How Contractors Can Work With Their Surety to Avoid Financial Ruin

March 9, 2021

Contractor filling out paperwork

Image credit: King+Climbers/shutterstock.com

There can be a myriad of problems when a Contractor cannot fulfill its contractual obligation in connection with a construction project. This puts the Owner in a position to suffer a financial loss. In addition, the Contractor’s subcontractors and material suppliers may not receive payment from the Contractor for labor performed or materials supplied.

These problems can lead to long and drawn-out disputes such as costly litigation or in the alternative, mediation, or binding arbitration. At the onset of any project-related problem, it behooves the Contractor to become immediately proactive in attempting to resolve these issues.

In a situation where the Contractor is undertaking a bonded contract, it is even more imperative for the Contractor to become proactive. Under the typical construction contract, the Contractor’s primary obligation is to the Project Owner.

However, on a bonded contract, the Contractor (Principal) owes an obligation to the project owner (Obligee) as well as, the Contractor’s Surety (Surety).  

The Contractor’s Surety typically issues a Performance Bond which guarantees that its Principal will fulfill its contractual obligation to the Obligee. Furthermore, should the Principal fail to fulfill its contract with the Obligee, the Surety will “step into the shoes” of its Principal and complete the Principal’s remaining obligations under the bonded contract, thus protecting the Obligee from financial exposure caused by the Principal’s failure(s).

In addition to a Performance Bond, the Surety also issues a Payment Bond. The Payment Bond is meant to protect the Principal’s subcontractors and material suppliers in the event the Principal fails to make payment for labor performed or materials supplied on the bonded contract.

COMMUNICATION

All too often, when Contractors are having difficulty with a project, they tend to limit or altogether stop communicating with their Surety. This is the worst course of action a Principal can take.

It is always better for the Principal to be upfront with the Surety. When the Surety requests their Principal provide documentation during the claim process, it is best for the Principal to cooperate as much as possible.

FINANCIAL ISSUES

One problem could be purely financial caused by cash flow issues. In this case, a Surety may provide funds to complete the project.

LACK OF PROJECT MANAGEMENT

Another problem could be the lack of project management. The Surety may provide a Construction Manager, registered Architect, or a licensed Professional Engineer to manage the completion of the project.

The Principal must be mindful, any costs the Surety incurs either by providing funds, project management or both are the ultimate responsibility of the Principal and its Indemnitors. Seeking the Surety’s assistance will typically keep the losses to a minimum rather than hiding project problems which are likely to lead to a financial disaster.

CONSTRUCTION ATTORNEYS

Having a good construction attorney that is knowledgeable with suretyship can provide valuable legal advice. Invariably, legal disputes do occur and an attorney with an understanding of surety may assist in resolving them.

More importantly, a good attorney can help you assess the risks you are considering undertaking in connection with a project. The attorney can also advise you of your rights and obligations under a contract. Furthermore, they can negotiate on your behalf and guide you through any disputes that might arise.

Avoiding or mitigating a default comes down to maintaining an open channel of communications with the Obligee and the Surety. In addition, properly managing the project, cash flow as well as, understanding your contractual obligations is good practice. Any default on a project should be avoided at all costs. The Surety can help you understand the consequences of a default, but it is imperative for you to be proactive. Staying informed and keeping in touch with your Surety can go a long way in avoiding a financial disaster.

If you have any additional questions regarding Surety Bonding, contact TSIB today.

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Topics: Surety Bonding, Contracts

Written by The TSIB Team