CAIB 3 - Chapter 5 - Instructor Slides.pdf

 Three Big Things Students have three minutes to write down three of the biggest or most important concepts we have gone over so far in class, in the chat window. After studying this week, have these three big things changed? Remember the Forgetting Curve! State and explain the 3 typ...

 Three Big Things Students have three minutes to write down three of the biggest or most important concepts we have gone over so far in class, in the chat window. After studying this week, have these three big things changed? Remember the Forgetting Curve! State and explain the 3 types of total loss under a Marine Policy? (/6)  Marine Cargo Insurance Policies Claims Settlement Total Losses In marine this means complete loss of the subject matter. There are three types of total losses: ○ Actual total Loss The property is totally lost or so badly damaged there is no value to it. ○ Constructive Total Loss The cost of salvaging the cargo is too high relative to the value saved. ○ Total loss of a part Total loss of one shippers cargo, without total loss to other shipments is a total loss of a part of the shipment.  Chapter 5 Surety Bonds Section 1: The Meaning of Surety  Learning Topics Suretyship - History Qualifying for a Surety Bond Characteristics of Surety Bonds  The Meaning of Surety Definition Surety – “The state of being sure, certain and secure.” Definition Suretyship – “Guarantee of performance.” Suretyship 1) Personal Suretyship ○ Agreement meant that a guarantor would honor the promise in the avenue that the debtor defaulted.  The Meaning of Surety 2) Corporate Suretyship There are two main classes of bonds issued under the above: 1) Fidelity Bond and 2) Surety Bond 1) Fidelity Bond Protects a company for the dishonest acts of employees. 2) Surety Bond This is an undertaking by one party (the surety) to become accountable to another party (the obligee) for the performance of an obligation or undertaking by a third party (the principle).  The Meaning of Surety Qualifying For a Surety Bond Following 3 “Cs” form basis of credit appraisal: ○ A) Character Review of the companies management performance. Need to make sure that the principle is of good character. ○ B) Capacity Assessment of the principles ability to complete the work in the reasonable time frame fulfilling their contractual obligations. ○ C) Capital Need to make sure that the principle is able to have the financial capacity to complete the work.  The Meaning of Surety Benefits of Suretyship Principle: Added confidence gained from the fact that the surety is satisfied in their ability to carry out the required task. Obligee: Guarantee provides them with the confidence needed to undertake projects.  Characteristics of Surety Bonds 1) Three Party Contract ○ A) Principle Definition: “The person primarily liable.” Example: Contractor who is building a residence for someone. ○ B) Obligee Definition: “The party to whom someone else is obligated under a contract.” They are the party to whom a bond is given. ○ C) Surety One who undertakes to pay money or do another act in the event that the principle fails to complete.  Characteristics of Surety Bonds 2) Principle is liable to surety Is a promise made to, the obligee and not to the principle. A bond is to protect the obligee ○ It a secondary obligation arising only on the default of the principle. The surety will only respond if the principle cannot fulfill obligation to obligee. ○ Surety’s duty to pay arises immediately upon default of the principle If the principle fails then the surety needs to pay. 2 ways a surety can collect from the principle: 1) Assignment to surety of obligee’s rights. 2) Right of subrogation  Characteristics of Surety Bonds 3) No losses expected. ○ Surety is based on the extension of credit without risk; therefore, they do not plan to pay out on a loss. 4) Of indeterminate length and non-cancellable. ○ The actual bond will end once the principle has fulfilled all obligations to the obligee. 5) Statutory or non-statutory in form ○ Definition: Statutory Bond “One that is required by a municipal ordinance, or federal or provincial regulation or statute.” ○ Definition: Non-Statutory Bond “One that is not required by law though required by contracts.”  Characteristics of Surety Bonds 6) Bond Limit (Penalty) ○ Definition: Bond Limit “the amount of credit given to the principle by the surety.” ○ The amount does not change within the period of the contract. 7) Bond Premium ○ The cost of a bond. 8) Written contract ○ The surety must provide in writing the contract under seal of the surety.  Important Terms So Far Students take two minutes to write down one important term that has been discussed so far in the course, in the chat window. Remember the Forgetting Curve!  Section 2 Types of Surety Bonds  Learning Topics Contract Bonds License and Permit Bonds Judicial Bonds Miscellaneous Bonds  Contractual Bonds Their intent is to guarantee fulfillment under public and private contracts. They are widely used in the construction industry and examples include: ○ Bid Bond ○ Performance Bond ○ Labor Bond ○ Material and Maintenance Bonds.  Who Requires Construction Bonds? A) Owners ○ Owners face a number of risks including: The refusal of inability of the successful bidder to enter into a contract. Failure of the contractor to complete the project at the contract price. The inability of the contractor to pay subcontractors and suppliers. B) General Contractors ○ Needed on larger building or commercial contracts.  