Tag Archives | Surety Bond

Maintaining the Surety Bonding Relationship

By on January 28, 2013 in Construction

BondworthyBecause the surety relationship is so critically important to the growth and development of your construction company, maintain a close relationship with your bonding company whether you seek to establish, grow or maintain your bonding capacity.

Get to know the surety company

What ratios and figures does it consider most important? What kinds of companies does it underwrite? Some mainly serve large contractors, while others specialize in new or smaller firms. You will establish a stronger relationship with a bonding company that tends to serve your type of company.

And get to know the surety’s home office as well. A local underwriter may understand your underbilling strategy, but if the home office only sees figures on paper, and not the capable, trustworthy company that stands behind the figures, it may discount your worth.

Be a communicator

Schedule regular meetings — right after your yearly financial report is a good time — and keep up a flow of clear, well-presented financial information and job status reports.

Surety companies know that problems arise in construction projects; what they want is accurate and detailed information. So don’t surprise a surety with bad news late in the game. If you see trouble brewing, bring your surety into the loop immediately.

Also, notify your bonding company of changes in your company, such as shifts in ownership or top management and forays into new markets or specialties.

Communication is a two-way process. While you’re telling an underwriter about your business, listen closely.

Surety companies want contractors to succeed on projects, and if a surety believes your firm might not succeed, understand why and address those issues in your business. The surety has real-world experience, and its reluctance to write a bond indicates real problems.

Ensure utmost integrity

A surety wants complete confidence in a contractor’s integrity. Unjustified bonuses, questionable loans, powerboats on company accounts and well-paid relatives with vague responsibilities are all danger signs.

Also, no bond applicant should ever try to hide assets. If the worst happens, the surety will find those assets and take them, and bill you for the effort.

And remember, bonding companies don’t just look at your bonded work. They view your entire backlog as potential risk. If you’re losing money on a $20-million unbonded project, why will you do any better on a bonded $10-million job?

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Boost Your Bonding Capacity With Shareholder Loans

By on January 11, 2013 in Construction
Boost your Bonding Capacaty

Boost your Bonding Capacaty

In the current environment, conservative underwriting standards and low bond limits have made it more difficult for construction companies to obtain the surety credit they need.

One strategy for enhancing your construction business’s financial position and boosting its bonding capacity is to have the owners make loans to the company. So long as these “shareholder loans” (which can also be made by entities other than corporations — such as LLCs and partnerships) are subordinated to bond claims, most sureties will treat the proceeds as a capital equivalent in evaluating a company’s bonding capacity.

Debt vs. capital

Why not beef up your balance sheet by simply infusing it with new capital — either through additional owner contributions or with money from outside investors? Such infusions can have significant disadvantages. Bringing in outside investors would dilute the current owners’ interests. And additional owner contributions can lead to undesirable tax consequences.

If your business is organized as a C corporation, for example, any paid-in capital would be subject to double taxation — once at the corporate level and again at the shareholder level — when it’s paid out as a dividend. For other types of entities, double taxation isn’t an issue, but distributions generally reduce an owner’s basis, which may have negative tax implications.

With shareholder loans, on the other hand, principal payments typically aren’t taxable (unless, in the case of certain pass-through entities, the shareholder’s basis in the loan has been reduced by business losses or other adjustments). Plus, interest payments, although taxable, are deductible by the construction company. Loans also provide an advantage in the event of the company’s bankruptcy, because debt is generally paid before equity is returned.

Subordinated loans

A surety won’t view a shareholder loan as a capital equivalent unless the loan is evidenced by a promissory note and the contractor signs a subordination agreement. The loan should be structured and documented carefully, with a market rate of interest and commercially reasonable terms, to ensure that it’s treated as a legitimate loan rather than a contribution to equity.

A subordination agreement provides that the loan is subordinate to all of the surety’s rights and claims against the business in connection with furnishing a bond, and that the surety will be paid in full before any payments are made to the shareholder. In addition, in the event of the construction company’s bankruptcy or insolvency, the agreement assigns to the surety any rights the shareholder may have against the company in relation to the loan.

The surety will also consider the source of the funds. Loans should come from the owners’ personal funds, such as salaries, bonuses, dividends or distributions from the company. Sureties generally frown upon loans made from borrowed funds (for example, an owner borrows money from a bank and lends the proceeds to the company), for fear that shareholder loan proceeds will be used to pay back the lender.

