada the new construction “mecca”.
Ongoing commitment to infrastructure
Federal commitment $48B over 10 years.
By 2020 Canada to be world’s 5th largest
construction market (9th in 2010)
 Increased foreign investment from
depressed areas (e.g. Europe)
Larger and longer projects
Challenges to small and mid-sized contractors
Protect Against Construction Risk
Surety Bonds
Performance Bonds
Labour & Material Payment Bonds
Liquid Security
Irrevocable Letters of Credit
Cash/Negotiable instruments on Deposit
Default Insurance Products
Why Contractors Fail
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
II – Surety Bonds
What are They?
How do they Work?
Surety is not Insurance
Surety is not Insurance
INSURANCE
 2 party agreement;
Insured & Insurer
 Premiums actuarially
determined
 Losses anticipated
 No recourse against
insured in the event of
loss
SURETY
 3 party agreement;
Principal, Surety &
Obligee
 Premiums only a service
charge
 No losses anticipated
 Recourse against the
Principal via indemnity
agreement
Surety Bonds: 2 Essential Services
Prequalification:
Assurance that the bonded contractor is
qualified for the job for which they are
contracted.
Security:
Financial Protection in the event that the
bonded contractor should default on its
obligation.
Prequalification
Ongoing, Thorough & Value Added
Intensive:
Ongoing
Comprehensive:
Value Added
Standard Construction Bonds
Prequalification
Prequalification Letter
Bid Bond
Consent of Surety
Security
Performance Bond
Labour & Material Payment Bond
Renewable Multi-Year Bonds (service contracts)
Prequalification Letter
Not a bond but a letter from 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 refer to the project at hand.
SAC standard form available on SAC website.
Bid Bonds
protection from the “lowest irresponsible bidder”
provide assurance that contractor will:
enter into 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
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
Performance Bonds
 Guarantees Contractor will perform contract in
accordance with its terms & conditions.
 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
Labour &Material Payment Bonds
Guarantee that the contractor will pay all direct
subcontractors, suppliers for materials and services
provided to bonded project.
Obligee is trustee on behalf of the claimants
Claimant must have a direct contract with the
Principal
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
III – Surety Bonds
How are they Obtained?
Who Obtains the Bond?
Lender Includes bonding requirement in loan
agreement with borrower (project owner).
Project owner then includes bonding
requirement in tender documents or contract
specifications
The contractor obtains the bonding
Selects a professional surety bond broker or
agent who assists in submitting case to a surety
underwriting company
How is a Bond Obtained?
Contractor Submits Financial
Statements and other background
information to Surety
Participates in prequalification process:
an in-depth look at contractor’s
business operations and financial
structure.
Surety’s Financial Analysis
 Balance Sheet
Working Capital / Net Worth
Ratio Analyses
Receivable/Payables aging analysis
Work on hand; profitability, maturity, trending
 Income Statement
Profitability
Revenue
Trend Analysis; 3 to 5 years
 Cash Flow Analysis
 Accountant’s Opinion/Explanatory Notes
What Else does a Surety Need?
Complete details on Affiliated / Related
Companies; ownership, financial information,
etc.
Detailed Work on Hand Schedules
Aged Listing of Receivables and Payables
Organization Chart of Key Employees
Detailed Resumes of Principal & Employees
Business Plan & Contingency Plans
Subcontractor & Supplier References
What Else does a Surety Need?
Details of construction operations; areas of
expertise, list of key projects, key people, etc.
Letters of Recommendations from Owners
Evidence and details of a Line of Credit from a
Financial Institution
Details of business continuity plans in the event
of death or incapacity of owners/key people
Reports on Similar Completed Projects
Owner, contract price, date completed, profit
earned
IV– Surety Bonds
Myths & Misconceptions
Myths & Misconceptions
Myth #1: Sureties Don’t Respond to Claims.
A surety bond will provide:
Professional prequalification to weed out
unqualified contractors.
True performance security; i.e. provides owners
with a completed project in the event of default.
Payment protection to subs and suppliers.
A surety bond will not provide:
Cash-on-demand. There MUST be a default.
Dispute resolution.
A “magic lamp”.
Protection beyond the scope of the contract.
Myths & Misconceptions
Myth #1: Sureties Don’t Pay Claims.
Also….
