Payment Bonds & Contract Bonding: Notice, Claimants, & Bond Capacity, Exams of Nursing

Download Payment Bonds & Contract Bonding: Notice, Claimants, & Bond Capacity and more Exams Nursing in PDF only on Docsity! AFSB 152 EXAM (Chapters 1 - 10) 557 Questions and Answers 2024 How a typical design process works: - ✔1️. The design professional interviews the client and measures current and future needs 2. The design professional reviews existing facilities for potential renovation and for their ability to handle future growth needs 3. Professionals obtain required zoning approvals and ensures plans comply with government regulations 4. For new construction, the future owner either acquires an option to acquire the land or building being renovated 5. The owner obtains a building permit 6. The owner arranges financing before construction An underwriting concern with reverse flow international bonding is that: - ✔T️he financial strength of many of the international companies resides outside of the US A limited liability company is most similar to a: - ✔S️ubchapter S Corporation What describes the importance of supplementary data in a contractor's financial report? - ✔S️upplementary data is highly significant in a contractor's financial report Courts have created the surety's rights of subrogation by ruling on which one of the following actions by the surety? - ✔A️ surety that pays under its bond may take over the recovery rights of those persons to whom or on whose behalf the surety has made payment Contractor A bid a job at $8 million. Contractor B, Contractor C, and Contractor D bid the job at $7.1 million, $7.0 million, and $6.9 million. In this case, most sureties would apply the 10 percent rule to Contractor A's bid and: - ✔A️n average of all of the above bids What performance bond option is particularly effective in the face of a threat of "blacklisting" by a public, governmental body obligee? - ✔T️o fund the excess cost of completion and reserve the surety's rights to sue the obligee for repayment Analyst's must inquire about any subsequent changes and determine whether they have material positive or negative effects on the analysis. The analysis should consider events and conditions in these areas: - ✔-️ Financial performance of contracts: a variety of factors, such as project management, weather, and productivity of the labor force can affect financial performance - Mix of assets and liabilities that may change the financial structure of the contracting entity - Changes in ownership or management of the contracting entity - Litigation involving the contractor If a contractor fails to sign a contract after being awarded the bid, and the difference between the principal's bid and the next lowest bid is more than the bond penalty, then? - ✔T️he contractor is liable for the excess amount If there is work on a highway project that requires a deep excavation and extensive pile driving, the contractor should have concerns for? - ✔D️amage to surrounding structures Which type of guarantees do underwriters typically consider objectionable? - ✔E️fficiency guarantees on the finished project that hold the contractor responsible What is the reason contractor's are required to provide bid bonds? - ✔T️his is because obligees do not have time to review every single bidder's qualifications Benefit of Surety Bonds to Architects or Engineers: - ✔T️he bond provides confidence that, in the surety's judgement, the contractor can translate project plans into a finished product. A contractor's ability to acquire, maintain, and successfully manage backlogs is reflected in which of these income statement results over several accounting periods? - ✔O️perating Profit What is a surety bond? - ✔A️ written contract that expresses one partys promise to answer for another partys failure to do something as promised What is a surety? - ✔T️he party to a surety bond that guarantees to the obligee that the principal will fulfill an obligation or perform as required by the underlying contract, permit, or law. What is an obligee? - ✔T️he party to a surety bond that receives the suretys guarantee that the principal will fulfill an obligation or perform as promised What is a principal? - ✔T️he party to a surety bond whose obligation or performance the surety guarantees What is suretyship? - Two common methods for contractors to illustrate their scheduling: - ✔1️. Bar Charts 2. Critical Path Method What is critical path method (CPM)? - ✔A️ process that identifies every major element of the construction project, as well as time estimate for each element, and assembles these elements into one master schedule Shows the logical sequence of work activities that must be finished for completion of the project within the time budget What is a punch list? - ✔A️ list of small finishing tasks that must be accomplished for completion What is the design process? - ✔A️rchitect prepares sketches, renderings, of the new structure --> property owner approves the sketches and employs professional engineers --> engineers restrict their practices to specialized areas What does a construction manager do? - ✔O️ffers alternative designs to minimize costs and maximize use of facilities. They also frequently assist in preparing specifications, advertising/reviewing bids, awarding contracts, managing construction, and approving requisitions, billings, and final payments Hired during the feasibility study or the design process Why must construction management contracts be carefully reviewed? - ✔T️o determine the risks and obligations the construction manager is assuming: - at one extreme, the CM may receive a fee simply for coordinating the construction of the project and may not assume any risk for finishing on time or within budget - at the other extreme, the CM may have, in effect, virtually all the obligations and risks commonly assumed by a general contractor What are the benefits of design/build contractors? - ✔-️ reduced costs because the owner doesn't pay a design fee in addition to the construction overhead and profit - reduced planning time because delays in communication among design professionals, contractors, and the owner are eliminated - reduced costs because of the contractor's experience with and knowledge of the costs associated with various construction techniques and materials What are the two types of financing programs typically used for construction: - ✔1️. Construction Mortgage - a loan that provides financing during the construction period - typically the owner usually pays interest on the funds borrowed but makes no principal payment 2. Permanent Mortgage - a loan that provides financing after construction is complete - payments to the lender include both interest and principal, and the mortgage is expected to be in effect for a number of years. What is the largest risk a lender during the construction process? - ✔T️he largest risk to the lender is contractor default during the construction process: In order to protect itself, the lender should require the furnishing of performance and payment bonds by a reputable surety company. The lender can request it be named as an additional obligee. How should a contractor confirm that financing for a project is in place? - ✔T️hrough a letter from the financial institution or a copy of the loan agreement Contractor Selection methods: - ✔1️. Negotiation - works best when the owner has prequalified the contractor and a high level of mutual trust exists 2. Competitive Bidding - works best for the owner when the design professional has prepared plans and specifications that are accurate, complete, thoroughly understood by bidders Why is the day the bid submitted an intense time for a general contractor? - ✔T️he GC must assemble the prices and scope of work from subcontractors and material suppliers as little as two to three hours before submitting the bid to the owner. If a union contractor is bidding to both a union general contractor and a nonunion contractor, which contractor will usually get the better price? - ✔T️he union general contractor What are the 4 main categories of general building construction? - ✔1️. Commerical 2. Industrial 3. Residential 4. Public Work Examples of Commerical Construction: - ✔S️hopping centers and office buildings; typically private owners Examples of Industrial Construction: - ✔R️anges from small, single-story warehouses and manufacturing buildings to large industrial complexes, manufacturing plants, and processing facilities Examples of Residential Construction: - ✔T️his field includes smaller companies that build residential units and developers Are performance and payment bonds required for residential construction? - ✔G️enerally not required, a municipality (city) may require a developer to post a subdivision bond guaranteeing that roads, water and sewer lines, sidewalks will be installed according to plans filed with the municipality What is a general building contractor? - ✔A️n independent contractor who obtains the primary contract for a project and either completes all the work or subcontracts portions (or all) of the work to other independent contractors who specialize in such work What is a general engineering contractor? - ✔A️ contractor that constructs locks and dams, power plants, large bridges, sewage and water treatment plants, or similar projects for public and private owners The majority of their work is owned by public bodies requiring surety bonds Heavy and Highway Construction Contractors: - ✔T️ypically make large expenditures for construction equipment: - street and road contractors ranges from small operators who pave private driveways and commercial parking lots to those who construct public streets and interstate highways - highway contractors build and rebuild highways for federal, state, and local governments. - underground contractors construct sewers and water mains, lay conduit for underground electrical lines, install gas mains, and work on oil and gas pipelines. Many types of subcontractors specialize in tasks such as: - ✔1️. Excavation and Site Preparation 2. Concrete Construction 3. Sprinkler Installation 4. Steel Erection 5. Roofing 6. Masonry 7. Drywall and Tile Installation 8. Flooring 9. Painting 10. Landscaping What are the unique problems that subcontractors encounter because they most often work with general contractors rather than directly with project owners? - ✔T️hey are often subject to terms and conditions of the general contractors written agreement with the owner, even though they rarely have an opportunity to review or change the agreement. They can fall victim to GC's who, do not promptly pay them. Their work is directly tied to the GC's work, so poor performance by the GC will directly affect the performance of the subcontractor. Trend toward design/build projects: - ✔T️he trend toward more design/build projects is particularly evident in larger, private sector commercial and industrial construction. Most design/build contracts have been for private owners, but the concept is used in the public arena for government owned projects as well Tax: Any income or loss is merely reported on the owners personal tax return and is taxed directly to the individual at his or her tax rates What is a partnership? - ✔A️ for profit business entity jointly owned by two or more persons who share ownership and profits (or losses), although not necessarily on an equal basis What is a general partnership? - ✔A️ separate legal entity for purposes such as owning property, hiring employees, and suing and being sued. A partnership may arise from a formal written agreement or informally, with no written agreement. No statutory requirements apply to capitalization of a partnership. A partner may contribute property, services, or both for a partnership interest. Liability: A partnership in which each partner assumes unlimited joint liability for all the partnership debts Tax: Each partner must report his/her distributive share of the partnerships income and deductions What is a limited partnership? - ✔A️ limited partnership must have at least one general partner, who makes business decisions and is personally liable for the business debts, and at least one limited partner, who invests money but has little or no control over daily decisions or operations. Limited partners are not personally liable for the business's