Performance Bonds – How Balance Sheet Claims Affect Underwriting

This blog post will discuss the implications to surety bond capacity of carrying claims on a construction contractor’s balance sheet.

Construction is a risky business.   There are many parties involved and at times, these parties are not on the same page.  There is the architect, the owner, the general contractor, the sub contractors, the suppliers, the surety company, the surety company of the bonded sub contractors and the inspectors, all with different roles, and all of these parties need to be in agreement if a trouble free project is going to be produced.  If one really looks at what it takes to build a project, especially a public works project, it is amazing that more problems do not occur.

Issues do occur, change orders (claims for work that was not in the original plans and specifications) may not be approved.  Subcontractors can go out of business, the city inspector can make unreasonable demands, and many other circumstances can lead to issues.  Often times these issues lead to claims and claims lead to hiring attorneys and once attorneys are involved, every party, (with the exception of the law firms) usually loses.

What does this have to do with the underwriting of performance bonds you ask?  Often times the a contractor that needs surety bonds will have a claim.  The contractor, for instance has billed for change orders and these change orders are being disputed. (The most common reason for dispute would be the a claim that the change order was included in the original scope of the job.) The contractor will usually “carry” or include these claims as assets on the balance sheet.   Claims of this mature will be considered “under billing”, or costs in excess of billings on a balance sheet.

Under billings are scrutinized by the surety bond underwriters because it is not uncommon for claims to be included in this category.  Furthermore, once it is determined that these claims are being carried on the balance sheet, the surety company will discount this asset, negatively impacting the working capital and net worth of the company, the key components of the performance bond line.

Attorneys have a motivation convince a contractor to  pursue a claim.  Throughout my 27 year carrier in  he bond business  we have come across dozens of instances where a contractor carries a claim at the urging of the attorney, and the contractor usually loses the claim in its entirety or receives a lot less that the contractor thought was due.  The attorney still gets paid.

In if you are a contractor, before you decide to pursue a claim consider the following:

1. Understand that if you carry the claim on the company balance sheet, the surety company underwriter will discount the claim from its analysis.
2. A claim is a distraction, there is no way around that.  The time and energy pursuing the claim may be better spent pursuing other, more profitable activities.
3. If an attorney will not take the claim  on a contingent basis (they only get paid the claim is successful) the chances that you will prevail are minimal.
4. Even if the claim is won, it maybe too late, the lack of surety program could have already done irreparable harm

So before you pursue that claim, try every means possible to come to an amicable solution, even if it means settling for less than you think you are owed.