Who Requires Construction Bonds? C) Subcontractors ○ Subcontractors are hired by General Contractors to complete work, example: roofer or plumber. ○ The following will influence if a subcontractor needs a bond: Term of the contract. The relationship between the contractor and sub trades. The value of the subcontract. The subtrade’s price in relation to other bidders. Whether the general contractor wishes to pay the cost of a bond, rather than assuming the risks associated with not doing so.  Bid Bonds A bid bond is furnished to the owner (Obligee) of a project and is not in force until the contractors tender is accepted. When issued the owner of the project is assured of the following: ○ The principle has been pre-qualified to bid on the project. ○ The principle is bidding in good faith. The surety guarantees the obligee that the principle can and will ○ Enter into a contract to perform the work at the tendered price. ○ Provide whatever security is specified to ensure performance of the contract.  Bid Bonds B) Certified Cheque. ○ Many tendered documents allow for certified cheque to be submitted in lieu of any other security. ○ The above is not recommended for the following reasons: Ties up contractors working capital which can be used for other projects. If contractor selects above method of deposit instead of bid bond it means they may not of been qualified for a bid bond. The time limits for accepting tenders, or making claims against a bid bond, do not apply to certified cheques.  Bid Bonds C) Surety’s Consent ○ The above is referred to under various names such as consent of surety, agreement for bond and bid letter. ○ They are prepared under letter and sealed. ○ The letters assure the owner that if the principle is successful in a bid, the surety will issue such other bonds as specified for performance of the contract.  Bid Bonds Reasons for Default under a bid bond. ○ Error in judgment Contractors can make mistakes in preparing tender documents. ○ Mistakes in arithmetic Miscalculation of the amount of the contracts.  Bid Bonds Effect of Default of Contractor. ○ When the successful bidder fails to enter into a formal contract, the bid bond is forfeited. ○ Amount of the penalty will be determined by the costs incurred to: Compensate the owner for the delay and additional costs should the project need to get re-tendered. Pay the difference between the defaulting contractor's bid and the amount for which the work is subsequently contracted.  Bid Bonds Bond Premium An annual service undertaking fee is charged to cover the annual costs in investigating the applicant, As well as costs incurred in providing bid bonds and letters of surety.  Performance Bonds A performance bond guarantees the following: ○ A) Actual performance of the contract in accordance with its specified terms and conditions. If the contractor performs all of the conditions the performance bond is void. If they fail to perform the performance bond will come into effect. ○ B) That the faulty work will be corrected and defective materials replaced for a period of one year after completion of performance. This does not apply to work completed by the sub-trades.  Performance Bonds Bond Penalty ○ The limit or penalty is often not 100% of the contract price. ○ It is normally around 50%. Modifications to the Contract ○ There is an allowance of 10% under the contract for changes to the contract price.  Performance Bonds Reasons for Default Under Performance Bond ○ A) Involuntary Default Insolvency No money to complete the project or the company goes into receivership. Incompetence Contractor did not have the qualifications to complete the work. Delays Resulting from: Modifications to the contract; Failure to receive materials and equipment when needed; Bad weather; Labour disputes. Failure of major subcontractors when no bonding in place.  Performance Bonds B) Voluntary Default ○ The contractor realizes that it is unable to complete the contract and chooses to withdraw to reduce its loss. ○ Above can be caused by the following: Improper estimate of the contract costs or cash flow issues.  Performance Bonds Making a claim ○ To file a claim under a performance bond the following procedures must get following:: 1) The surety must get notified by the obligee as required by a bond and within the time limit specified. 2) The obligee must satisfy the surety that a default occurred. 3) The obligee must show that the terms of the contract with the obligee and the principle have been observes, to the extent that the surety is not compromised.  Performance Bonds Effect of Default of Contractor ○ If the surety finds the contractor in default they can do the following: ○ 1) Complete the contract. They will make sure that the outstanding work on the contract is done. ○ 2) Obtain a bid(s) for submission to the obligee for completion of the contracts. Bond Premium ○ Under a performance bond, the premium is paid for in advance. ○ The premium paid is subject to adjustment based on the final price of the contracts.  