debts. Liability: A form of partnership made up of one or more general partners, who have unlimited liability, and one or more limited partners, whose liability is limited to the amount of capital they have contributed to the partnership Tax: Pay taxes once on the business's income as individuals rather than both at the corporate level and when they receive personal income or profit from the business Why are limited partnerships not appropriate for many buisness ventures? - ✔T️his is because limited partners lose their limited liability status if they exercise management or control over the partnership. Because of this restriction, limited partnerships are established primarily to attract equity capital What is a corporation? - ✔A️n entity organized under law and entitled to the same rights as a person, distinct from its owners. The corporate entity has continuity of life beyond the lives of the owners The formation of a corporation creates a legal, taxable entity that is separate and distinct from its individual owners, or shareholders What is a promoter? - ✔A️ person who brings a corporation into being by filing the articles of incorporation with the specified state agency What are articles of incorporation? - ✔A️ document prepared during the formation of a corporation stating the corporations goals and objectives and the kind of business for which the corporation was organized What are shareholders? - ✔A️n individual owner whose liability is limited to his or her investment in the corporation What are Subchapter S Corporations? - ✔A️ small business corporation restricted to no more than 100 stockholders that elects to be taxed under Subchapter S of the Internal Revenue Code. A Subchapter S corporation provides limited liability to its owners and tax treatment similar to that of a partnership. Profits, losses, and other tax items are passed through to the shareholders and are taxable to them on their individual returns. What is the primary difference of Subchapter S Corporations and C Corporations? - ✔T️hey primarily differ in taxation and S Corporations have a limited amount of shareholders What is the primary advantage of Subchapter S Corporations? - ✔I️ts income is not taxed at the corporate level, instead all corporate income, loss, and credit flows through to the shareholders personal returns and are taxed at the shareholders individual tax rates What is a merger? - ✔A️ type of acquisition in which two or more business entities are combined into one; a merger of two corporations means that one will be absorbed by the other and go out of existence, while the absorbing corporation continues to exist Generally, apart from objections from shareholders or creditors who may be harmed, a business corporation has the right to sell, transfer, or otherwise dispose of its property. The exception is that: - ✔A️ corporation cannot dispose of all of its property unless it receives fair value. Also, even though a corporation's assets are sold or transferred to another corporation in an asset transaction, both corporations remain in existence. What is asset transaction? - ✔A️ method by which a corporation acquires the assets of another in which the target corporations assets are transferred to the acquiring corporation in exchange for cash, notes, or stock What is a limited liability company (LLC)? - ✔H️ybrid business structure created by statute, the owners of LLCs are typically called members and these members typically are binded to the LLC to such transactions as loans, loan guarantees, and indemnity agreements Liability: A form of business entity that provides its owners the limited liability of a corporation and the tax advantages of a partnership Tax: Tax liability is passed through to the individual members What is a joint venture? - ✔A️ business association formed by an express or implied agreement of two or more persons (including corporations) to accomplish a particular project, such as the construction of a building | Each partner is jointly and severally liable for completing the entire project Liability: Partners in a joint venture have unlimited liability for the ventures debt and obligations Tax: Partners can include their portion of the joint ventures profits and losses in their individual tax returns; tax advantage What are the advantages and disadvantages of joint ventures? - ✔A️dvantages: include the ability to participate in a project that would be too large or unsuitable to undertake separately and the favorable tax treatment of profits Disadvantages: include each participant's responsibility, jointly and severally, for the project. If one fails, the others can be held responsible for completing the entire project. Additionally, any losses on the project could affect each participant's financial status What is an idemnity agreement? - ✔A️ contract under which one party (the indemnitor) agrees to reimburse a second party (the indemnitee) for losses that the indemnitee has already paid What types of joint venture agreements are there? - ✔-️ Open Joint Venture - Silent Joint Venture - Limited Joint Venture What is an Open Joint Venture? - ✔P️articipants in an open joint venture make its existence known to third parties. The joint venture bids, contracts, and conducts business in its own name. What is a Silent Joint Venture? - ✔P️articipants in a joint venture might not want to disclose that it exists, so they form a silent joint venture, under which projects are bid in the name of only one of the venturers. What is a Limited Joint Venture? - ✔U️nder a limited joint venture, one of the participants limits either the type of work it will perform or its level of financial participation. Usually formed to either complete highly specialized work that may constitute only a small part of the entire job or to cap a party's individual investment. Indemnity Agreements for the various joint venture types: - 2. Mediation 3. Arbitration What is litigation? - ✔A️ formal lawsuit that seeks damages for losses incurred, final and binding. Can be expensive and time consuming, with highly uncertain results. What is mediation? - ✔A️n alternative dispute resolution method by which the disputing parties use a neutral outside party to examine the issues and develop a mutual agreeable settlement, nonbinding. What is arbitration? - ✔A️n alternative dispute resolution (ADR) method by which disputing parties use a neutral outside party to examine the issues and develop a settlement, which can be final and binding. Advantages of mediation over litigation and arbitration? - ✔1️. Reduced Costs 2. Promptness of Resolution 3. Preservation of business relationships 4. Avoidance of shock verdicts 5. Ability to maintain control over the outcome What is a strike clause? - ✔T️he contract provision that enables a contractor to seek a time extension if labor disputes delay the work What is the force majeure clause? - ✔A️ contract provision that protects parties who cannot perform contractual obligations because of causes outside their control What is a pay when paid clause? - ✔A️ contract provision that requires payment for the subcontractor's work at the same time the prime contractor receives payment from the project owner What is a price escalation clause? - ✔A️llows the contractor to make a claim against the owner for costs beyond the original bid if an unforeseen increase in the price of equipment, fuel, labor, materials, or service occurs What is a progress payment? - ✔A️ periodic or percentage installment payment for service; could be based on in place units or on completion of a % of the work What is a materials payment clause? - ✔E️ntitles a contractor to payment for materials stored on-site; if no such clause exists in the contract, the contractor must finance the project by paying its suppliers before it receives payment from the owner. What is a final payment clause? - ✔A️ clause governing the contractor's obligation to submit a punch list (list of defects or items remaining to be done) upon substantial completion and the owner's obligation to make final payment following the architect's certificate of completion What is a bonus clause? - ✔A️ contract provision that provides an incentive payment for exemplary performance in saving either cost, time, or both. What are some common insurance coverages that are almost always required for any construction project? - ✔C️ertain insurance coverages are usually required for any construction project, including general liability, workers compensation, commercial auto, umbrella excess liability, and builders risk insurance. What is a rock clause? - ✔A️ contract provision that requires the contractor to establish a fixed price per cubic yard for excavated rock This clause eliminates the contractor's having to guess the quantity of rock to be excavated when determining the total price for the project work, and it gives the owner a more realistic price for the work to be performed What is a time for completion clause? - ✔A️ contract provision that specifies the number of days in which the construction must reach completion A contractor's failure to complete the work on time does not normally constitute a material breach of contract that would justify the owner's termination of the contract What is a material breach of contract? - ✔V️iolation of the agreement that would justify a nonbreaching party's termination of the contract What is a time is of the essence provision? - ✔A️ contract clause that specifies that time is critical for completion of the project; eliminates the argument that late completion is not a material breach Compensable delay vs. Excusable delay vs. Nonexcusable delay: - ✔C️ompensable - if the delay is the owner's fault; entitles the contractor to additional compensation and extension of time Excusable - neither party's fault Non-excusable - if the delay is the contractor's fault; contractor bears the cost and consequences of the delay Direct (actual) vs consequential damages: - ✔D️irect (actual) - Direct damages arise from the direct, natural, and immediate effect of the breach and are recoverable when proved Consequential - damages that do not flow directly or immediately from the act of the party, but only from the consequences or results of that act What are consequential damages for a contractor? - ✔t️he costs of items such as idle labor and equipment, materials, labor cost escalations, and extended job site and home office overhead associated with delay What are the consequential damages for a owner? - ✔i️ncluding the loss it suffered because of delay, such as loss of rents, loss of use, or additional interest paid on the construction loan What are liquidated damages? - ✔A️ reasonable estimation of actual damages, agreed to by contracting parties and included in the contract, to be paid in the event of a breach or for negligence. Typically, a specific dollar amount to be assessed for each day of delay Can a liquidated damages clause recover both actual damages caused by delay and liquidated damages? - ✔N️o, and a court will not enforce an unreasonable liquidated damages clause What is a maintenance clause (warranty clause)? - ✔A️ssures the owner that the contractor will correct any defective work for a period of time after a project is finished What is an indemnification clause? - ✔A️ contract provision that attempts to shift the risk and liability for one's own negligent acts to another What is a termination for convenience clause? - ✔A️ contract provision that enables an owner to end a partially completed project, provided the owner pays for the work performed plus profit and overhead May also be used to limit the amount the owner must pay the contractor if it's determined that the owner improperly terminated the contractor for default What is "wrap-up" coverage? - ✔I️nsurance coverage that insures all entities performing work on the project What is a mechanic's lien law? - ✔A️ statute that provides unpaid suppliers of labor and materials a statutory right to file liens against real estate for the value of their labor or materials What is the Miller Act? - ✔R️equires prime contractors or government construction projects to post bonds guaranteeing both performance of their contractual duties and payment of their subcontractors and material suppliers Who does the Miller Act cover? - ✔F️irst tier Claimants - subcontractors and