Performance matters

Shareholder loans and subordination agreements, by themselves, aren’t enough to provide a surety with the comfort it needs to extend credit. To boost its bonding capacity, the contractor must still satisfy the surety that it’s financially healthy and that prospects for future growth and profitability are strong.

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Keep Business Ethics Front and Center

By on November 28, 2012 in General, Governments
Sandersen Knox & Company LLP, CPA, Tax Accountants, Auditors

Keep Business Ethics Front and Center

With high-profile wrongdoing at Enron, WorldCom, Tyco International, and others still in recent memory — many wonder if ethics still has a role in the business world.

The question is even more relevant today, given the languishing economy. It doesn’t require much resolve to do the right things, such as paying suppliers on time and adhering to top-notch quality, when times are booming. But, if you’re short on cash, it can be easy to extend payables past their due date or skimp on quality. It’s in such times that emphasis on business ethics or “the principles of conduct governing an individual or group” is most important. With that in mind, Sandersen Knox & Company would like to share some thoughts on keeping business ethics front and center.

Setting the tone at the top

The phrase “tone at the top” is often used to describe both the attitude and actions of a business’s owners and executive management. If top managers emphasize the need to act with integrity, but don’t follow through with their actions, employees will notice. For instance, a company president who stresses honesty, yet asks an employee to backdate a check so it doesn’t clear right away, conveys the message that doing the right thing is less important than achieving a particular result.

Such actions can, in turn, prompt employees to act unethically. Consider this: The Ethics Resource Center’s asked participants in a recent study if they’d observed at least one form of a specific misconduct in the previous year. When it came to falsifying time or expense reports, 4% of respondents working in organizations with strong ethical cultures reported such an incident, compared with 19% in companies with weak ethical cultures.

Examining candidates’ values

To maintain a culture that values ethics, hire employees who also place a premium on an ethical work environment. A job candidate who values moving up at any cost may come across as an ambitious go-getter. However, if a worker starts cutting corners and fudging results — say, by recording sales before they’re actually completed — he or she will undermine your efforts to foster an ethical corporate culture.

Implementing formal policies

Owners and managers should regularly discuss workplace ethics with both employees and business partners. There should also be a written policy that outlines the approach to doing business. Putting the policy in black-and-white and making it easily available can help prevent misunderstandings, and emphasize the point that integrity comes first. An ethics policy might include provisions that state expectations for employees regarding the proper use of the business’s assets and their duty to avoid situations that would constitute a conflict of interest, such as hiring a family member.

Harnessing strong internal controls

Internal controls are processes designed to provide a reasonable assurance that your financial statements are credible and accurate, that your company complies with applicable laws, and that its operations are efficient.

A strong system of internal controls might seem most applicable in larger businesses, but it’s critical to smaller companies, which often are less able to withstand a fraudulent or criminal act. Internal controls help safeguard the company’s assets and ensure that decisions made by management, lenders and investors are based on accurate information.

A fundamental element of strong internal controls is to segregate duties within financial operations and reporting. While this won’t eliminate the possibility of fraud, having two people involved in an operation makes it more difficult to pull off. An employee who issues checks or payments, for example, shouldn’t also be responsible for recording those transactions. When checks arrive via mail, one employee should log them and another deposit them.

It’s also critical that management take a keen interest in the business’s financials. Employees should know that management regularly — and, ideally, randomly — looks in financial reports for transactions that raise a red flag, such as an unexplained spike in expenses.

Sustaining an ethical workplace

SKC suggests setting a tone at the top that stresses integrity, a written ethics policy, a commitment to hiring employees who take ethics seriously and a system of strong internal controls will help you develop and sustain an ethical workplace environment. Work with a business consultant and CPA to ensure that your ethics policies and internal controls are operating as intended.

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Subcontractors and surety bonds: 5 tips for getting paid

By on August 24, 2012 in Construction, General

When it comes to getting paid, especially in the current environment, subcontractors shouldn’t take any chances. If you’re a subcontractor that works on bonded projects, there are steps you can take to help ensure you get paid for your work and materials. Here are five tips to consider:

1. Don’t assume

Payment and performance bonds are generally required on public projects, under the federal Miller Act or one of the many state-level “Little Miller” acts. Some private construction contracts require bonds, but in most cases they’re unnecessary because state mechanics’ lien laws provide the most effective remedy for subcontractors who haven’t been paid. Mechanics’ liens can’t be filed on public property, however, so payment bonds generally serve as a substitute on public projects.

If you’re contemplating work on a public project, however, don’t assume that you’ll be protected by a payment bond. For one thing, some apparently public projects are, in fact, privately financed, and the Miller Act doesn’t apply. And even if the Miller Act or a Little Miller act applies, that doesn’t necessarily mean you’re covered.

