Knowledge Corner

When beginning work on a project, it’s often required that the contractors have surety bonds in place. However, not only can a surety bond protect a contractor, but it can also protect the project owner when there are issues interfering with the completion of a project.

Unfortunately, in the construction industry a contractor could default on their contract. Therefore, it is important to understand why defaults occur and what happens when they do. 

Default Causes

Contractor default can happen for any number of reasons, but those reasons are not always foreseeable or manageable. Many contractor defaults are caused by: 

• Financial problems
  • When a contractor is faced with financial constraints, a default could happen. Problems with cash flow, overwhelming debt, bad accounting services, or poor job costing can be issues. Since there is no money to finish the project, this causes the contractor to halt construction.
• Overextension
  • Contractors that overextend usually have an unrealistic understanding of what the project entails in terms of the cost or time involved and their firm’s capabilities of being able to handle the same. When a contractor takes on too much work and has too many projects going concurrently, this ultimately forces one or more of the projects to suffer, resulting in default.
• Contractor Performance
  • If the contractor is behind schedule, over budget, or does not have the management or trade skills required to finish the job, then it will likely lead to a default on the project. This causes major strains on relationships with subcontractors, suppliers, vendors, and customers.

Steps after a Default

When a default does occur, a claim is often made against the contractor with the individual surety(s). The bond protects the Obligee (Project Owner) from default in a financial sense. The surety company has various options it can execute to correct the issue for the customer. 

• Deny The Claim
  • Deny any obligation based on known facts.
• Finance the Existing Contractor
  • Work with and assist the Principal on the defaulted project allowing them to complete the job.
• Pay the Obligee (Project Owner) 
  • Pay the Obligee the penalty amount of the bond.
• Obligee Completion
  • The surety agency can suggest to the Obligee (Project Owner) to find a new contractor on their own. The surety would pay compensation for damages and losses to the project owner up to the amount of the bond and recoup the cost from the original contractor. This is used when the owner’s plan for project completion is reasonable and does not expose any other risks.
• Tender
  • The surety agency will find a new contractor to finish the project. However, the company itself will not oversee the completion and the Obligee (Project Owner) will receive compensation if damages or losses have occurred. The new contractor is approved by the surety and the project owners to ensure stability. 

Defaulting affects your reputation and your bottom line. It’s important to make sure your finances are in order. Working with a Surety Broker can help your company get to the next level and allow your company to take on more work. If you have more questions or want a free Surety Review, reach out to TSIB today!

TSIB’s Risk Consultants are currently servicing the following locations:
East Coast: New York City, NY; Bergen County, NJ; Fairfield County, CT; Philadelphia, PA
Texas: Austin, San Antonio, Houston, Dallas
California: Orange County, Los Angeles County, Riverside County, San Bernardino County, San Diego County

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