Owner must have fulfilled its contract obligations
L & M Claimants must comply with the terms of the
bond and be prepared to document claim
Problems or questions? Contact the Surety
Association of Canada
Phone: 905-677-1353
Fax:
905-677-3345
email:
sness@surety-canada.com
Myths & Misconceptions
Myth #2: A 50% Bond only provide 50% Protection
50 percent bond gives you 100 percent protection up
to the bond amount
Example:
Contract Price = $ 1 million
50 % Performance bond ($500,000)
Contract is 50% complete
Surety arranges completion for $ 700,000
Surety’s loss is ???
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
bond company 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 a barrier to unqualified contractors
Myths & Misconceptions
Myth #4: Payment Bonds Don’t Help Owners
Ensure that subs working on your jobs will be paid.
Many are local rate payers.
Ease the Administrative burden in the event of default.
Reduces the Owner’s Legal Exposure.
More competitive prices from subs who are now certain
of being paid
Speedier resolution of a default; continuity of team.
Myths & Misconceptions
Myth #5: We don’t need a bond; our contractor is
huge.
Excerpt from “Why Contractors Fail” by Hugh Rice
and Arthur Heimbach, FMI Corporation 2007
“Recent history has shown that construction firms are
not too big to fail even though they may have annual
revenues ranging from hundreds of millions to several
billions of dollars.”
“There are bonding safeguards to protect project owners
and others when a contractor fails.”
V – Surety Bonds
What Happens when a
Contractor Defaults?
Before a Default is Declared
Surety has extensive experience with contracts
and solving construction problems.
Surety has intimate knowledge of 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.
Claims
When A Contractor Defaults:
Surety will promptly acknowledge notice of default
and being to gather information.
Surety will begin an investigation as soon as
possible.
Surety will conclude the investigation as soon as
possible.
If requested by owner, surety will provide periodic
written updates on investigation status and best
estimates as to completion date.
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.
How can the Project Owner 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.
Claim Example 1
Highway Development Project
Provincial Government Declares
Default on Highway Project
Case Background:
 The Principal, a road building company, was working
on a provincial transportation project when it
experienced financial distress and could not complete
the project, valued at $5.8MM.
 The Obligee, a Provincial Government transportation
department held surety security for 50% of the project
amount to mitigate both contract performance risk
and labour & materials payment risk.
Claims Example 1
Highway Development Project
Surety’s Action:
 The Surety Company advised the Obligee it
would start preparing the tender package to
complete the work.
 The Obligee expressed interest to choose its
own completion contractor.
 The Surety Company and the Obligee settled
for financial payment; where the Surety paid
the Obligee the anticipated completion costs.
Claims Example 1
Highway Development Project
 At the same time, the Surety Company paid out
multiple subcontractor and supplier claims under
the labour and material payments bond.
 Total amount paid out by the surety on this
project were $3.3MM.
Claims Example 1
Highway Development Project
“[this] is certainly a good example of the value of
having a performance bond [and labour &
materials payment bond] and we were pleased
that the bonding company offered flexibility in
coming to a solution that met our needs. The
negotiated settlement provided advantages to us,
as the Owner, in that it gave us control of the
work, which enabled the completion to be
expedited in an efficient manner…”
Owner Testimonial
Claim Example 2
Underground Contractor Defaults on 13
Municipal Projects
Claim Example 2
Case Background:
 The Principal, a sewer, watermain, curb/gutter, and
roadwork contractor with approximately $10 million
annual sales was forced into receivership when bank
called its loan.
 A regional municipality was left with 12 unfinished
contracts. Another municipal owner was impacted
with 1 uncompleted contract as well. Total value of
the contracts underway were $7.4 million.
 Project contracts were anywhere from $500 thousand
to $3 million range.
The surety:
Claim Example 2
 worked with the owners to ascertain the status of
each contract and identified the remaining work to be
completed.
 obtained quotes for completion of outstanding work,
presented these to Obligees and arranged for
completion contracts to be executed.
 reviewed claims from unpaid 48 trades and suppliers.
All claims settled within 72 hours.
 total surety payout in excess of $6.7 million. All 13
Contracts completed with no loss to Obligee.
VI – Surety Bonds
Unseen Services to
Owners & Lenders
Unseen Services of Surety Bonds
A surety can provide assistance and default prevention
services to owners & lenders by:

Facilitating the resolution of construction
performance issues that could lead to default

Providing management and business assistance
to assist contractors with administrative issues.

Providing financial assistance to financially
distressed contractors

Providing technical/engineering expertise if
required
Unseen Services of Surety Bonds
Confederation Bridge
New Brunswick to PEI
Confederation Bridge
Fixed Link from PEI to mainland 12.9 km
3 ½ year project; cost of $800 million. Opened
June 1997.
Performance & Payment Bonds provided by a
three member co-surety pool.
