Knowledge Corner

In the construction industry, there are times when Contractor default occurs. Unfortunately, defaults are not always foreseeable or manageable. Here are several factors a Surety will review in order to make the decision on whether to retain a defaulted Contractor.

Financial Solvency

Unquestionably, the financial solvency of the Contractor is the primary concern of the Surety. It is important to note, although the defaulted Contractor is principally liable to the Surety for any loss it causes the Surety to incur, a Surety will typically require their Contractor to execute an indemnity agreement.

A Surety will require corporate indemnity from the Contractor as well as, personal indemnity. Personal indemnity may include:

• company officers in their personal capacity
• spousal indemnity
• company investors (if any)

In this case, a Surety will first analyze whether their corporate and/or personal indemnitors are financially solvent. If so, the Surety may consider having the defaulted Contractor perform the project completion.

The Surety will also examine the status of the of the project. Is the project twenty, fifty or ninety percent complete? The more complete the project, the less financial risk to the Surety. The analysis will also include determining whether there are remaining contract funds which the Surety is entitled to use to complete the project. Therefore, if the project is nearly complete and there are sufficient contract funds and/or solvent indemnitors, a Surety will likely make the decision to retain the defaulted Contractor. This may be because the Surety will need to expend less money to help reduce any loss the Surety will incur.

The analysis will also consider that the defaulted Contractor has the most knowledge with respect to the details of the project. A new Contractor will have a greater learning curve which will increase the cost to complete the project thereby causing a greater loss to the Surety.   

Collateral

Another factor which may influence the Surety is collateral. It is usual for a Surety to require collateral be posted with it by the Contractor and/or its indemnitors prior to the issuance of any bond. Collateral can be in the form of cash or an Irrevocable Letter of Credit (ILOC) issued by a bank. Under the indemnity agreement, the Surety is entitled to the use of the collateral to lessen or even avert any loss caused the defaulted Contractor. Should the Surety determine the collateral is sufficient to cover the loss, the Surety may consider retaining its defaulted Contractor to complete the project.        

These are some of the factors a Surety will most likely consider when deciding whether to retain a defaulted Contractor. Any analysis a Surety undertakes is primarily financial. The Surety looks to find every avenue of financial recovery to minimize their loss whether through remaining contract funds, collateral, or indemnity.      

If you have any additional questions on the factors Sureties review reach out to TSIB today and speak with one of our team members!

TSIB’s Risk Consultants are currently servicing the following locations:

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