Labour & Material Payment Bond The above bond guarantees that the sub trades and suppliers will be paid for the work and materials entered into the project. The above bond also serves an important business function by: ○ A) Reducing the cost of construction. Reduces credit risk to suppliers is favorable to lower rates. ○ B) Eliminating or reducing delays in construction. When there is payment assured it is easier to access labour and materials. ○ C) Freeing up credit. If payment of suppliers is guaranteed, credit risk to lenders is reduced.  Labour & Material Payment Bond Bond Penalty ○ The above is issued in conjunction with and for the same limits as the performance bond. Making a claim ○ Written notice The contractor, owner and surety must be advised in writing, usually by registered mail or the specifics of the claim. ○ Time limits Any claims reported within 120 days of the last day work was done or materials supplied will be paid.  Labour & Material Payment Bond Making a claim ○ Right of legal action Must wait 90 days from the last date on which work was done or materials supplied prior to serving legal action. ○ Project identification Supplies and materials need to get clearly identified.  Maintenance Bond The above bond given to the obligee is that the principle will fulfil the warranty obligations stated in the contracts. Surety's are reluctant to issue a maintenance bond for the following reasons: ○ The longer the guarantee the greater the chance for defects to appear. ○ Determining the causes of any defects become difficult as time passes. ○ Judgments awarded by courts tended to increase vulnerability of contractors to claims.  Create a “How” question Students take two minutes to create a “How” question based on the concepts covered so far, in the chat window. No question is too simple! Remember the Forgetting Curve!  Qualifying the Contractor Information from the contractor that the surety will want to review: 1) History ○ Want to know who started the company, when it started, how they start it and why did they start it. ○ They want to know information on the principles of the company and their previous positions. 2) Financial Strength of Owners ○ Personal statements from the shareholders of the firm are required. 3) Organizational Chart ○ Clearly define the responsibilities of each key person within the firm.  Qualifying the Contractor 4) Corporate Structure ○ Sureties rather deal with incorporated entities as there is structure in the event of death to key personnel. 5) Key Personnel Resumes ○ These should show clearly the qualification, special training, etc… of key personnel.  Qualifying the Contractor 6) Banking Information ○ A Bank Letter of Reference will be required by the surety showing the following information: Amount of line of credit and amount currently in use. Identification of type of security held on line of credit. Average account balances. Commentary on the general operation of the account and the length of time contractor has dealt with bank.  Qualifying the Contractor 7) Accounting Information ○ Year end financial statements are required for a 3-5 year period and should include cover letter from accounting company. 8) Surety Information ○ If contractor already had or has a surety policy the new surety market would want to see the document. 9) Completed Work Record ○ A record of the most important projects completed over the past 5 years should be provided.  Qualifying the Contractor 10) Work in Progress Record ○ A list of uncompleted contracts currently on hand should be reported. 11) Fixed Asset Schedule ○ A list of fixed assets owned by the contractor should be provided. 12) Principle Suppliers ○ The surety will require the names and addresses of principle suppliers and sub-trades.  Qualifying the Contractor 13) Insurances Carried ○ The surety will want to know what insurance is required. 14) Business Plan ○ A business plan is good to submit so the surety knows estimated projects and funds. 15) Receivables and Payables ○ A list of accounts receivables and payable are required by the surety.  Determining the Bond Limits Working capital, net worth and profitability are the main items of interest in the financial statement. A) Working Capital ○ Definition: Representation of the amount of funds available to pay continuing business operating expenses until payment is received for work being undertaken by the contractor. ○ Formula: WC = CA – CL CA = Company Assets CL = Current Liabilities  Determining the Bond Limits A) Working Capital ○ Factors affecting working capital include: Labour and Material ratio A project with high percentage of material will not tie up working capital to same extent as a project with a high labor component. Subcontractors Using subtrades does not deplete working capital as quickly as working with the contractor’s own labor. Customer paying habits Customers that do not pay on time will tie up working capital.  Determining the Bond Limits B) Net Worth ○ Net worth is calculated by establishing the amount of money remaining after all assets have been liquidated and all liabilities cleared. ○ Calculation: Net worth = Assets – Liabilities ○ The surety company will review the above to determine the contractors business is growing or declining. C) Profitability ○ An analysis of working capital and net worth will reveal the profitability of the contractor.  