Common Types of Construction Bond Claims and How Contractors Can Avoid Them
Today’s blog is written by guest author, Todd Bryant who is the president and founder of Bryant Surety Bonds, and he helps contractors get bonded and start their business.
There are various reasons for construction bond claims to arise. Many of these are due to contractors not being careful enough with their finances, the management of their projects or something else. Other claims are due to reasons beyond a contractor’s control – such as major-scale natural or economic events that disrupt or destroy the progress on a certain project.
Yet, of the above, a predominant amount of construction bond claims are due to contractor inattention. Luckily, there are also many ways to keep problems at bay and avoid claims. With that said, here are some of the most frequent types of construction bond claims and various ways that contractors can avoid these.
How Do Construction Bond Claims Occur?
Surety bond claims occur whenever the bond principal, in this case a contractor, does not comply with the conditions set out in the surety bond agreement.
Construction surety bonds are put in place to protect project owners and subcontractors, the bond obligees, from various types of contractor default. As soon as a contractor does not comply with the contract made with the project owner or with the subcontractors, these parties (under a number of conditions, of course) can file a claim against the respective surety bond and ask the surety to step in and resolve the issues.
If and when a contractor is found to be in breach of their agreement the surety has the obligation, under the surety bond agreement, to step in and mitigate the situation. The surety does so either by taking over the project, in cases of performance bond claims, or compensate subcontractors, in cases of payment bond claims.
But what are the most common reasons for construction bond claims that sureties have to deal with?
The Top Reasons for Contractor Default
All construction bond claims are due to some kind of default on the side of a contractor. The reasons for contractor default can broadly be summed up as follows:
- Contractor overexpansion or overextension
- Poor leadership and management of projects and employees
- Financial and accounting issues
- Performance issues
Contractor overexpansion has to do with the tendency of some contractors to take on too much, too fast. Overexpansion or overextension is related to the inability of a contractor and their staff to keep track of projects commitments. Spreading your resources and personnel too thin means that all your projects will suffer to one degree or another.
And if you ask your workers to work faster so that you may tick off some of your commitments, there’s a very real possibility that there will be faults in their work. So, instead of obsessing about volume or trying to forcefully grow the business in a very short amount of time, contractors should try to remain realistic and keep a steady pace.
There are few occasions when contractors can pull off a rapid expansion in a perfect manner and while risk is inherent to the construction business, it is very important to remain realistic about what is and what is not possible!
Poor Leadership and Management:
The ability to prioritize, make firm decisions and keep an overview of the whole business is part of the role of leaders and managers. Hence, the inability of leaders and managers to be realistic and level headed, rather than overly optimistic, can create significant difficulties.
This includes issues such as: inadequate supervision of projects and lack of close management, lack of good training of staff on operations and company policy, lack of a good business plan and contingency plan and no clear organizational goals or objectives. In other words, though these issues are mostly internal to the organization, they have direct effects on its external performance.
In a recent case, contractor CH2M was defaulted by the Central Texas Regional Mobility Authority on the project to expand the North MoPac Boulevard in Austin, TX. The contractor was defaulted by the project owner for being 3 months late with its completion, due to what the owner perceives as inability to properly manage both human and financial resources. As a result, the project owner is expected to file a claim against the bond, unless the contractor “cures” the default by devoting more time and resources to the project.
To avoid these pitfalls and the bond claims that arise out of them, leadership and management have to make sure to provide high quality training to staff and keep the organizational strategy and long-term goals in mind. Developing proper business acumen, if lacking, is another important aspect to strengthening leadership and keeping the company going.
Financial and Accounting Issues:
Financial problems are probably on the top of the list when it comes to reasons for construction bond claims. These issues can cause both performance bond claims as well as payment bond claims.
Such claims may arise, for example, when a contractor goes bankrupt and is therefore unable to continue working on a project, and purchase new equipment or materials. The reasons behind bankruptcy are usually a complex combination of poor accounting and cost estimates, bad project management systems, lack of proper insurance, tight cash flow and a decrease in revenues and margins.
It is therefore vitally important that contractors work with a professional construction CPA. Not only does a construction CPA know what is required to keep a construction business financially stable but having a construction CPA is also very important when you apply to obtain your surety bond.
Across the board, sureties are more willing to write bonds to those contractors who have a professional taking care of their finances than to those who try to do it themselves or have a non-construction CPA at work.
All of the above reasons for claims lead to performance issues in the end. From cash flow problems to overextending, being behind schedule and ultimately abandoning a job, all of this leads to poor performance and a claim on one’s bond.
Further reasons that can cause performance-related claims are lack of experience in a certain field or type of construction, lack of skilled personnel and working with unreliable subcontractors.
Keeping all of the above in check is the key to performing well and avoiding a claim on one’s performance bond.
Work With Your Surety to Avoid Claims:
Many, if not all, of the above issues can be avoided if you work with a good surety. Your choice of surety can often mean the difference between a claim and the avoidance of a claim.
Furthermore, even if you pick a great surety, you may still fail to make good use of them, if you do not keep in touch whenever you experience difficulties and only call them once a claim has been filed against your bond. Communicating often, openly and transparently to your surety is one of the best ways you can avoid potential claims.
Are there any other reasons for construction bond claims to occur which aren’t listed here? And what is your experience with avoiding or managing claims? Leave us a comment, we value your input and would like to hear from you!