suppliers that have direct contracts with the prime contractor What is the invitation for bids (IFB)? - ✔A️ solicitation document used to encourage contractors to bid on specific contracts. It describes the project and the quantities, specifications, delivery schedule, and other provisions of the contract including location, date, and time for opening of bids If the bidder makes an exception to or alters any part of the IFB, the bid will be considered irregular and not accepted What is a pre-solicitation notice? - ✔A️ notice sent out to all prospective bidders before the invitation for bids is issued, this notice seeks to stimulate the interest of the greatest number of contractors This notice provides a description of the project's location, estimated completion date, estimated cost range, and available documentation. An analyst's notes taken during a review of a contract status report, might include: - ✔O️bservations on individual contracts, an overall assessment of backlog, and general comments The income statement line-item that is widely recognized as the best measure of the contractor's success in the principal business activity is: - ✔I️ncome from operations A claim representative needs the principal's cooperation when gathering information to process a claim; one problem that could result from an uncooperative principal is: - ✔P️ayment of additional attorneys' fees and expenses to enforce the surety's rights How does sealed bidding on large federal projects (for public works) differ from sealed bidding on private projects? - ✔W️ith sealed bidding on large federal projects (for public works), the contract must be awarded to the lowest responsible bidder whereas in private works the contract can be awarded to whomever the owner or architect choose Solicitation occurs through the architect's office What is Dodge Data & Analytics? - ✔T️racks construction projects throughout North America by locality, captures construction project details that enable contractors to find contract jobs that are within their desired markets and locations, and offers tools for developing bids and bidding on projects The contract documents, which may be included in third-party contractors' applications or obtained from the architect, contain these elements: - ✔-️ invitation to bidders - bid/bond forms - form of agreement - general conditions - supplementary conditions - technical provisions - drawings and plans - addenda What are cuts? - ✔C️hanges in which subcontractors revise submitted bids in a subsequent bid or scope of work Possible reasons for the frequent use of cut sheets: - ✔1️. Subcontractors fear that their original prices have been disclosed to competitors. 2. Subcontractors receive late cuts from lower-tier bidders and suppliers. 3. Subcontractors reach better prices as a result of further estimating. 4. A subcontractor's desire to get the job increases. If a dispute arises between an owner and its general contractor or a general contractor and its subcontractor, how is the issue usually decided? - ✔T️he issue is usually decided by examining the contract documents What happens when general contractors use a subcontractors' or suppliers' low price in their bids and the subcontractor or supplier later refuses to honor the bid? - ✔G️eneral contractors have to accept the second-lowest subcontractor bid to get the work performed and, in such cases, general contractors may seek relief from the courts for their losses The parol evidence rule states that: - ✔P️rior or oral agreements that attempt to change or modify written contracts are not enforceable by law. A written contract is held to reflect the full agreement of the parties. Exceptions to this rule are allowed in cases of ambiguity, fraud, accident, or mistake, but these factors are difficult to prove. What type of error may legally excuse a contractor from performing a contract as bid? - ✔O️nly mechanical/clerical errors in the bid that are reported promptly may legally excuse the contractor from performing the contract as bid Errors in interpreting the drawings and specifications or in judgment ARE NOT mistakes for which relief is usually granted While gathering data, an estimator continually makes adjustments to account for various aspects of these important considerations: - ✔-️ Local conditions - Materials and equipment - Labor, overhead, and profit - Subcontractors What are overhead costs? - ✔T️he indirect costs of materials, equipment, buildings, or personnel needed to support the construction What are the 3 keys to profitable construction? - ✔1️. Careful estimating 2. Good construction practices 3. Efficient job supervision Elements of estimating: - ✔T️he first estimate occurs when the owner, with a concept in mind, wants to know if a project is economically feasible or not. In the most cases, an architect prepares a preliminary estimate, which, although it can vary 25% or more from the actual contractor's prices, can still give the owner the idea of the cost. This process may occur several more times during the preliminary and detailed design stages. Once a detailed design is produced and accompanied by a cost estimate, project changes are made to bring the cost in line with the target cost the owner has established What is the tender preparation stage? - ✔A️t this stage, the contractor completes a detailed, comprehensive pricing estimate for the entire project. The information needed to complete this estimate ranges from production labor hours to general, home-office administrative costs. --> begins after the architect and owner solicit bids, when the contractors begin their estimating processes What is the Davis-Bacon Act? - ✔R️equires that the prevailing wage rate be paid to workers on public works Why do subcontractors wait to submit their figures until the general contractor's bid deadline? - ✔T️his practice avoids further negotiation by the general contractor to reduce the subcontractor's price Estimating the cost of a construction project requires careful consideration of all the parts and processes necessary to complete the project, including? - ✔-️ local conditions - materials and equipment - labor, overhead, and profit - subcontractors They keys to profitable construction are: - ✔1️. Careful estimating 2. Good construction practices 3. Efficient job supervision Throughout a construction project, many other local conditions can affect the ultimate completion cost estimate. The areas of greatest concern on most projects are the: - ✔A️vailability of competent subcontractors, characteristics of the local labor pool, and the availability and cost of materials. Architects must comply with: - ✔ all federal, state, and local laws, regulations, ordinances, requirements, and codes, as well as with regulations and licensing requirements of the architectural profession When contract documents specifically request two or more alternative quotes (such as one with and one without some feature), the contractor: - ✔M️ust clearly furnish each of the requested quotes, or the bid might be judged nonresponsive What does it mean to be a responsible bidder? - ✔A️ contractor that has experience in the type of project being bid, pays its bills on time, has sufficient capital to finance the job, and does not owe federal or state taxes is considered to be responsible In contract bond underwriting, the contractor, underwriter, and producer should have what common objective? - ✔S️ound, timely, carefully considered underwriting decisions that serve the interests of each party What are the responsibilities of the contractor in the underwriting process? - ✔-️ Providing financial statements to the surety - Permitting additional information to the underwriter - Notifying of substantial changes - Providing a business plan - Request bonds promptly - Provide backlog data (unfinished work) - Provide project-specific information Examples of changes that the contractor should inform the underwriter and producer of include: - ✔S️ignificant changes in estimated gross profits (or losses) on contracts, major purchases or sales of fixed assets, litigation started by or against the contractor, and the departure or retirement of a key member of the organization. What are the producer's responsibilities in the underwriting process? - ✔-️ Knowing the bond markets - Advising the contractor in preparing and providing information needed by the underwriter - Keeping the underwriter informed - Reviewing underwriting decisions - Appealing decisions - Supporting decisions What is the branch-office underwriter's role in the underwriting process? - ✔-️ requesting contractor information - analyzing contractor data - making underwriting decisions - negotiating bonding needs - keeping the home-office informed - negotiating with home-office - supporting home-office decisions - keeping the contractor and producer informed Why should an underwriter be especially interested in a contractor's bill-paying history? - ✔B️ecause a payment bond guarantees the payment of certain obligations incurred in the performance of work, the underwriter should be particularly interested in the contractor's bill-paying history An underwriter can divide a principal's organizational information into what categories? - ✔-️ formation, history, and current ownership - work experience - contractor's personnel - related business entities - indemnity available to the surety - bill-paying history - contractor's equipment - business continuity plan What is the required information underwriters should know about a company's owner's? - ✔-️ Their names, ages, educational background, experience - respective amounts of ownership - extent of their involvement in the business - other business interests, if any The underwriter must evaluate the nature of completed jobs and work programs, as well as any related experience trends, to understand the principal's past growth and future potential. The principal should provide this information? - ✔-️ Type, size, and location of work - largest previous backlog - profitability The underwriter should have extensive knowledge of all key people in the contractor's organization. Resumes may provide most of the needed information, and for larger companies, an organizational chart can be helpful. Underwriters should investigate these categories of a construction company's personnel? - ✔-️ Business management team - Project management staff - Superintendents - Estimating personnel Many construction companies can be underwritten as stand-alone entities. In other instances, the underwriter must consider related businesses, which can be one or both of these: - ✔-️ Subsidiaries - Affiliates Information about related entities should include these items: - A description of the businesses of subsidiaries and affiliates - Financial information about these related companies - How the subsidiaries or affiliates might affect the construction company's operations or finances The legal consideration for the surety's executing bonds on behalf of the principal is payment of a premium and execution and delivery of an indemnity agreement. The indemnity agreement expands and adds to the surety's common-law right to be indemnified by the principal. The underwriter determines who will sign the agreement. In addition to the principal, these parties, referred to as indemnitors, typically sign it: - ✔-️ Owners and shareholders of the principal, and their spouses - Subsidiary, associated, affiliated companies of the principal - The parent company, if the principal is a subsidiary company Most well-managed, well-financed contractors pay their bills when they're due. Because a payment bond guarantees the payment of certain obligations incurred in the performance of work, the underwriter should be particularly interested in the contractor's bill-paying history. These are among the sources that enable the underwriter to determine how the contractor meets its payment obligations: - ✔-️ Reports from credit-reporting services - Schedules of accounts payable - Reference checks The underwriter should be certain that the contractor owns or has access to equipment that will enable the work to be performed efficiently. This is especially important when the contractor is engaged in equipment-intensive work such as highway or utility-line construction. The underwriter needs this information about the contractor's