Performance Bonds with Collateral: “Buy Now, Pay Later”

FOR IMMEDIATE RELEASE
(Free-Press-Release.com) August 9, 2010 -- For construction contractors it sounds so great. You have a chance to get a new project. You need a bond to get the project. You’re having trouble qualifying but then an underwriter offers to provide the performance bond if you give them collateral. What seems to be a creative solution can actually become a long term problem in itself.

The concept of using collateral to obtain a bond means that you give funds, normally in the form of an Irrevocable Letter of Credit, to the surety. These funds are intended to protect the surety’s interests in the event of a bond claim or default. It is a way of taking some risk off the underwriter to facilitate approving the bond. That part of the process works fine. What comes next is the issue… Many contractors conclude that the complications that follow make the collateral “solution” no real solution at all!

Problem #1: “The collateral depleted my cash account.”
When starting a new contract, the contractor may have to fund the project for 45 or even 60 days until the first requisition is paid. This may be difficult to do if the company’s available cash was used to fund the collateral account. Money tied up in this manner is NOT AVAILABLE to aid in the performance of the work.

Problem #2: “The work is half done. Can I have half the collateral back?”

The surety will not give partial releases as the project is being accomplished. They have no way to determine how much will be needed if a problem occurs, so they must hold 100% of your money to protect themselves.

Problem #3: “The job is done. NOW can I have my money back?!!”
Still No! The surety has a continuing obligation under the Payment Bond, plus one year for defective materials and workmanship under the Performance Bond. No collateral release for you!

And if that’s not bad enough, the process starts all over again if a second bond is issued during this period. So when do you get your collateral back? Good question…

The answer of course is to not do the collateral transaction in the first place. Collateral can become a self perpetuating arrangement where it is easier to take the next bond from the surety than it is to move on – even though you are unhappy with the approval terms. Contractors and their agents need to seek underwriters with the creativity and underwriting skills needed to write the business without the use of this so called “solution.”

Edmund Scarborough     IBCS group     steve Golia