The Miller Act, for example, requires bond protection only for first-tier subcontractors and suppliers (those that contract directly with the prime contractor) and for second-tier subcontractors and suppliers who contract with a first-tier subcontractor. Most Little Miller acts have similar requirements.

Even if a bond is legally required — and you’re within the class of subcontractors entitled to make a claim — there’s no guarantee that the general contractor has actually furnished one. Rather than assuming that the bond requirement has been fulfilled, you should ask for a copy of the executed bond to verify that the general contractor has complied and that the bond is valid and sufficient.

2. Make alternative security arrangements

If there’s no bond, consider requesting an alternative form of security. For example, you might ask the general contractor to place a certain amount of cash in escrow, provide a letter of credit, or furnish personal guarantees. If the general contractor refuses to provide such security, and you’re uncomfortable with its ability to pay you in a timely fashion, you should seriously consider walking away from the job.

3. Check the surety’s financial condition

Like many businesses in today’s economy, some sureties are struggling financially. Even if you’re covered by a valid, sufficient payment bond, if the surety becomes insolvent you may be left without protection.

Before you sign a contract, it’s a good idea to investigate whether the surety is financially stable. Also, find out whether the state in which the project is located has an insurance guaranty association or similar program that provides you with insurance in the event the surety becomes insolvent.

4. Know the rules

To preserve your right to recover payments from the surety, be sure that you understand any contractual terms that govern your right to payment, as well as all applicable notice and statute of limitation requirements related to the bond.

Under the Miller Act, for example, you must provide written notice of your claim to the principal (the general contractor or other party responsible for furnishing the bond) within 90 days after the last day on which you furnished labor or materials for the project. The federal act also imposes a one-year statute of limitations on bond claims. The bond agreement itself may impose additional procedural requirements.

5. Document your claim

Having the documentation to back up your claim is essential. First, to comply with statutory notice requirements, you’ll need to state the amount of your claim with a high degree of accuracy. Second, you’ll need solid documentation to prove that you’re entitled to payment under the bond.

Don’t take chances

It’s a big mistake to assume that you’re protected by payment or performance bonds. Before you sign a contract, work with your financial and legal advisors to perform the due diligence needed to confirm that required bonds exist, that they’re valid and sufficient, and that the surety is financially stable. This is the best way to protect your compensation for your work and materials.

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IRS employment exams: Will your construction company pass the test?

By on August 23, 2012 in Construction, General, Tax

Recently, the IRS launched an audit program that focuses on employment tax issues. As part of a National Research Project (NRP), the IRS will randomly select approximately 6,000 employers over the next three years for detailed employment tax examinations.

The program is designed to gauge compliance with employment tax law and related reporting requirements, and to gather information that will help the IRS select and audit future returns with the greatest compliance risk. The IRS offers few details about the specific issues it plans to probe, but it’s a safe bet that auditors will be scrutinizing areas that have led to audit adjustments in the past.

Targeted areas

For construction companies, the Service’s Construction Industry Audit Technique Guide (ATG) provides clues to what auditors will be looking for. Here are some of the main employment tax issues NRP audits will target:

Worker classification. The employee vs. independent contractor issue is a significant one in the construction industry. The ATG warns agents that “the use of subcontractors is common within the construction industry. Many taxpayers treat employees as subcontractors to avoid paying employment taxes. The agent may need to seek guidance from an employment tax specialist when confronted with potential employment tax issues.”

It seems unlikely that many contractors deliberately misclassify employees as independent contractors to avoid employment taxes. But even inadvertent misclassification can have serious consequences, including back taxes, penalties and interest; additional employee benefit obligations; and liability for overtime pay. To avoid these costs and ensure you can support your tax position, review your employment practices and procedures, relationships with independent contractors, and written contracts.

Officer compensation. The IRS will likely focus on two issues involving owner-employees: 1) C corporations that pay unreasonably high salaries, which are really disguised dividends, and 2) S corporation shareholders who receive unreasonably low compensation to reduce employment taxes. To avoid unpleasant tax surprises, be sure to maintain documentation that supports the reasonableness of owner salaries.

Reimbursed expenses. Agents will be looking for employee expense reimbursements that aren’t paid through an “accountable plan” and, therefore, should be included in income and subject to employment taxes. Payments under a nonaccountable plan, while they may be deductible by the employer, are usually taxable income to the employee. Your plan is accountable if it’s in writing and requires:

  1. Reimbursed expenses to have a business connection,
  2. Employees to adequately substantiate expenses in writing within a reasonable time, and
  3. Employees to return any excess reimbursements or advances within a reasonable time.

