City Discovered a Better Way To Bond?

We ran into a situation this week where a public body “the city” took an unusual approach to bonding a project. Maybe they invented a great new way to bond / protect public work!No payment bond to protect suppliers of labor and material! (How could we be so stupid all this time?)Bidders must provide evidence that a maintenance bond can be supplied. It is for a fixed amount, approximately 10% of the estimated contract amount.To address the risk that the contractor may perform the work incorrectly, the city is using a prequalification process to evaluate each proposer.Our readers may recognize that this approach is not normal. Maybe the city has invented a new way to adequately protect the interests of the tax payers, or it may just be a bad idea.

On the plus side, since the cost of the bond is included in the contract amount, the city may have saved about $3,000 for the tax payers. That’s the approximate difference between the cost of a traditional 100% performance and payment bond as opposed to this maintenance bond issued for a lower dollar value.However, this fails to take into consideration the time and expense associated with the pre-qualification process. Who devised the evaluation criteria? Who performs the actual review? Presumably there is an evaluation of prior experience, human and physical resources, financial condition including other contractual obligations, credit status, and the plan for performance of the work. How long does the evaluation of the bidders take and how much does it cost? Is it more than $3,000?

Regardless of how expertly the pre-qualification is performed, projects can still have problems and defaults. In fact, disputes are normal in construction. When they boil over, it can be detrimental to the project owner (the city) costing more time and money.In the absence of a performance bond, what solution is available to the taxpayers if a contractor does fail in the midst of the project? The city would be forced to conduct an evaluation regarding the remaining portion of the work, then re-advertise the project and spend additional time and money to bring in a completion contractor. (Contractors expect to make exceptional profits when performing a rescue.)Another potential issue arises from the responsibility to pay suppliers of labor and material.The city plans to rely on the maintenance bond, but what happens under the default scenario? If the contract is not successfully completed and accepted, there will be no maintenance bond!

If they do get the 10% maintenance bond issued, who pays if they set the arbitrary bond amount too low? What if there is a 15% problem, not too hard to imagine. Again, the taxpayers lose.In light of the significant downside risk associated with this strategy, it is hard to imagine how the city concluded it was prudent. The approach taken by most public bodies is to require a 100% performance and payment bond. Everyone hopes the project will go smoothly with related bills paid on time. The reality is that most jobs do, but not all.Bear in mind, on a typical bonded project, the underwriters exercise a high level of scrutiny over who they support. Bonding companies are risk averse. This means highly trained professionals evaluate each contractor’s capabilities and only provide the bonding support when they have passed all the tests. Underwriters do this for a living. For them, it’s not a sideline.Our conclusion is that this alternative strategy places an unnecessary risk on the tax payers. Let’s face it, bonds are an economical way to screen the contractors, assure successful performance and guarantee bills are paid. The 100% P&P bond requirement is normally statutory because it is the most efficient way to protect the public interest.