Establishing and following a rigorous subtrade prequalification practice is a key part of risk management for all contractors; however, the implementation of such a practice can be challenging.
The common rationale of “we know these guys” is a common pitfall when looking at subtrade risk management. While most contractors likely know the history and performance capability of many of their subtrades, they may not be aware of any financial challenges they are facing.
With pressures mounting from labour shortages, COVID-19 delays and material cost increases, maintaining successful performance and healthy margins can be a challenge for any trade. To manage these concerns and avoid defaults, it is prudent for contractors to give themselves the full degree of protection from performance or default issues. One of the more comprehensive risk management tools for contractors to consider is to request surety bonds from key trades on larger projects.
How can bonding help with the subcontractor selection process?
As most contractors are aware, in order to qualify for bonding, companies are put through a thorough underwriting review on, at least, an annual basis. These reviews include a careful look at the company’s backlog to see how profitable their work is, a review of any receivable issues that could hinder future performance and a careful evaluation of their ongoing financial results.
As noted by Matt Baynton, senior vice-president surety of Trisura Guarantee, “I would argue that the surety assists in the process by giving an owner or contractor additional comfort that the subcontractor has been vetted, by a third party, from a financial and ability to perform standpoint. This helps owners and contractors narrow in on subtrades that are qualified financially and technically to complete their scope of work. The surety is essentially pre-qualifying the subcontractor.”
When should you request bonds from subtrades?
The general consensus in the surety industry is that bonds should be considered for all major trades that represent either a large percentage of the total job, or from trades that are completing a critical path scope of work on the project. While there is a cost associated with this, usually around one per cent of the contract value, it is not a high cost when considering the protection that bonding provides.
The following are a few of the factors in considering the bonding of a subtrade:
- The contractor’s familiarity and past experience with the specific trade.
- Magnitude of the specific subtrade’s contract value in relation to the overall project and the potential impact on the project’s critical path.
- The subtrades’ prior experience with the size, scope, location and owner of the project.
- Specialized nature of the work performed by the subtrade. Are there readily available replacement contractors or suppliers in the event of default?
- Projects with a constricted timetable for completion, particularly when significant liquidated damages clauses are included, that can materially increase the risk for the GC and subtrade.
- Does your subtrade need to hire any key subtrades below them?
What happens when a default occurs?
Although subtrade defaults are rare, when they do occur they can be devastating to the construction schedule of a project and also cause considerable financial stress on the prime contractor. As Mark Skanes, vice-president of Western Surety explains, having bonds from a trade can provide considerable protection and peace of mind.
“When bonding is in place for a subtrade and there is a default, the assistance provided by the surety is really threefold. Firstly, if the subtrade is bonded, a surety would have already completed a prequalification process. This will ensure that even though the subtrade is in default, you have a much better chance of dealing with a subtrade that has some sophistication and financial standing which would help mitigate the default.
“Secondly, the surety can help facilitate discussion between the subtrade and the general contractor to keep the project moving. Lastly, under an indemnity agreement, the surety can, in a worst-case scenario, step into the shoes of the defaulting subtrade to provide financing and expertise to keep the job moving forward. There are also some new and innovative bond wordings that can provide speedy project restart in comparison to the more traditional model.”
While the industry remains cautiously optimistic about the future, it’s wise to begin more prudent practices of risk management during this period. Surety bonding for subtrades is just one aspect of a strong risk management toolbox that should be considered, especially for larger critical path trades. The stakes are too high.
Jamie Collum is the vice-president of construction for FCA Insurance. He has delivered numerous seminars and presentations on construction bonding and general industry updates in Ontario to various construction associations over the years. Andrew Cartwright is the vice-president of surety for FCA Insurance. Andrew recently joined FCA after a decade long tenure as RVP for a large national surety company. Send comments and column ideas to email@example.com.