Interpreting Financial Statements There are two main ways to interpret financial statements: 1) Completed contract method ○ Under this method, the job profit or loss is not recognized on the financial statement until project is complete or near completion. ○ The above method distorts the financial position of the contractor as it allows bills and other costs to get charges against a business. ○ Advantage: the contractor is able to defer paying tax on profits until project is substantially completed.  Interpreting Financial Statements 2) Percentage of completion method ○ This is the preferred accounting method for work in progress. ○ Earnings from the work completed are calculated as a percentage of the total contract price. ○ Profit or loss is recognized on a current basis and allows for a reasonable estimate of the amounts needed to complete the job.  Interpreting Financial Statements 2) Percentage of completion method ○ Advantage of this method is that it will generally reveal over and under billings on jobs. ○ Underwriter will use a “Work in Progress Report” to understand the contractors true financial state. ○ The “Work in Progress Report” contains the following: Contract description and location. Contract amount. Percentage completed to date. Amount billed to date. Estimated cost and date to complete.  Interpreting Financial Statements In order for surety to feel confident that the contractor will not default, they may ask contractor to provide own guarantee in the following ways: A) Indemnity Agreements: Agreement allows surety a right of action for all losses incurred by it in investigating, adjusting and settling a claim against the defaulting contractor. B) Third Party Indemnities: Required to make good any claims the contractor cannot pay. C) Collateral Security: Collateral can take form of cash or letters of credit.  Interpreting Financial Statements In order for surety to feel confident that the contractor will not default, the may ask contractor to provide own guarantee in the following ways: D) Subordination Agreements ○ The above are also called “Postponement Agreements.” ○ The above provides surety with guarantee that shareholder loans to the company will remain in place until the surety allows them to get paid. ○ Intent of agreement is to ensure all bills are paid before shareholders are paid.  Making an Underwriting Decision Not all contractors will be eligible for bonding. A) New Contractors ○ At a disadvantage when seeking bonding as they have little to no track record on projects completed. ○ They need to us whatever level of bonding they are able to obtain to greatest advantage. B) Contractors with poor records or performance ○ If the contractor does not deal with their issues and seen unfavorable due to issues they may not receive proper coverage on bonding.  Issuing a Bond Factors used to issue a bond. Nature of the work. ○ Surety more likely to provide a bond if the work falls within the contractors expertise. Project location. ○ Location of project may increase potential of default. ○ The above is true for more remote locations.  Issuing a Bond Factors used to issue a bond. Bond limits required. ○ Surety will want to ensure that the limits it approves are not in excess of the credit is has established as the maximum for all work undertaken by the contractor. Completion date. ○ Longer contacts generally use more working capital and involve more risk.  Issuing a Bond Factors used to issue a bond. Conditions ○ Special contract conditions can affect the ability of the contractor to successfully perform the contract. ○ It's important for the surety to ensure that payments are made by the owner on a regular basis for work and materials supplied by the contractor. Communications ○ If the contractor communicates to the surety accurate prediction on job costs and profits the surety will be more favorable to release bonding.  License and Permit Bonds Federal, provincial and municipal laws require most businesses be licensed. The licensing provides the government with the following: ○ Source of revenues. ○ Means of regulating the activities of license-holders. All businesses must operate in accordance with statutes, regulations or ordinances designed to ensure the safety and general welfare of the public. Permits fulfil the same general functions as licenses.  License and Permit Bonds There are 5 guarantees provided by various license and permit bonds: 1) Compliance Guarantees Bonds provide the guarantee that the principles will comply with those laws that affect them. 2) Financial Guarantees Bonds usually require surety company to protect the government that granted the license or permit against monetary damages Bonds provide the guarantee that the principles will comply with those laws that affect them.  License and Permit Bonds There are 5 guarantees provided by various license and permit bonds: 3) Indemnity Guarantees This extends provisions contained in the bond to third parties sustaining financial damages. Third parties can claim directly against the surety for monetary damages when licensee fails to comply with statutes, regulations, ordinances or codes. 4) Good Faith Guarantees These state that the principle will act in good faith. 5) Credit Guarantees These are normally required of principles who sell the property of others.  License and Permit Bonds Three (3) characteristics common to all license and permit bonds ○ 1) A bond limit or penalty is determined by the statute or other regulation and is usually quite low. ○ 2) Covers all statutory or other regulatory obligations of the principle and these details are not required to be described in a bond. ○ 3) Term of a bond generally coincides with the term of the license or permit.  