Owner: Public Works Canada
Contractor: Strait Crossing Development Inc; a
private consortium of four companies.
Senior Partner: Morrison Knudsen Inc. of
Boise Idaho – 35% share.
Confederation Bridge
 Morrison Knudsen; Established 1932, $2.86 billion in
sales
 1996 – MK files for Chapter 11 bankruptcy protection;
threatens survival or project.
 Sureties act quickly; arrange to finance MK through to
completion to allow for the company to be sold.
 Default prevented and project completed on time.
NOT ONE DAY OF WORK WAS MISSED.
The local community, the general public
unaware of any problems
VII - Other Forms of
Contract Security
Liquid Security (LOC’s)
Yield cash; not performance
Provide no prequalification assurance
Available in smaller; perhaps insufficient
amounts (5% to 10%)
Deplete a contractor’s borrowing power and can
bring on the very problem they seek to avoid
No dedicated protection for subs or suppliers
Work well for financial risks
Contractor Default Insurance (CDI)
Introduced in 1996 to protect very large general
contractors from subcontractor default.
Indemnity product – compensates for loss incurred
Significant deductibles and co-payment
Insured should have in house construction
administration experience and strong cash flow.
Does a good job at providing the protection for
which it was designed; i.e. protecting large G.C.’s
against construction default.
NOT designed to protect owners from risks
associated with default of prime contractor.
The “CDI for Owners” Non-Solution
Large general contractors approaching owners
and lenders with a “cost savings” proposal.
Sign on to G.C.’s CDI policy
“better protection, more cost effective better
management of subcontractors”, etc.
Save the bond premium.
The “CDI for Owners” Non-Solution
What they don’t tell you….
CDI is NOT an alternative to Surety Bonds
OWNERS NOT PROTECTED FROM G.C. DEFAULT
Owners have limited or no access to CDI benefits
Endorsement only responds when G.C. is
insolvent.
Contracts with unpaid trades are unenforceable
If Prime Contractor should default: No Protection
“Cost Savings” are minimal or non-existent.
CDI protects Contractors; NOT Owners
Waiving Final Bonds
Owners Save the bond premium by calling for bid
security and waiving requirements for final bonds.
Penny-wise; Pound Insane.
Contractor failure can bring catastrophic
consequences if not adequately managed.
Contractor failures on the rise as the economy
continues to struggle.
NO contractor; large or small is immune to financial
and economic forces
Morrison Knudsen: from Fortune 500 to Chapter 11
in two years.
VIII – e-Bonding
Did someone mention
“paperless” ??!!!
Electronic Delivery of Bonds
Issues and Challenges
Commercial
Legal
Technological
SAC’s Efforts to Address the Issues &
Challenges
Commercial Issues & Challenges
SAC encourages and promotes electronic
delivery of surety bonds.
Don’t Act on your own. Will only work with
industry buy-in.
Flexibility; evaluate; establish criteria and
standards, leave it to others to find a way to
meet them..
Electronic equivalent of a courier.
Legal Issues & Challenges
PIPEDA passed by parliament in 2000.
Umbrella legislation
Each jurisdiction followed with its own
legislation over the next two years
Challenge: What about seals?
Deed vs Contract - “Deemed” sealed, overt
act of sealing will constitute seal equivalent.
Verbiage not sufficient.
Friedmann Equity vs Final Note – Supreme
Court of Canada
Technological Issues & Challenges
Technology is in place; systems have been
developed and marketed in Canada and
U.S.
All systems are NOT created equal;
different focus; different capabilities
 Criteria:
Integrity of content;
Secure access
Verifiable / enforceable
SAC & e-Bonding
Publications on SAC website:
Designing Electronic Pathways Together.
Vendors Guideline.
 Criteria checklist.
Position Paper: Surety Bonds in a Digital
World.
Working with owners and vendors:
Mock Tender – Defense Construction
Development of template language for
inclusion in tender documents.
Six e-Tendering Tips for Owners
1) Consult Consult Consult: Without Buy-in
from other stakeholders, the advantages
can be squandered.
2) Don’t Reinvent the Wheel: Learn from
what’s been done. Are you in the software
development business?
3) Insist on Verifiability… whatever the
approach, know that the bond is valid and
enforceable.
Six e-Tendering Tips for Owners
4) … But be Flexible About Everything Else:
Allow vendors to find ways to meet the
criteria and standards you set.
5) It’s Up to You: Initiative has to come from
owners and end-users. SAC can provide
guidance but only you can start the journey
6) Take the Time to Get it Right: Pilot projects;
Phase-in implementation. Allow for time to
work out the kinks and for the industry time to
adjust. Mock Tenders.