equipment: - ✔-️ A list of the major items of equipment that the contractor owns, leases, or rents - The age and condition of the equipment - When major items of equipment might need to be purchased or replaced and how this would affect the contractor's finances - An appraisal or estimate of the equipment's fair market value What are buy-sell agreements? - ✔A️ contract under which owners of a business agree on behalf of their estates to sell, and a purchaser agrees to buy, their interest in a business at a specified or determinable price upon the occurrence of a stated event, such as the owner's death, disability, or retirement. What is a contract status report? - ✔A️ financial statement that describes the status of job performance. What is a bank letter? - ✔A️ document that specifies the amount and terms of the available line of credit. The quality of plans and specifications can greatly influence these three tasks and can determine whether the contractor can successfully perform the work. Thousands of bond forms are used throughout the United States. Some of them, and in some instances the standard forms presented by public authorities, include one or more provisions that are objectionable to underwriters and contractors alike. These are examples of such provisions: - ✔-️ Additional Obligees: naming one or more additional obligees, such as the lenders who are financing the project, is objectionable unless the bond includes a so- called dual-obligee clause, co-obligee clause, or savings clause that establishes certain obligations of the additional obligees - Forfeiture Provisions: Bonds that require forfeiture of the penal amount on demand of the obligee are commonly referred to as forfeiture bonds; Most sureties would find these provisions objectionable and would decline to execute the bond unless they were eliminated. - Waivers of Rights or Defenses: Provisions that require the surety to waive its rights or defenses are unacceptable. - Limits on Surety options: Provisions that excessively limit the surety's options if the contractor defaults are unacceptable. - Provisions Inconsistent with Contract Requirements: Producers and underwriters should be careful when asked to recommend bond forms in connection with a specific contract. An otherwise acceptable bond form might be inappropriate because it contains provisions that are not in harmony with other provisions in the contract. - Provisions broader than statutory requirements What are two common measurements of the size of a construction project? - ✔T️wo measurements of size are the dollar amount of the bid or contract and the size of the physical undertaking. Size is often the single reason contractors decide not to bid for contracts and why underwriters decline requests for bonds. Site risks are related to factors such as: - ✔A️ccess, space, drainage, and soil type Knowing when a project is too large for a contractor is not always easy; however, an underwriter might establish certain guidelines. For example, many sureties generally will not consider: - ✔C️ontracts more than 50 percent larger than the contractor's largest previously completed contract. The cost of the labor required to complete a construction project is one of the most difficult expenses to estimate accurately. Labor cost considerations include these: - ✔-️ the estimator must estimate the amount of labor needed to perform tasks, this is usually measured in labor hours; the estimator must have knowledge of the skills/time needed to perform each task - the estimator must know the costs of labor; measured as wage rate per hour - workers productivity is subject to many variables; such as condition of equipment, the skill of workers, the weather, etc. When complexity is considered, other risk factors that become increasingly important include: - ✔-️ project management and supervision (experience and expertise) - the construction equipment needed to perform the work - the plans and specifications (quality). Other risk factors that could be affected by labor-related risks include: - ✔T️he costs of construction equipment charged to the job (productivity), the reliability of cost estimates, and estimated gross profit (or loss) on the contract. What is a rock clause? - ✔T️his mitigates the risk of encountering rock by providing that contractors encountering rock are entitled to additional payment based on a unit price, such as an amount per cubic yard In selecting subcontractors, general contractors, as well as some subcontractors who subcontract just part of their work, should consider these elements: - ✔-️ the subcontractor's qualifications - the subcontractor's ability to finance the work - working relationships - necessity of furnishing bonds - the subcontractor's price Materials, including equipment that is to be installed as part of the project, are among the easiest items to quantify and price. Even so, a risk analysis should consider these points: - ✔-️ whether the items are shelf items or specialized materials or equipment - the supplier's reputation for reliability in holding to prices quoted to contractors - the supplier's reputation for delivering materials on time - requirements that certain suppliers provide supply contract bonds to the contractor; not required but the contractor should consider them when placing orders for certain items With most projects, predicting what outcomes will be in one year provides less uncertainty than predicting what they'll be in three years. For that reason, time is an obvious risk factor in the construction business. Two elements of time should be considered in risk analysis: - ✔1️. the amount of time between awarding the contract and beginning work 2. the amount of time needed to perform the work. The time needed to perform the work might cover several years. In those instances, time-related risks include: - ✔e️ffects of inflation, price and wage escalation, and the effect of time on the risks faced by subcontractors and material suppliers What is the typical maintenance guarantee of a contract? - ✔P️rovides that the contractor is responsible for performing corrective work when a problem is related to defects in workmanship or materials and arises within 12 months after the contractor completes the contract and the owner accepts the work What are some of the broader guarantees that may appear in a contract? - ✔-️ efficiency guarantee - design guarantee - long-term maintenance periods (Terms that exceed two years are likely to be objectionable, 5-10 years for roofs are usually objectionable) What are efficiency guarantees? - ✔T️hese relate to the amount of output of a process. In general, a contractor that has performed the work according to the plans and specifications provided by the owner's design professional should not be responsible for efficiency. Those who drafted the plans and specifications are more appropriately responsible for the efficiency of the finished project. What are design guarantees? - ✔M️ost construction projects are designed by architects and engineers for contract owners. In general, contractors should not be responsible for the designs made by design professionals. However, under design-build contracts, a contractor may intentionally assume responsibility to the owner for a design made either by the contractor's employees or by design professionals who are under contract with the contractor. What is a bid spread? - ✔t️he difference between the amount of the lowest bid and the next lowest bid, or the average of the second and third bidder, for a contract; often a good indicator in determining the accuracy of a contractor's bid When the bid spread is over 10 percent, the underwriter will ask the low bidder to explain why Reasons for bid spreads include: - ✔E️rrors, better prices from subcontractors and suppliers than from competitors, different methods for performing the work, or another competitive advantage The contractor may find, for example, that a project located a great distance from its headquarters is more difficult to: - ✔E️stimate, plan, and manage than an identical project that is located closer. Labor forces, subcontractors and suppliers, weather conditions, and relationships with labor forces may differ substantially between the respective areas. What are the common reasons an underwriter may ask for estimated gross profit: - ✔-️ the size of the contract is unusually large for the contractor - the complexity of the work is beyond that normally taken by the contractor - the project is the contractor's first job to be undertaken in a new geographic area - the work is of a type that the contractor doesn't usually perform What is gross profit? - ✔T️he difference between contract revenue and contract costs ✔P️rovides reasonable assurance that the statement is free from material misstatement A newly formed contractor is applying for a construction bond from a surety. The contractor is considering whether to submit information prepared by its bookkeeping service or to hire a CPA to prepare a financial statement. Which option should the contractor select? - ✔A️lthough information prepared by bookkeeping services may be useful, bonding companies generally require annual statements prepared by a CPA. Therefore, the contractor should hire a CPA to prepare a financial statement. Why do bonding companies usually require long-form financial disclosures? - ✔T️hese disclosures assist producer and underwriter analysis and also reduce the need for contractors and CPA's to prepare supplementary information Why are long-form disclosure financial reports particularly valuable to bond producers and underwriters? - ✔T️hey have the credibility of the CPA behind them, and they conveniently display essential information to end users The basic components of a financial report include? - ✔-️ Independent auditor's report - Balance sheet - Income statement - Statement of changes in stockholder's equity (statement of retained earnings) - Statement of cash flows - Notes to financial statement What is an independent auditor's report? - ✔D️iscloses the scope of engagement by the CPA and whether the level of service provided was for an audit, review, or compilation financial report What is a balance sheet? - ✔M️easures the contractor's financial condition at a point in time by summarizing principal groups of assets and liabilities and the equity components What is an income statement? - ✔M️easures the contractor's financial results over a period of time What is the statement of changes in stockholder's equity (or statement of retained earnings)? - ✔R️econciles equity at the beginning and end of the accounting period; reasons for changes may include income statement results from operations, accrued or paid dividends, and the issue or redemption of capital stock What is the statement of cash flows? - ✔P️rovides insight into changes in the cash account in terms of changes in all other balance sheet accounts and reveals sources and uses of cash related to operating, investing in, and financing activities What is are the notes to financial statement? - ✔P️rovides the user with information, such as the nature of the contractor's business, significant accounting policies, related party transactions, and contingencies Sometimes, it may be necessary for an underwriter to seek direct verification of a contractor's financial data. What's the typical scope of this verification effort? - ✔T️he underwriter's direct verification is usually limited to confirming the accuracy of schedules provided by the contractor What is an annual statement? - ✔A️n organization's financial report as of the end of the fiscal or tax year usually audited by a CPA that provides full disclosure of an organization's financial position What is an interim financial statement? - ✔A️ 6-month or quarterly financial report within the fiscal or tax year used to closely monitor and accurately understand a contractor's financial condition, which is subject to relatively quick change What is a contractor's fiscal or tax year? - ✔I️t is either the calendar year or another 12-month period approved by the IRS for the contractor's tax reporting With few exceptions, the fiscal or tax year of proprietorships, partnerships, and S Corporations is the calendar year Why do bonding companies usually require interim financial statements and contract status