Keep in mind that reimbursement of employees through an accountable plan won’t convert otherwise nondeductible expenses into deductible ones.

Be prepared

The chances of being selected for an NRP audit may be slim, but the same issues are likely to be raised in ordinary audits, too. In light of renewed IRS interest in employment tax issues, work with your attorney and CPA to review your employment practices, procedures and records to be sure they meet the agency’s standards.

While you’re at it, if you have or plan to bid on any public works projects, you should also review your compensation practices for compliance with prevailing wage requirements. (See the sidebar “Avoid getting fried by Davis-Bacon.”)

Avoid getting fried by Davis-Bacon

The combination of a struggling economy, a depressed real estate market and the stimulus law’s creation of new infrastructure projects has led many contractors to bid on public works projects for the first time.

If you’re new to government contracting, become familiar with the Davis-Bacon Act, a federal law that requires you to pay a “prevailing wage” on most federal projects. Prevailing wage rates typically consist of a minimum basic hourly rate and, if appropriate, a fringe benefit amount. In addition to the federal law, most states have “mini” Davis-Bacon acts that impose prevailing wage requirements on state-funded projects.

Essentially, Davis-Bacon and its state counterparts require you to pay wages on a public project that are comparable to wages paid for similar work in the area where the project is located. Penalties for disregarding the prevailing wage include monetary damages, contract termination and even debarment from future contracts.

Contractors often pay the basic rate and fringe benefit amounts in cash. But in many cases, it’s more cost effective to satisfy the fringe benefit requirements through benefit plans, such as qualified retirement plans, health plans or even paid time off.

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General Liability Insurance – Check the Fine Print

By on August 23, 2012 in Construction, General

Sandersen Knox & Associates LLP, CPA, Tax Accountants, AuditorsRead the fine print in insurance policies

It’s common for an owner to require the general contractor to name the owner as an “additional insured” under the general contractor’s commercial general liability (CGL) policy. Likewise, a general contractor typically requires subcontractors to name it as an additional insured under their CGL policies.

Doing so helps protect the additional insured against liability in connection with activities of the “named insured” (the contractor or sub that purchased the policy). But if you haven’t read the fine print of the insurance policy, you may or may not be covered as an additional insured to the extent you expect.

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Use these simple tools to combat check fraud

By on August 21, 2012 in Construction, General

If yours is like most companies today, your profit margins are thinner than usual. To protect the bottom line, it’s critical to implement solid internal controls to minimize fraud, error and waste.

Fraud is a serious problem in businesses. In the 2012 Report to the Nations on Occupational Fraud and Abuse, a survey conducted by the Association of Certified Fraud Examiners, manufacturing,banking, construction, and government all had significant rankings among all industries in terms of both frequency of fraud and median loss.

One of the most common schemes today is also one of the simplest: check fraud. It’s relatively easy to create a forged or counterfeit check with nothing more than a computer, scanner and printer. Fortunately, there are simple solutions to this problem.

Positive pay

Positive pay is one of the most straightforward — and effective — safeguards against check fraud. With each check run, you transmit an electronic file to your bank with a list of check numbers, account numbers, dates and amounts. Bank personnel review checks as they come in. And, most important, they won’t pay a check that doesn’t match the list without your approval.

For added protection, many banks allow you to set up special rules. For example, you might reserve the right to approve checks that exceed a certain amount or have been outstanding for a specified period of time.

If you don’t have time to put together a list of checks each month, find out whether your bank offers “reverse positive pay.” Under this approach, the bank sends you information about checks as they come in, and you approve payments on a check-by-check basis.

Going paperless

Another way to minimize check fraud is to reduce your reliance on paper checks. Many companies use direct deposits for payroll. If you have employees who are “unbanked” — that is, they have no bank account — you might consider using “payroll cards.” Employees can use these cards to withdraw cash from ATMs or, in some cases, as a debit card.

Eliminating paper checks not only reduces opportunities for check fraud, but also decreases your administrative costs. To prevent unauthorized payments, use separate bank accounts for electronic and paper-based payments.

Management Oversight

Lack of management oversight continues to be a significant factor, along with the ethical tone set by management in many cases. A small business owner who physically opens the bank statement and examines the transaction list and check copies on a regular (or at least periodic) basis is in a much better position to combat fraud than the one who is careless about his affairs.

