Subcontractor Bonds for Prequalification and Risk Management

Utilizing Subcontractor Bonds for Prequalification and Risk Management

Whether you are a paper general contractor subcontracting nearly 100% of work or a prime engineering firm subcontracting work scope you do not self-perform, subcontractors are often extremely important contributors to a project. Because of this, it is critical to perform both prequalification and contractual risk management to avoid problems.

Some solid risk management procedures include properly structured subcontracts which include flow-down of contractual responsibilities from the prime contract, indemnity provisions holding the G.C. and owner harmless, minimum insurance requirements for general liability, work comp, and auto as well as safety plans. I would also recommend using subcontractor bonds either as policy above a specified subcontract dollar value or used selectively for new or unfamiliar subs. Requiring bonds from your subcontractors allows you to outsource the prequalification and vetting process on the front end while offering performance and payment security from the bond itself.

Benefits of Subcontractor Bonds:

• 3^rd Party Prequalification Services – when underwriting support of a subcontractor’s bond request, a surety will review financial strength and current performance, credit history, management capability, equipment, reputation, as well as project factors like size, scope, and geographic location.
• Performance Security – the Performance bond will guarantee the contractual clauses and provisions laid out in the subcontract agreement. If the subcontractor is not performing its obligations under the contract, a claim can be made under the performance bond.
• Payment Protections – since liens are typically not available on public projects, the Payment bond protects subcontractor and supplier tiers downstream from the bonded subcontractor.
• Requiring a bond from your subcontractor can also add incentive and focus on a particular project as surety companies typically require both corporate and personal indemnities to back the bond.

A prime or general contractor can also benefit from using subcontractor bonds when they are requesting a bond outside of their normal size or scope.  The G.C.’s surety company will gain comfort in knowing the subcontractors have been prequalified and offer performance security. Amongst their underwriting considerations, knowing subcontractors are bonded can go a long way towards supporting a large or unique bonded project or spike backlog for their G.C. client.

Do Subcontractor Bonds Reduce The Size of Bond I Need?

One misconception I hear often is that using subcontract bonds will reduce the amount of the prime contract bond required, and this is not the case. We should keep in mind these are distinctly separate contractual relationships. The prime contract bond covers the entire contract for the owner’s protection and offers no protections for the G.C. Whereas, subcontract bonds required by the G.C. protect them from performance and payment risks. Another issue that can often be confusing is considering a project “double bonded” when both the prime contract and subcontracts are guaranteed with bonds. For the same reasons as stated above, the protections offered by the bonds are not “doubled”, they are applied to distinctly separate contracts and protect different parties.

If your construction firm often operates as a subcontractor, it is a good idea to have your bonding relationship in place and up to date so you can respond if a G.C. requires bonding. From a marketing standpoint, another benefit of establishing your bonding is being able to tell prospective G.C.’s or owners you are bondable and including a letter of bond-ability with your proposals. Normally, we write these letters as an ongoing service for our clients free of cost and it can make a big difference in being selected for a project.

Schmalz & Associates is an agency exclusively supporting contractors bonding needs. Eric Schmalz was an underwriter and manager for over 15 years working for Top 10 surety companies and now helps his contractor clients establish and maximize their bonding.  Please call 512-640-6444, email eric@schmalzsurety.com or visit the website at www.schmalzsurety.com

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This article was originally published in the February 2021 issue of Austin Construction News.