reports? - ✔S️ince contractor's financial condition can change dramatically - either positively or negatively - in a relatively short time These statements may be review statements prepared by the CPA or compilation statements prepared by either the CPA or the contractor's accounting staff. Interim statements should follow the format of the annual statement. What might oddly dated statements indicate to a surety? - ✔M️ay indicate unreliable and unsophisticated accounting systems. Such statements and status reports are, with few exceptions, unacceptable to bonding companies. The underwriter's direct verification is usually limited to: - ✔C️onfirming the accuracy of schedules provided by the contractor; the schedules may include cash in banks, notes, accounts receivable, and notes and accounts payable. An underwriter's direct verifications should supplement an informed assessment of the contractor's accounting system, the statement as a whole, and the preparer's qualifications When verifying cash, receivables, and payables, the underwriter is aware that the contractor's books and the books of the contractor's bank, debtors, and creditors often show different amounts for a given date. These variations most often result from: - ✔t️iming differences Direct verifications may be most appropriate and useful for evaluating an individual indemnitor's financial statement that is unlikely to be affected by timing differences. In these instances, the principal items usually verified are: - ✔C️ash balances and notes payable to banks. Investment portfolios and other major assets and liabilities can often be sufficiently verified by reviewing records provided by the individual Underwriters seeking to confirm information through the verification process should first obtain: - ✔W️ritten authorization from the contractor or indemnitor being evaluated The primary objective of most contractors' selection of tax-reporting method is? These methods have historically been? - ✔T️o defer the payment of income taxes to the greatest extent permitted by tax laws and regulations Methods have historically been cash, simple accrual, and completed-contract methods When it comes to financial reporting, the primary consideration is: - ✔A️ccuracy - statements that most accurately measure both the company's financial condition on statement dates and the company's financial performance during the accounting period Which method generally provides the best measure of financial condition and performance and is therefore preferred for business management purposes? - ✔P️ercentage-of-completion What is the billing-cost-gross profit relationship? - ✔A️ measurement that indicates how the amount of billings, costs incurred, and recognized gross profit each relate to the estimated final amounts of the elements; used to estimate profits on uncompleted contracts.; may be balance or unbalanced What is the cost-to-cost method? - ✔A️n accounting process that determines the stage of completion, or percentage complete, of uncompleted contracts What is an unbalanced contract (or front-end loaded contract)? - ✔A️n uncompleted contract that has greater billings to date as a percentage of estimated total contract billings How imbalances are (or are not) accounted for in balance sheets and income statements is the major point of difference in the: - ✔S️imple accrual, completed-contract, and percentage-of-completion methods, and to a large extent, cash method - profit margin - gross profits recognized What information do most contract status reports typically include? - ✔T️hese reports typically provide at least basic information related to the contract price, billings, costs, gross profit on completion, and scheduled completion date. What is a contract status report? - ✔A️ financial statement that describes the status of job performance at a given point in time What are the two types of contract status reports? - ✔1️. Basic Contract Status Reports (or short-form contract status reports) 2. Comprehensive Contract Status Reports (or long-form contract status reports) All contract status reports reveal or enable the user to determine some or all of this information: - ✔-️ performance and status of uncompleted contracts as of the date of the status report. - performance of contracts completed during the accounting period covered by the status report. - Gross profit adequacy and stability. - Gross profits (losses) recognized from the inception of the contracts and in respective accounting periods. - Backlog remaining in contracts included in the status report. - Gross profit remaining in contracts included in the status report. - Approximate duration of uncompleted contracts and the backlog. How is gross profit adequacy and stability evaluated? - ✔-️ Assessing adequacy requires an understanding of the contractor's overhead structure - Stability is evaluated by comparing original estimates of gross profits with subsequent estimates What is backlog or work-on-hand? - ✔T️he balance of work to be performed on uncompleted contracts, or the estimated cost to complete the work outstanding, or the amount yet to be billed (unfinished work) Why is backlog important to contractor's and underwriters? - ✔C️ontractor's: It provides the revenue and gross profit sources that largely determine future operating results Underwriters: The backlog limits to which the contractor and surety agree generally define a contractor's bonding capacity; these limits are necessary for planning Contract status reports may show or help determine quantitative measurements, including: - ✔T️he amount of backlog, the amounts of gross profit earned from the inception and during respective fiscal periods, the profit potential remaining in backlog, and the amounts of underbilling and overbilling Contract status reports may show or help determine qualitative measurements, including: - ✔D️etermining the adequacy and stability of gross profit margins and evaluating overbillings and under-billings. One objective is to determine whether the status report disclosure is reasonably dependable and sufficient for underwriting purposes. Any contract status report should meet what criteria? - ✔1️. Reliability - user must have confidence that the preparer of the form had access to accurate revenue, cost, and gross profit data 2. Readability - a format that displays data in logical sequence facilitates analysis 3. Consistent cost classifications - classification of direct jobs must be consistent with the classification used in the contractor's annual financial statements 4. Disclosure - the form must contain sufficient data to satisfy the user's requirements The best form or format is one that most fully satisfies the user's needs and requirements Generally, the contract status report provides information about: - ✔T️he contract price, billings, costs, gross profit on completion, and scheduled completion date for each listed project contract Advantages and disadvantages of basic reports: - ✔A️dvantages: Such a report offers convenience to the preparer because they can be designed specifically for the client Disadvantages: Main disadvantage is related to the bonding company's dependence on calculations made by bonding company personnel; no provision is made for disclosing profits (losses) recognized in respective accounting periods when contract performance occurs, and profits (losses) are recognized in more than one period. What method of recognizing construction profits/losses is typically used for Comprehensive Contract Status Reports? - ✔P️ercentage-of-Completion Method Advantages and disadvantages of comprehensive reports: - ✔A️dvantages: Includes completeness and reliability, because all figures are prepared and verified by the contractor or the contractor's CPA Disadvantages: The additional time and expense required to prepare them The basic contract status report includes this information: - ✔-️ contract price - original estimated gross profit - total amount billed to date, including retainage - direct costs incurred to date - excess of billings over costs - excess of costs over billings - current estimate of direct costs to complete - estimated gross profit (loss) on completion - scheduled date of contract completion The comprehensive contract status report includes this information: - ✔-️ contract price - original estimated gross profit - current estimated total direct cost - estimated gross profit (loss) on completion - direct cost to date - percent complete - total gross profit (loss) recognized to date - gross profit (loss) recognized in previous fiscal periods - gross profit (loss) recognized in this period - total amount billed to date, including retainage - total billings in excess of total costs to date - billings in excess of costs and recognized earnings (overbilling) - costs and recognized earnings in excess of billings (underbilling) - schedule completion date The Financial Accounting Standards Board works to standardize revenue recognition across industries through its Accounting Standards Codification (ASC) to increase transparency and ease of use; ASC Topic 606 spells out? - ✔T️he acceptable methods of revenue recognition For contractors, the requirements under the ASC include: - ✔1️. More detailed footnote disclosures regarding the company's revenue- recognition procedures 2. Use of the terms "contract assets" and "contract liabilities" instead of "under- billings" and "overbillings" 3. Additional disclosures regarding how the contractor reflects contract modifications (exp: liquidated damages and change orders) To determine whether these figures are reasonably dependable, when analyzing a series of status reports, underwriters and producers consider changes in? - ✔-️ contract price - estimates of costs to complete the contract - gross profit estimates (or billing-cost-gross profit relationships) They also periodically monitor job performance The underwriter's or producer's analysis of a series of status reports usually involves changes in: - ✔1️. Contract Price - change orders or modifications often increases/decreases contract price 2. Estimates of costs to complete the contract 3. Gross profit estimates Before analyzing a financial statement, underwriters should ascertain that the statement meets these standards: - ✔1️. The contractor's accounting system is adequate 2. The CPA is well qualified to provide professional services, including preparation of the annual financial statement, to the contractor 3. The scope of engagement of the CPA includes the appropriate level of service 4. The annual statement is prepared in accordance to GAAP A thorough financial analysis covers these principal areas: - ✔-️ The effects of subsequent recognition of conditions that existed but were not evident during the accounting period or while the financial statement was being prepared - The effects of subsequent events and conditions relating to the contractor's financial affairs - The analyst's judgment regarding classification of amounts in the financial statement - The analyst's judgment regarding amounts to be allowed for underwriting purposes - Qualitative assessment of all amounts included in the financial statement - Quantitative and qualitative assessments of the financial statement in its entirety Despite application of GAAP and tests of accounting data, certain existing conditions might not be detected either during the accounting period or while the financial statement is being prepared. Examples of such conditions include? - ✔F️inancial and performance problems experienced by the contract owner, subcontractors, or suppliers and defective workmanship and materials in the work performed Failure to recognize certain existing conditions before completion of the financial statement may result in? - ✔A️n inadvertent overestimate of contract revenue or an underestimate of the cost to complete the work. The dynamic nature of the construction business, as well as the use of estimates, suggests that some subsequent changes should be expected. The analyst should consider events and conditions in these areas: - ✔-️ Financial performance of contracts: a variety of factors, such as project management, weather, and productivity of the labor force, can affect financial performance - Mix of assets and liabilities that may change the financial structure of the contracting entity - Changes in