By Tim Cool
For most of my professional career, I have been anti-performance and payment bond-oriented. To me, they seem like such a waste of money. In short, they’re just an insurance policy (although the Surety industry would say they are not “insurance” but rather a “guarantee” — semantics!) in the unlikely event the general contractor on a job is unable to complete the project (usually due to a bankruptcy or other major catastrophe related to the contractor).
In theory, that sounds great. It almost feels like the proverbial “Get Out Of Jail” card.
But is it really?
Here are the issues I have with these kinds of bonds on a General Contractor:
1) Have you ever met an insurance company anxious to pay a claim? I haven’t either. Same applies here. The issuing companies (referred to as Sureties) are in the business to make money from premiums, not paying out claims. In light of that, claims can drag on for long periods of time. This can leave a project sitting idle for months with no work transacting, materials impacted due to the exposure to the weather and a congregation (and staff) dismayed that they can’t use the ministry tool they so badly need, while continuing to pay interest on the construction loan.
2) It’s expensive. The normal cost of a bond is about 1 percent of the construction value. So, if you are constructing a $5-million project, that could be $50,000. DANG — what else could you do with $50,000? I have recently seen rates as low as .7 percent and as high as 1.25 percent.
3) In most instances, bonds are required by banks, not the client (church). And who do you suppose the bank is trying to protect? Correct: themselves. I recently had a conversation with one of the nations largest banks about waiving a bond on one of our projects. They agreed with me that the GC was well qualified and had a 60-year track record of positive performance. But they were uncomfortable with the debt service ratio of the loan (that they agreed to) and as such were not willing to take the “risk” to waive the bond. So, the bond to cover the lack of performance of the GC really had nothing to do with the GC or its capability or anticipated performance.
I plead my case with the bank, but in the end the bank used the flimsy rational of, “But you never know what could happen, and the GC could go out of business.” That, in turn, lead me to ask: “Well, then, can we get a bond on the bank to insure that you don’t go out of business?” Unfortunately, there is no such instrument — and the bank told me that would never happen.
Hmm … does any one remember the Savings and Loan debacle?
Now, with that said, I’ve seen the advantage of bond-ability more in the past few years — not for what a bond can “do”, but rather what they reveal. Let me explain.
In our Project Facilitator role (Owners Rep, Project Manager, etc), we are asked to assist churches determine the right construction partner for the project. We always recommend doing an interview / vetting exercise early in the design process so the entire project team can work in an integrated and collaborative environment. As such, we will generally vet out three to five contractors. One of the questions we almost always ask is, Can you provide a Performance Bond? If so, what is your bonding rate? That might seem odd, given my comments above, but here’s my rationale:
- In larger construction projects, bond-ability is almost always expected. As such, it’s the “ticket to the dance,” just like it’s expected that your company has integrity. Think of it this way: If you hire a painter, you expect them to own ladders and paintbrushes.
- If a company can obtain a bond, it indicates that it has its financial house in relative order and is considered a reasonable risk by the surety.
- A firms bonding rate is a key indicator of a company’s level of financial strength. If its rate is less than 1 percent, then it’s generally much stronger financially or has impeccable longevity. If it’s between 1 percent and 1.25 percent, it might still be considered a good risk, but might not have the same financial horse power; or, the company might not obtain as many bonds (not all construction jobs require a bond), thus might be charged more when it does obtain them. Anything higher than 1.25 percent on a General Contractor is a major yellow flag. (“Run, Forrest, run!”)
So, while I still would prefer to not bond the General Contractor on a project — my personal preference is to bond the major subs — bonding capability can be a great measuring stick as you consider your project team.
Tim Cool is project executive at Visioneering Studios in Charlotte, NC, and founder of Cool Solutions Group. Since 1986, Cool has served the church community in the areas of construction, facility planning and facility management. He can be reached at firstname.lastname@example.org. This blog originally appeared on his blog, “Cool Conversations Live.”