Judicial Bonds Judicial bonds are prescribed by statute and depending on the matter may be filed with: ○ 1) Probate Court or, Deals with matters involving the settlement of estates and appointments of guardians. ○ 2) Court of Equity Deals with specific performance of a contract or other equitable remedy.  Judicial Bonds There are two (2) classes of judicial bonds 1) Court Bonds (These include all bonds required in matters of litigation) ○ A) Plaintiff’s and Defendants’ Bonds Plaintiff bonds are issued with plaintiff seeks equitable remedy as opposed to monetary. Defendants bonds are issued if the defendant directs to continue performing a certain act or wishes to retain property in question during the court proceedings.  Judicial Bonds 1) Court Bonds (These include all bonds required in matters of litigation) ○ B) Attachment Bond This guarantees if the court decides against the plaintiff the defendant will be paid any damages as the result of having such property attached. ○ C) Release of Attachment Bond This will release any property of the defendant that the court may have possession over.  Judicial Bonds 1) Court Bonds (These include all bonds required in matters of litigation) ○ D) Injunction Bond This can be obtained from the courts to ensure that the defendant in an action performs or refrains from performing some act or function. ○ E) Appeal Bond It is required of a plaintiff who did not obtain the remedy that was sought sand desires to appeal to a higher court.  Judicial Bonds 2) Fiduciary Bonds ○ Definition – Fiduciary: One who occupies a position of special trust or confidence in the handling or supervising of the affairs or funds of another. There are three (3) main classes of fiduciary bonds 1) Administrators and Executors ○ This is the most common type of fiduciary bond. ○ When a person dies without a will an administrator is appointed to settle the estate. ○ When a will exists an executor or executrix will deal with the estate.  Judicial Bonds There are three (3) main classes of fiduciary bonds 1) Administrators and Executors ○ Duties and responsibilities of administrators and executors Collecting the assets of the estate and preserving them from loss. Paying all debts which have been incurred by the decedent. Providing the courts with accounting documents of all transactions. Distributing all remaining assets.  Judicial Bonds 2) Guardians and Committees ○ Definition – Guardian: “Someone who has been nominated in a will and who is subsequently appointed by the court to manage the affairs of a minor.” ○ If property is left to the minor the guardian needs to file a guardianship bond. ○ The above bond guarantees the fiduciary will Faithfully perform all duties Observe all directives of the court Provide an accounting of all monies and other property when court requests  Judicial Bonds 3) Trustees in Bankruptcy ○ A trustee is appointed by the court to liquidate all assets and to divide all remaining proceeds amongst the creditors. ○ A bond needs filing guaranteeing faithful performance of the duties of the trustee in accordance with rules and conditions as set out in the act.  Miscellaneous Bonds 1) Custom and Excise Bonds All businesses are required to collect provincial and federal taxes or duties on the goods or services sold by them. The above bond guarantees the payment of those taxes and duties. 2) Lost Document Bond The above is required when a valuable paper such as a stock certificate or corporate or government bond has been mislaid or destroyed. Issued on a 1) open penalty or 2) fixed penalty basis.  Miscellaneous Bonds 2) Lost Document Bond 1) Open Penalty ○ The above means that the amount payable by a bond is unlimited. ○ It is used for lost stock certificates or other securities having frequent and varied fluctuations in value. 2) Fixed Penalty ○ The above is used for losses involving certified cheques or investment certificates having a maximum predetermined value.  Miscellaneous Bonds 3) Consignment Bond It is required when goods are left with others for purposes of sale. The above guarantees item is returned if not sold or proceeds paid if sold. 4) Utility Payment Bond The above guarantees payment on utilities. 5) Land Restoration Bond Municipality can require above bond guaranteeing restoration of the land to an acceptable position if worked on.  What Jumped Out At You? Students have two minutes to write down the topic or fact that resonates or sticks in your head the most, from today’s class. No concept is too small! Remember the Forgetting Curve!  Key Terms Surety Suretyship Surety Bond Obligee Principle Penalty Statutory Bond Non-Statutory Bond Contractual Bond Consent of Surety Working Capital Net Worth License and Permit  Your Assignment Please refer to your IGO assignment in your student portal and use information from the Chapter 5 slides to answer the question. You can submit your IGO activity to your facilitator or ask questions in class. For an explanation of the slide information and an answer to the activity, please check out the “IGO Answers” videos in your student portal. Please ask questions if you need to! What are the 8 characteristics of a Surety Bond? (/8)