ownership or management of the contracting entity: these changes can materially affect the capital structure and overall balance sheet condition and can lead to important changes in how business is conducted - Litigation involving the contractor What is an independent auditor's/accountant's report? - ✔A️ statement that demonstrates the auditor's or accountant's scope of service (audit, review, compilation). Alternatively referred to as the cover letter or transmittal letter. What are the principal components analyzed in an independent auditor's/accountant's report? - ✔-️ Balance sheet - Statement of income - Statement of cash flows - Notes to the financial statement - Supplementary data A quantitative and qualitative analysis of the balance sheet includes these aspects: - ✔-️ Line-item analysis of balance sheet components and assessment of the balance sheet in its entirety - review of the balance sheet's equity section - determination of working capital, which is the difference in as-allowed current assets and as-charged current liabilities What is the equity section referred to as in different lines of ownership/business? - ✔-️ Corporation = stockholders' equity or shareholders' equity - Proprietorship = owner's equity - Partnership = partners' equity or partnership equity In many instances, what does a treasury stock transaction signal? - ✔A️ management change related to a stockholder's death, retirement, resignation, or termination Treasury stock is not an asset of the corporation; it is the corporation's own stock that it has purchased from a former owner of the stock How do financial statements account for treasury stock? - ✔F️inancial statements account for treasury stock by considering it a reduction in stockholders' equity. This reduction is typically offset by the reduction in cash or an increase in notes payable associated with the purchase What is the income statement key to helping underwriters for? - ✔T️o understand how bottom-line results, or net incomes, were achieved Widely recognized as the best measure of the contractor's overall financial performance What is the statement of cash flows important to underwriters for? - ✔I️t provides further insight to business activity and liquidity in terms other than working capital; it reveals the cash effect of the contractor's operating, investing, and financing activities Key disclosures describe such areas as: - ✔T️he contractor's business and organization, accounting policies, receivables, debt, leases, taxes, backlog, and contingencies; comprehensive notes always speed up the analytical process When analyzing a contractor's financial statement, underwriters review these components to better understand the contractor's financial status: - ✔-️ income statement - statement of cash flows - footnotes - supplementary data What is the accountant's report? - ✔A️ statement that demonstrates the certified public accountants (CPA's) scope of service and begins the analysis of a contractor's financial statement What are the 3 steps of analysis: - ✔1️. Quality assessment of CPA, content, and procedure 2. Balance sheet and income statement analysis 3. Overall assessment of financial statement and additional reports What are the 3 parts to an analyst's quality assessment: - ✔1️. Scope of CPA's engagement 2. Components of financial statement - basic schedules, supplemental information - particular interest in schedule 2 - contracts in progress and schedule 3 - contracts completed 3. Accounting Method The larger a contractor's backlog relative to its working capital or shareholders'/owners' equity, the? - ✔G️reater the possibility it could become overextended and default on its obligations to complete the projects to which it has committed resources What is a trend analysis? - ✔A️ trend analysis compares financial data during the 3-5 year period before the contractor's most recent financial statement What are the principal financial areas subject to trend analysis? - ✔-️ major balance sheet elements (working capital, shareholders'/owners' equity) - line-item components of balance sheets - combinations of line-item components of balance sheets - line-item components of income statements and entire income statements - financial performance of each construction contract included in the trend analysis period What are the information sources underwriters can access to perform trend analysis? - ✔-️ financial statements covering the trend analysis period - contract status reports - a financial statement spreadsheets, called a financial statement comparison form - a gross profit comparison spreadsheet, called a gross profit comparison form What is a financial statement spreadsheet? - ✔A️lso called a financial statement comparison form, which summarizes balance sheet and income statement data for the trend analysis period - other objective or subjective factors based on the analyst's experience What are the 4 types of miscellaneous contract bonds? - ✔4️ common types of miscellaneous contract bonds: - supply contract bonds - service contract bonds - demolition contract bonds - hazardous waste contract bonds What are supply contract bonds? - ✔S️upply contracts cover delivery of goods, such as raw materials, food, clothing, and fuel, and contain provisions that specify the quantity and price of items required; most a written for a specific time period, but some require continual delivery Underwriting factors of supply contract bonds: - ✔-️ this type of bond is generally not considered hazardous because most are of short duration and involve easily replicated products with many sources - must consider the quality of the items supplied; with poor worksmanship the owner could consider the principal in default - must be certain that the principal has the capacity and resources (both human and financial) to deliver quality products What supply contract is considered to be hazardous? - ✔S️upplying fuel to a public entity The hazard arises from several factors: - magnitude of the contract - if the obligee is a political entity - the volatility of the market - product supplied requires large bank financing or is traded on a commodities exchange The principal supplier can control the risk by entering into the supply contract with: - availability and pricing contingencies - store large amounts of backup fuel - locking in prices with wholesalers or producers through price escalation clauses - securing alternate suppliers What are service contract bonds? - ✔C️ontracts that cover useful labor that does not produce a tangible commodity Examples of service contracts: - ✔J️anitorial services, automotive service labor, boiler repair, food services, guard services, trash-removal, air-conditioning, elevator maintenance, and school bus service labor What is the main difference between construction and service contracts? - ✔T️he bidding process; while low bidders are normally awarded construction contracts, high bidders are usually awarded service contracts This is because service providers agree to return a percentage of revenues or a flat fee to obligees for services rendered Characteristics of food service contracts: - ✔U️sually covers the type of food and beverages wanted, they type of equipment that each party will provide to prepare and serve the food and beverages, and the price or compensation arrangements What is a renew option clause? - ✔A️ clause that federal service contracts may contain that allow either party to renew the contract; increases surety risk Example: School bus service contract for a municipality What advantage do underwriters have on food service contracts? - ✔T️he underwriter has the advantage of knowing competitor prices through bids submitted by other contractors or vendors on a specific contract Characteristics of trash-removal contracts: - ✔V️ery hazardous contract; there could be toxic materials placed in nontoxic waste containers, which could lead to the subsequent disposing of unanticipated hazardous material which could inadvertently violate various laws. - Equipment used is also heavy and expensive What underwriting factors are considered for a demolition project? - ✔U️nderwriters must consider the complexity of demolition projects, including materials being removed, subcontracting possibilities, and conditions of the demolition site If subcontracting portions of the job is necessary, the principal and surety should bond the subcontractors Characteristics of janitorial or security service contracts: - ✔T️hese services may cover a variety of locations, so contractors may have to move from one geographic location to another and may find local labor conditions vary greatly; higher costs not considered or represented in the original contract bid can therefore arise unexpectedly if a client opens a new facility that the vendor is obligated to serve. Another issue is whether quality issues or standards are clearly articulated What are the financial factors of a demolition project? - ✔T️he contractor commonly figures the cost of wrecking a building and carting off the debris. However, if materials in the building have salvage value, the contractor may allow a credit for those items are identifying a market for them Demolition contractors must carry high limits of general liability insurance, which is available in limited markets and at a high premium. Contractors that cancel this insurance before the demolition contract is completed expose the bond to: - ✔A️ suit for indemnity; Moreover, cancellation might lead to the contractor's default and necessitate the surety's completion of the bonded demolition project What does the term "hazardous waste" typically connote? - ✔S️ignificant Exposure, whether from defense costs or indemnification What is the comprehensive environmental response, compensation, and liability act (CERCLA)? - ✔E️nacted to facilitate the cleanup of abandoned or uncontrolled sites containing hazardous substances, including old dump sites What is a response action contractor (RAC)? - ✔A️ contract that performs remedial work at a hazardous waste site. The contractor is indemnified for the release of hazardous substances that result from its response action activities Liabilities of response action contractor's (RAC)? - ✔M️ay have liability under state law, they are not liable under CERCLA for damages resulting from release of hazardous substances unless the release results from gross negligence or the RAC's misconduct What is the surety's exposure for response action contractor's (RAC)? - ✔T️he surety for a RAC is not responsible for damages arising from hazardous materials released by the RAC. However, this provision does not supersede state laws. How can a surety best limit their liability when bonding RAC's? - ✔B️y ensuring the bond does not require it to finance the principal or engage a completing contractor because this would make the surety be viewed as "operator of a hazardous waste facility" which could have legal implications. Ideally, the bond should allow the surety to indemnify the owner for completion costs If a loss has been sustained under a surety bond, the indemnitor may wish to satisfy its obligation by conveying title to real estate to the surety. However, the surety should not agree to this until? - ✔I️t is certain that no hazardous materials are present; this typically requires an environmental survey of the property What risks are involved with hazardous waste bonds? - ✔-️ These bonds have significant risk exposures from defense costs/indemnification, and the contract bond surety may be exposed to large-dollar/long-term exposures. - With an RAC, the principal can be sued for the release of hazardous waste arising from the performance of a cleanup contract. The surety may have to finance protracted legal or administrative proceedings to secure reimbursement. - When a surety elects to finance its principal to complete a bonded project, the surety may be viewed as the operator of a hazardous waste facility that disposes of or treats hazardous waste. What makes design/build contracts a high-risk undertaking with significant loss potential? - - legal and consulting fees for arbitration and litigation Why might sureties have a harder time confirming a Design/Build contract is in line with industry norms? - ✔D️esign/build projects lack competitive bids, meaning the contractor's price can't be measured