Over the past decade, the surety industry has performed exceptionally well, with isolated large claims that have not been indicative of widespread industry concerns.
However, 2023 is shaping up differently, with an increase in claims activity being reported, particularly against Labour and Material Payment Bonds (L&M bonds). For many in the industry this is not overly surprising as historically there has been a direct correlation between rising interest rates and surety bond claims.
Despite this uptick in claims activity, Steven D. Ness, the president and chief operating officer of the Surety Association of Canada, remains optimistic stating, “Surety results for 2022 were quite impressive, but it’s no secret that the challenges we’re facing; inflation, interest rates, along with material and skilled labour shortages would suggest that 2023 might not be quite so rosy.
“Some pessimistic souls are even predicting doomsday scenarios, suggesting that we could see a return of the bad old days of the early ‘90s when the industry posted 100+ per cent loss ratios in consecutive years ($1+ lost for every $1 of bond premium written). I’m not one of them. The industry has grown exponentially over the last 30 years, not just in terms of direct written premiums, but in sophistication and professionalism.
“In 2023, we are far better positioned to deal with a loss ratio downturn than we were in 1993 with more professional staffing and sophisticated claims handling processes; all supported by cutting-edge technology that would have been inconceivable three decades ago. We may have some bumpy roads ahead, but we’re not about to drive off a cliff.”
Whether the doomsday scenario comes to fruition or not, it is still important for contractors and owners to understand how an L&M bond claim is processed by a surety from both the perspective of a claimant and the principal on the bond (most commonly the general contractor).
While each surety has their own unique approach, the sureties generally follow a standard protocol:
- Investigation: The surety company must investigate the claim to determine its validity by reviewing the contract, payment history, and documentation of the work performed to ensure the claimant has not been paid for the work or materials supplied. This is also the opportunity for the defending party (typically the general contractor) to dispute the claim and provide any supporting documentation for non-payment.
- Notice to contractor: If the claim is deemed valid, the surety company will provide notice to the contractor of their intent to pay the claimant. The contractor should be provided with an opportunity to cure the default by making the payment before the surety company satisfies the claim.
- Payment: If the contractor does not cure the default, the surety company steps in to satisfy the claim by paying the claimant directly.
- Indemnity: After paying the claimant, the surety company has the right to seek reimbursement from the contractor for the amount paid out, called indemnification.
Although the process of handling payment disputes may seem straightforward, it can be quite complex. Disputes may involve a variety of issues, such as concerns about workmanship, delay claims, over-billings and back charges.
In such cases, the surety may need to delay its response to the claim in order to obtain additional information and conduct a thorough review. Despite the complexity, the surety will persevere in its efforts to determine the legitimacy of the claim and will request relevant supporting documentation from all parties involved as new information is presented.
For that reason, thorough and proper documentation is vital in prosecuting or defending a payment bond claim.
Having clear purchase orders and/or contracts in place with subtrades is key for general contractors so all parties know and understand their obligations. From there, each party should ensure they are following the contractual or legislated payment terms.
If a payment is disputed, clear communication between the parties around the reasons for full or partial non-payment should occur.
This could be a notice of non-payment, notice of back-charges or delay or a notice of an improper invoice amongst others. This documentation will come in handy if a claim is pursued against a bond.
In our experience it is often the party that can provide the clearest documentation to back up their position that ends up with the favourable claims result (either an acceptance or denial of the claim).
As always, if you are either considering pursuing a claim or required to defend your position against a claim, we highly recommend you reach out to your surety bond broker for proper advice.
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. Send comments and column ideas to firstname.lastname@example.org.