Be proactive

The best strategy for combating fraud is to be proactive. In some cases, your bank may ultimately be liable for unauthorized payments. But a better idea is to work with your bank to prevent check fraud from draining your account in the first place. Be aware of what controls you put in place and their purpose:

  • External audits should not be relied upon as an organization’s primary fraud detection method. Such audits are the most commonly implemented “control” in various surveys; however, they detected only 3% of the frauds reported to us, and they ranked poorly in limiting fraud losses.  The focus of external auditors is less at the transaction level and more at the financial statement level.
  • While external audits serve an important purpose and can have a strong preventive effect on potential fraud, their usefulness as a means of uncovering fraud is limited.

There is no substitute in small business for an engaged owner or manager.  This is how you set the tone and how the responsible party person closest to the action can spot issues while they are fresh.

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Mission Critical: Prequalifying Subcontractors Important in Today’s Economy

By on April 23, 2012 in Construction, General

Subcontractor failure is one of the biggest risks faced by general contractors (GCs) today. And one of the most effective strategies for minimizing this risk is subcontractor prequalification. This process benefits subs, as well, by providing them with a competitive advantage once they’ve made the list.

Prequalification isn’t new but, in the current economy, it’s playing a more prominent role in the construction business. Many contractors are even using Web-based collaborative tools to help streamline the process.

Dangerous Conditions

As you know, a distressed economy amplifies the risks associated with subcontractor failures. There are several reasons for this:

  • Construction work is more difficult to come by, prompting some subcontractors to seek work outside their comfort zones (in terms of skill set, geographic location, financial resources and manpower).
  • Most sureties have tightened their underwriting standards and reduced bonding capacity for subs.
  • Credit lines and other forms of financing are more difficult to obtain.
  • Subcontractor default insurance (SDI) may be less effective in bad times — a GC experiencing multiple subcontractor defaults in a single policy year, for example, can have significant financial exposure, even with SDI.

The best protection is a carefully developed subcontractor prequalification program. Surety bond agents typically prequalify subcontractors for underwriting purposes, but an internal program is important for unbonded subs. Also, SDI providers generally require insured contractors to have a prequalification program in place.

Subcontractor Red Flags Could Signal Trouble

Here are some examples of red flags that may signal potential subcontractor failures or defaults:

  •  Reluctance to furnish or update financial statements or other requested information.
  • Sloppy presentation of financials.
  • Declining cash flow or liquidity.
  • Increasing amounts of debt.
  • Growth in accounts receivable while income declines.
  • Insufficient working capital to meet backlog.
  • Failure to comply with debt covenants.
  • Denial of surety bonds. Bond worthy issues.
  • Increasing number of liens, claims or lawsuits.
  • Escalating employee turnover.
  • A pattern of profit fade.
  • Difficulty in determining job status and cost to complete.
  • Rising overhead.

Remember, prequalification of subcontractors is an essential element of your business planning environment in today’s times, and in any times.

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Bonding: Subprime is Not a Dirty Word

By on April 11, 2012 in Construction, General

The term “subprime” has had a bad rap, and with good reason. After all, it’s associated with predatory lending practices that have had a lot to do with the current financial crisis in the United States.

But subprime lending isn’t bad by definition; it simply means extending credit to less qualified borrowers, who pay a higher interest rate to compensate the lender for its increased risk. And it isn’t new — historically, most financial and insurance products have had some sort of subprime market.

In construction, subprime bonding works essentially the same way as traditional bonding. Performance bonds, payment bonds and other products are available either by the job or as part of a bonding program. The key difference is that subprime sureties charge higher rates (often double those charged for traditional bonds) to cover the additional risk.

In addition, subprime sureties usually demand personal guarantees from the owners as well as collateral, which may have to be in cash. For a particularly risky contractor, the surety may also require the use of an arrangement (funds control) to receive project payments, pay subcontractors and meet payroll.

A Sign of the Times

Naturally, subprime bonding shouldn’t be your first choice. But in the construction industry, access to bonding can be critical to a firm’s survival. And subprime bonding offers a viable option for contractors that don’t qualify for traditional bonding in today’s tight market. Contractors who were very bond worthy not long ago are now beginning to consider these options out of necessity.  Subprime bonding may also be appropriate for contractors that are entering new geographical markets, tackling new types of work or bidding on larger projects to stay competitive.

Check Your Options First

Before you pursue subprime bonding, consult your advisors to be sure you understand the risks and structure the best deal possible. As always, good business planning is a must.

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