against other bids What are construction management projects? - ✔A️ building method in which a construction company serves as the owner's agent in a major building project; the CM may or may not contract with each subcontractor for required work (typically contracts are signed between owner and subcontractors, not the CM) How does the CM role differ from the traditional role of a GC? - ✔T️he CM has the same duty of supervision on a construction management project as the GC does on a conventional project. However, the CM typically has no tradespeople or laborers working on the project. What is a GMP (Guaranteed Maximum Price) contract? - ✔T️he CM guarantees that the price of the project will not exceed an agreed-upon agreement, this also guarantees a fee to the CM for supervising and coordinating the project as the owner's agent, and the full fee is always paid on an agreed-upon schedule How does the GMP provide a financial advantage for both parties? - ✔T️he GMP has a savings clause providing that if the CM can complete the work at a cost less than the GMP, the CM and the owner will share the savings on a percentage basis, as agreed to in the contract. Why is a GMP particularly attractive to an owner? - ✔B️ecause the maximum amount of the contract is known What must a surety underwriter consider when bonding construction management contracts? - ✔T️hey must consider all the construction management contracts that a large contractor is completing; of particular concern is whether the contractor is actually performing as GC under a contract titled "construction management" What are the underwriting factors of efficiency guarantees: - ✔H️azardous; if a contract contains no escape clauses for impossible performance after reasonable and calculated attempts, a contract could exhaust all its assets and expose the surety's assets up to the penal sum of the bond for failure to meet the efficiency or performance criteria Similar to design/build contracts because the owner expects the contractor to bear the burden of developing the desired end product - more hazardous because the contractor usually has little say in what the efficiency guidelines will be What is the claims issue of efficiency guarantees? - ✔T️he measurement of damages can be different even if both parties agree on the testing methodology What is a forfeiture bond? - ✔I️f the principal fails to perform, the surety pays the bond penalty to the obligee What is an indemnity bond? - ✔T️he surety reimburses the obligee for any loss in achieving the performance or efficiency requirements What is a specific performance bond? - ✔T️his bond means the surety guarantees performance at all costs; the specific performance bond is open ended and extremely hazardous What is a completion bond? - ✔U️nder a completion bond, the surety guarantees the completion of the contract, regardless of whether the obligee has fulfilled its contractual obligations to the principal - involves greater risk What are the three types of completion bonds? - ✔-️ lenders bonds - subdivision bonds - timber contract bonds Difference between conventional contract bonds and completion bonds: - ✔U️nder a completion bond, the surety guarantees completion of the contract but unlike conventional performance bonds, the surety does not have the benefit of a contract balance to offset the cost to complete the work Underwriting factors of a completion bond: - ✔-️ Surety underwriters are generally reluctant to write completion bonds, when they do consider them, they expect principals to have material equity in the completed project. - The principal/owner should also have substantial worth beyond the property being bonded. - If the land on which the project is to be built is leased, the surety's risk is much greater than if it's owned - underwriter should establish that the lender if financially strong or that a bank or trustee holds construction funds in escrow What is the safest estimate type for a completion bond submission? - ✔T️he safest estimate type if the fixed bid of a reputable contractor, a party such as an engineer, architect, or a construction consultant can also provide a reliable cost estimate, in addition funds must be available for contingencies What is a lenders bond (mortgagors completion bond)? - ✔A️ bond that guarantees completion of the project if the principal fails to perform, in accordance with the plans and specifications, in the given time limit and free of liens Terms and conditions of completion bonds: - ✔-️ obligation should be limited to construction completion only and should not include obligations to pay interest or repay loans - the underwriter should clarify who is responsible for completion delays, liquidated damages, and maintenance guarantees - there is no standard completion bond form - savings clauses can be obtained to require the dual obligees to assume all contractual obligations of the original obligee, including the obligation to pay the contractor; this limits the surety's liability to the bond penalty, whether paid to either or both of obligees. Why are completion bonds with dual obligees more hazardous? - ✔B️ecause each obligee has different legal and practical interests; the market for dual obligee completion bonds is limited because of their legal complexities. Sureties can, however, protect themselves through a savings clause, which requires the dual obligees to assume all contractual obligations of the original obligee, including the obligation to pay the contractor. The surety's liability is limited to the bond penalty. Because the completion concept is broad in scope, the obligation should be limited to: - ✔C️onstruction completion only and should not include obligations to pay interest or repay loans. What are subdivision bonds? - ✔A️ contract bond guaranteeing a local governmental authority that a subdivision developer will complete the subdivision in accordance with approved proposals and at the developer's expense What are some of the factors that make subdivision bonds more hazardous than many other specialty bonds? - ✔T️he speculative nature of real estate development, economic downturns, volatile interest rates, land-carrying costs, and the long time it takes to complete a subdivision. (Subdivision work that takes two to three years to complete is generally considered hazardous.) What measures can a surety take to protect itself when underwriting subdivision bonds? - ✔-️ surety can require 1-year billings until the project is completed and can further mitigate exposure by reducing the bond penalty as work is completed - require collateral - have funds for the improvement costs escrowed with a bank How is the amount of a subdivision bond set? - ✔A️n engineer for the city or county usually sets the amount of the subdivision bond based on the engineer's estimated cost of the work plus a small contingency. The estimated cost may vary depending on the experiences the engineer has had with developers in the past. Bad experiences may lead to a higher contingency. and general conditions; costs that change when the quantity of output changes. (more difficult to calculate and have the greatest potential to escalate) What are fixed costs? - ✔I️nclude the cost of work that subcontractors and suppliers will complete under fixed price subcontracts and purchase orders; costs that do not change when the quantity of output changes during a particular time period. What are general and administrative expenses? - ✔I️nclude such items as officers' and staff salaries, rent or mortgage payments on buildings, equipment payments, power, insurance, advertising, and taxes; any costs associated with operating an organization's office. The two perspectives claim representatives should use when analyzing general and administration expenses: - ✔1️. He or she must determine accrued, but unpaid, general and administrative expenses. That is, what general debts does the principal have to third parties that are not associated with performing the bonded projects 2. The representative must determine the monthly expenses necessary to operate the principal's home office—information used to determine the cost to maintain the principal's home office for the period of time necessary to complete all of its bonded contracts in process. The surety claims representative also reviews the staff in the principal's organization, including senior officers, by asking questions such as these: - ✔-️ How long have staff members been with the principal, and what are their qualifications? - How are the principal's senior officers compensated, and what performance records do they have? - Are the senior officers helpful in resolving problems, or do they cause and/or aggravate the problems? The claims representative's review of the balance sheet is not conducted in accordance with GAAP, instead, the representative aims to: - ✔L️earn what a willing and able buyer would pay for the principal's assets and what the principal's creditors would accept in satisfaction of the principal's liabilities in the near term, or less than one year - that is the assets and liabilities fair market value To properly handle a claim against a performance bond, the surety's claims representative must understand: - ✔T️he characteristics of a performance bond; know who is covered under the bond; review the bond itself, the underlying contract, and any applicable statutes; and determine the surety's liability and any available defenses. What are defeasance bonds? - ✔B️ond's whose obligation becomes null and void if the principal promptly and faithfully performs the contract. Example: Miller's Act Performance Bond Most performance bonds require four events to occur before the surety has any obligation to act under its performance bond: - ✔-️ The principal must be in default (an uncured material breach of performance) under the contract. - The obligee must declare the principal to be in default under the contract. - The obligee must have performed its obligations under the contract. - The obligee must terminate the principal's right to proceed under the contract. If the obligee has performed its contractual obligations to the principal and the surety has not been otherwise discharged of its liability to the obligee, the obligee may have a valid performance bond claim against the surety. If so, the surety may be liable under its performance bond for one or more of these costs: - ✔-️ the excess cost to complete, up to the penal sum of the performance bond - damages incurred by a lender covered by a dual obligee rider to the performance bond - delay damages incurred by the obligee - damages incurred by the obligee as a result of warranty items or latent defects - taxes that are collected, deducted, or withheld from wages paid by the principal Obligees may claim other potential consequential damages against the surety, which the surety frequently disputes. Such consequential damages include: - ✔-️ interest on the cost of completion - additional architectural and engineering gees arising from the principal's default - lost profits - the obligee's attorneys' fees - extracontractual damages under various circumstances and theories, resulting in a claim for damages exceeding the performance bond's penal sum The surety may have certain defenses to the obligee's claims under the performance bond. The most obvious defense is: - ✔T️hat the principal has not materially breached the contract, but the obligee has; therefore, the obligee's termination of the principal's right to proceed under the contract is wrongful. The surety's defenses to an obligee's claims include: - ✔-️ the obligee's premature release of retainage or other securities - the obligee's payments under the contract in excess of the amounts certified and approved - material alterations or cardinal changes in the scope of a contract - the release of the principal from liability - the obligee's fradulent solicitation of the performance bond - preemption of the surety's right to perform under the bond If an obligee makes a valid claim against a performance bond, the surety must consider the advantages and disadvantages of all available claim settlement options. The performance bond might, in fact, limit the surety to one or more options—or it might be silent about them. Generally, however, the surety has four options in this circumstance: - ✔1️. Finance the principal 2. Take over the work 3. Tender a new contractor 4. Transfer the onus of completion to obligee Why do you think a surety might opt to finance the principal? - ✔B️y financing the principal, the surety can remedy a potential or existing default and avoid terminating the principal's right to proceed under the construction contract. Advantages and disadvantages of financing: - ✔A️dvantages: - if the surety finances the principal, subcontractors cannot renegotiate their subcontracts - when a new contractor estimates the cost to complete the work it adds markup for profit and overhead - the principal's work forces are familiar with the construction means and methods used on site, while a new contractor requires a period of adjustment to become productive - get to avoid demobilization and mobilization costs Disadvantages: - payment of claims not covered by bonds - no credit against the performance bond penalty - fixing the costs - taxes - principal and indemnitors might allege that the surety dominated the principal's business affairs resulting in the principal going out of business - principal and indemnitor's insolvency Before deciding to finance its principal, a surety considers: - ✔-️ The honesty, integrity, and character of the principal - Factors behind the principal's inability to perform or failure to pay bills, including disputes on other bonded or unbonded jobs that have reduced cash flow and numerous unresolved change orders and extras - Capacity of the construction organization to perform the contract, including the quality of its management and its technical competence (quality of the work performed) - The principal's or indemnitors' additional assets, or lack of them, to pledge to the surety to secure any loss Characteristics of the Takeover method: - ✔-️ surety steps into the principal's shoes and becomes the contractor of record, then subcontracts the remaining work to a qualified completion contractor - least preferred option for the surety and most preferred option for the obligee; least preferred because it waves the surety's penal sum of its performance bond meaning it is exposed without limitation to complete the project - obligee makes progress payments Advantages and disadvantages of Takeover: - ✔A️dvantages: - obligee may forgive or concede all or some portion of delay or liquidated damages ✔P️ayment bonds are executed jointly and severally by the principal and the surety in favor of the obligee. The obligee can be the property owner, the prime contractor, or a subcontractor. The principal can be a prime contractor or a subcontractor. *When the payment bond obligee is the property owner, it generally has no right to make a claim under the payment bond. Even in situations in which the obligee has no rights under the bond, the obligee still benefits from the payment bond. What do payment bonds cover/not cover: - ✔C️overed: - labor (wages): - materials: materials must be incorporated in the work, used in the work, or consumed in performing the work to be covered under a payment bond Not covered: - loans - insurance premiums - equipment (although the fair rental value of equipment leased under a standard lease agreement is generally covered by the Miller Act) - attorney's fees and taxes (attorneys' fees are recoverable when the agreement between the principal and the claimant specifically provides for the recovery of those fees) Claimants having a direct contractual relationship with a subcontractor but not with the prime contractor must give the prime contractor written notice of the amount claimed within: - ✔9️0 days from the date on which the claimant supplied the last of the labor or materials for which the claim is made. This notice provision allows the prime contractor to protect itself from the accumulation of large claims arising out of its subcontracts. A surety's defenses to payment bond claims include: - ✔-️ the payment bond's penal sum - notice of provisions - statutes of limitation - the claimant's acceptance of a lesser payment - principal's nonliability What is an interpleader? - ✔A️ lawsuit filed by the surety that claims that the total amount of the claims against the payment bond exceeds the penal sum of the payment bond When may bid bonds be neccessary? - ✔W️hen an obligee cannot review each bidder's qualifications, they may also be required to ensure that a principal's bid is both responsive and responsible To skillfully handle bid bond claims, a surety claims professional must first understand the need for bid bonds and then consider these aspects of associated claims: - ✔-️ penal sum - bid bond obligations - types of bid bonds - reasons for bid bond claims - surety's defenses - indemnity agreement claims Bid bonds are required for at least two reasons: - ✔1️. The obligee typically does not have the technical staff, expertise, or time necessary to review each bidder's qualifications; by requiring a bid bond, the obligee transfers the prequalification process to a third party, the surety. 2. Most statutes and bid specifications require the principal's bid to be both responsive and responsible What does it mean to be responsive? - ✔T️o be responsive, the bid must take form required by the obligee's bid specifications and invitation to bidders What does it mean to be responsible? - ✔T️o be responsible, the bid must be supported by the security - such as the bid bond, certified check, or letter of credit - set forth in the obligee's invitation to bidders and bid specifications Principal's review, refine, and adjust the amount of their bids right up until the final deadline for submitting them, for this reason, the penal sum of the bid bond is generally stated as a? - ✔P️ercentage of the principal's bid rather than as a fixed amount What do obligee's typically require a bid bond's penal sum to be: - ✔5️% to 10% of the bid The obligation under a bid bond depends on the specific bond language, the language in the bid specifications and the invitation to bidders, and any statutes that apply to the competitive bidding process. As a general rule, the obligation in a bid bond is threefold: - ✔-️ If the obligee accepts the principal's bid, the principal must execute appropriate formal contract documents. - The principal must furnish performance and payment bonds with an acceptable surety in the form and in the amount provided for in the bid specifications. - If the principal fails to formally execute the contract required by the obligee or to provide the bonds specified by the obligee, the principal and surety may be liable for damages under the bid bond. What documents will stipulate the time by which the principal must meet all of the bid bond's conditions? - ✔T️he bid specifications, the invitation to bidders, or the applicable statue; if the principal fails to meet those conditions within the time limit the obligee may declare a default and make a demand upon the principal and surety under the bid bond What are the two types of bid bonds? - ✔I️ndemnification bid bonds and forfeiture bonds What is an indemnification bid bond? (preferred instrument) - ✔A️ bond that guarantees that the principal and the surety, jointly and severally, agree to indemnify or pay the obligee damages; the amount of damages is the difference between the amount of the principal's bid and larger amounts for which the obligee contracts in good faith with another bidder to perform the work covered by the principal's bid What is a forfeiture bid bond? - ✔A️ bid bond that requires the principal and the surety, jointly, and severally, to pay to the obligee the total amount of the bid bond irrespective of the obligee's damages Why might a court not enforce a forfeiture bid bond? - ✔S️ome courts do not enforce forfeiture bid bonds because the amounts exceeding the obligee's damages represent a penalty. The surety claims representative must carefully review the law under which a bid bond will be interpreted to determine a court's view on enforcement of forfeiture bid bond contracts. What are the reasons for bid bond claims? - ✔-️ the surety may refuse to provide final performance and payment bonds on the principal's behalf after executing a bid bond, resulting in a claim against the bond - may arise as a result of the principal making unilateral bid mistakes including clerical and mathematical errors and errors in judgement What are the two remedies available for unilateral mistakes in a contract: - ✔R️eformation and Rescission What is reformation? - ✔R️are in cases of unliteral mistake, it permits the principal to change its bid to correct the mistake What is rescission? - ✔V️oids the principal's bid, resulting in no claim under the bid bond In those jurisdictions that allow for rescission in cases of unilateral bid mistakes, these requirements must usually be met: - ✔-️ The mistake must be promptly communicated to the obligee. - A mistake in fact must have occurred that can be easily proven by clear and convincing evidence. - The mistake must be clerical or mathematical, rather than a result of the principal's judgment. - The mistake must be one that the obligee knew or should have known existed. - The mistake must be sufficiently material that enforcement would be unconscionable or would unjustly enrich the obligee. - The mistake must not arise from the principal's gross negligence. - The obligee must not suffer any serious prejudice other than the loss of the mistaken bid. What document is the surety claims representative most effective tool for minimizing the surety's loss and maximizing its salvage in the event of a claim? - - The financing surety is frequently required to satisfy the principal's debts that are not covered by either the performance or the payment bond. Specifically, the surety must calculate the total overhead that it must pay to effect completion of the work by the principal. This is a time-sensitive calculation; for example, if the surety calculates 10 months of overhead necessary to complete the work, but the project is not completed for 14 months, the case loss reserve is inadequate. - The contract balance must be collected from the obligee as the work progresses. The obligee may set off its damages against the contract balance, thereby reducing the payments made for the completion of the work. The obligee's failure to pay, if not anticipated by the surety, can result in net case loss reserve inadequacy. Two general case loss reserve issues are associated with completion of the work by third parties: - ✔1️. the contractual arrangement for payment of the completion contractor affects the accuracy of the case loss reserve. If the completion contractor is being paid on a unit-price basis or a time-and-material basis, the total cost to complete is only an estimate rather than a fixed lump-sum price. As such, the actual total cost to complete can vary considerably from the estimate, resulting in case loss reserve inadequacy or redundancy. 2. third parties rarely give a fixed price to correct the principal's defective work. Most completion contractors perform remedial work on a time-and-material basis. The surety must estimate the total value of remedial work. Its estimate may be inaccurate, resulting in case loss reserve redundancy or inadequacy. What are expense reserves? - ✔T️he total expenses that a surety expects to incur for satisfying its performance, payment, and bid bond obligations Case expense reserves established by the surety claims representative include these costs: - ✔-️ attorney fees and expenses - consultant fees and expenses - accountants fees and expenses - all expenses associated with identifying and preserving assets of the principal and the indemnitors To make a sound decision with contract surety claims, claims representatives will find that which one of the following is the focal point of his inquiries? - ✔D️etermining the cash position of the principal's work-in-progress Which party executes a performance bond? - ✔S️urety What is a defense for a surety to the obligee's claim under a bid bond? - ✔T️he principal discovered a mathematical error in the bid it has provided to the obligee Qualitative analysis of stockholders equity: - ✔H️igher retained earnings compared to invested capital = shows company has been profitable Invested capital is higher than retained earnings = only marginal or even unacceptable profits