IX – Surety Bonds &The New
Paradigm
Discount Surety Company
Good News – I hear the paradigm is shifting
The New Paradigm
There are still too many contractors in the business and
there will be a shakeout, but if you are good, there will
be work for you. The market has favoured larger builders
over smaller ones. The smaller guys are getting squeezed
because the projects themselves have grown. Five years
ago, who would have heard of a billion dollar project,
but now there are two in the Toronto area alone and
business models are changing too. Now you have to
design, build, finance and, if you are smaller it’s become
tougher.
Geoff Smith – President & CEO; EllisDon
Bigger, Longer & Tougher
New Models of Project Delivery and Procurement
P3’s, AFP’s
Bundling
Building Information Modeling (BIM)
The need and the will to address Infrastructure
deficit
Already here, small to mid-sized contractors
feeling the squeeze
Just Starting
…and Faster - Technology
Last 20 years, internet, social media…etc…
revolutionize business and life.
Gen Y …Gen Z … the “WrRU” generation
Demand for instantaneous information and
immediate satisfaction.
Pressure for quicker, more expedient
resolution to construction and other
business problems.
Evolving Political Environment
Globalization of the construction industry
with the collapsing of trade barriers
Canada Europe Free Trade Agreement,
Plurinational Trade Service Agreement
Participation of large multinationals will
increase completion further.
liquid balance sheets and demand for liquid
security
The New Paradigm
The business model is changing, but there is no
way to really predict how it is changing. Ask our
clients what they want from us, and they aren’t
exactly sure yet. I spend a lot of time at night
thinking, ‘Okay, how will it all work out?’
Geoff Smith – President & CEO; EllisDon
X – So What are we doing
about it??
SAC Performance Bond
SAC consultations with Owners & Contractors;
More “certainty” in the claims process.
More responsiveness to a claim
More frequent and effective communication
between sureties and owners.
New “enhanced” performance bond provides
construction buyers with more timely &responsive
claim service.
Has been used by owners across the country and will
be adopted by CCDC as the new standard.
Provides more responsive services to owners by…..
SAC Performance Bond
Pre-Demand Conference to allow surety and owner
to prevent problems from turning into a default.
Timelines for Surety’s Response:
5 days to acknowledge a response & request info.
21 days (from receipt of information) for surety to
respond to owner with their response.
Emergency Remedial Work: Allows Owner to
address urgent issues (e.g. safety) under the bond.
Post-Demand Conference: Mechanism to minimize
or eliminate work stoppages while surety investigates.
Contact Coordinates: Contact information for all
parties to facilitate notices and communication.
Surety Bonds & P3 Projects
Comprehensive performance & financial security
against construction default on mega-P3 projects.
Sufficient capacity for mega-projects.
Broad and flexible protection packages which include:
Professional surety prequalfication
Specialty P3 bonds designed by member sureties:
 Provide liquid / cash on demand protection.
 Built-in “fast-track” dispute resolution
 Early Response; surety involved pre-default.
Protection for trades & suppliers via the payment bond.
Called for on Infrastructure Ontario Build-Finance and
Design-Build-Finance projects.
Renewable Multi-Year Bonds
Only applicable to service contracts; e.g. Waste
Management, Snow Removal, etc.
Initial Term is open. Renewal Terms are typically
1 year periods can be extended to two.
Surety issues an annual Renewal Certificate.
Failure to renew the Bond is not a ‘default’ under
the Contract or the Bond
2-year suit limitation – runs from earlier of expiry
of latest bonded ‘Term’ or date default declared
Can be modified to address O&M components of
P3’s
Headstart Performance BondTM
Created by The Guarantee Co of N.A. to protect GCs
from sub default (competitive alternative to SDI)
Industry Solution: available for use by other sureties.
Flexibility: Obligee given two mitigation options:
o Traditional Option: Surety investigates and implements
solution (as in standard bond); or,
o Headtstart Option: Obligee implements its own solution
upon surety’s acceptance of Obligee’s completion proposal.
Responsiveness:
o First dollar protection(no deductible or co-payment).
o Surety will respond in 3 days from receipt of Claims letter.
o Standard claims notice and mitigation agreement.
SURETY ONLINE LEARNING CENTRE
 The Surety Online Learning Centre accessible
from SAC website; www.suretycanada.com.
 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
Contact Us
Phone:
905-677-1353
Fax:
905-677-3345
email:
surety@suretycanada.com
or visit our
website:
www.suretycanada.com