Volume 50, Issue 9 - September 2015

Don’t Be Fooled
Avoiding Surety Bonding Pitfalls
by Ellen Rogers

Your mother was right. And it has nothing to do with eating vegetables.

She told you to tell the truth; reminded you that honesty is the best policy; stressed that she would always find out if you were dishonest. There was also that matter of cost: Lying never pays … at least not in the end.

Truth, honesty and ethics lay the foundation of success for many businesses. But just like when you were a kid, there is always a troublemaker. Darius X. Johnson is a troublemaker.

Earlier this year Johnson was arrested on a criminal complaint alleging wire fraud and money laundering in connection with his sale of phony insurance bonds for construction of the World Trade Center PATH transportation hub. According to the complaint, between September 2010 and June 2013, Johnson took part in a scheme to steal money by selling fake insurance bonds to contractors working on large construction projects in New York and elsewhere. Specifically, he is said to have sold fraudulent bonds provided by a company called Diamond Indemnity Trust to a construction subcontractor [American Architectural Inc.] which had a $6.2 million subcontract to supply and install glasswork at the WTC Hub. Johnson allegedly provided them with a phony letter of credit falsely indicating more than $6 million was held in Johnson’s attorney/client trust account in Brooklyn, N.Y.

For some contract glaziers, a surety bond, which guarantees to an owner that a project will be built as it’s intended, can be a costly undertaking.

According to the U.S. Department of Justice, after American Architectural paid its premium for the fraudulent bonds, Johnson used multiple transactions and bank accounts to wire a substantial portion of the premium payment to himself and a co-conspirator. In 2012, American Architectural filed for bankruptcy and defaulted on the WTC Hub project, but Johnson and Diamond Indemnity Trust failed to honor the bonds. As a result, the WTC Hub general contractor (Skanska) was forced to pay an additional amount of approximately $2 million to complete the job.

If convicted, Johnson could be fined up to $1 million for the wire fraud count and $250,000, or up to twice the amount of criminally derived property involved in the transaction, for the money-laundering count.

According to Michael Nestor, Port Authority inspector general, “Surety bonds on capital construction projects serve the critical purpose of insuring that the project gets completed in a timely manner, within projected costs, and that the subcontractors and suppliers are paid properly. Fraudulent surety bonds create a dual problem for the construction project and the owner. The premiums are paid out for the surety bonds, and no resulting benefit or protection is obtained.”

He adds, “The defendant allegedly victimized a World Trade Center project that was being rebuilt after the terrorist attacks to line his pockets.”

This recent case drew a significant amount of exposure, possibly given the nature of such a high-profile project. Occurrences like this one, sources say, are probably the exception rather than the norm. Still, you can’t be too cautious, and there are measures contract glaziers can take to ensure this doesn’t happen to them. It starts with understanding who and what you’re dealing with.

Need Help with a Bond?

It can be tough for a small glazing contractor to gain a surety bond. However, there are some programs that can help. The Small Business Administration (SBA), for example, has a program designed to provide and manage surety bond guarantees for qualified small and emerging businesses, in direct partnership with surety companies.

According to its website, the “SBA helps small contractors by guaranteeing bid, performance, and payment bonds issued by participating surety companies for contracts up to $6.5 million. SBA can guarantee a bond for a contract up to $10 million if a federal contracting officer certifies that SBA’s guarantee is necessary for the small business to obtain bonding.”

For a contractor to be eligible the SBA requires:

• The business must be classified as small. The business combined with its affiliates must not exceed the size standard designated for the primary industry of the business together with its affiliates;

• You must need an SBA guarantee to obtain a bond;

• The size of the public or private contract or subcontract must not exceed $6.5 million or $10 million if a federal contracting officer certifies that SBA’s guarantee is necessary to obtain bonding;

• Your business must satisfy credit, capacity and character evaluations completed by the surety company or an agency representing the surety company;

• There must be a reasonable expectation of successful contract performance; and

• The contract must require a bond.
Additional information about the program is available online at sba.gov.

Know Your Stuff

Surety bonding is a third-party guarantee to an owner that a contractor will complete its portion of a project. It’s a common requirement for most contract glaziers.

“Bonding is almost always required on any public project—municipal, local, state or federal,” says Benjamin Feinn, president of Koch Corp. in Louisville, Ky., adding it’s also common on private jobs.

According to bonding agent William Maher, with Dohn & Maher Associates in Palatine, Ill., two common types of bonds relevant to contract glaziers are performance and payment.

“One guarantees you’re doing the work and one guarantees you’ll pay your suppliers,” he says, adding that a project will usually have both. Maher says the bond requirement is typically covered during the bid process.

Gloria Hale, president and CEO of Hale Glass in Placentia, Calif., says while her company doesn’t do public projects, bonding is required on some private-sector work.

“Some of the ones where you have a large contract over $2 million to $3 million [general contractors] will require a bond because they want assurance the project will be completed.” She explains, for example, that if a contract glazier files bankruptcy, the general contractor [or whoever required the bond] would then have to find another company to complete the job.

“To protect themselves, they require a performance or payment bond that’s completed at a price negotiated in the beginning,” Hale says.

Ask Questions

Before jumping into any commitment, it’s important to know with whom you’re working.

Maher suggests finding an agent that specializes in surety bonding rather than working directly through your regular insurance company. He also suggests working with one that specializes in construction and to make sure they are credible and rated by an organization such as A.M. Best.

For instance, the Surety Information Office in Washington, D.C., points out that a number of organizations (see box on page 62) publish lists of rated companies; A.M. Best, for example, gives each company an alphabetical rating and a financial size category. Maher suggests not going lower than an A5-rated company.

Contract glaziers also have suggestions for working with a quality agent.

“I would want someone referred to me,” Hale says. “Look to your insurance agent to refer a bonding agent,” she says.

Carl Miller, president and CEO of Tab Glass in Clearwater, Fla., says reputation is critical. He works through an independent agent who works for brokers in the area where he lives. Miller says he found his agent after attending local construction-industry association meetings.

But he adds, “If I had never had a bond relationship or wanted another one, every agency has different lines they represent. You could go through your regular insurance carrier … [you need an] independent agent who can shop your policies across a range. And if they couldn’t help, they’d suggest someone.”

Feinn also poses some points to consider.

“If a company had never bonded projects … and had a track record of [good] earnings … I would ask, ‘why do you want to get into this?’ Bonding says you’re going for a different type of client and a different type of project— more risk is now involved.”

So if that’s the case, he offers some advice. “The procedures in your office must be crisp; that may not have mattered as much in the past. Also, the other thing is that the bonding company will do common sense financial checks … to see what your financial strengths are to support yourself in a project that goes poorly,” Feinn says. “What’s your lasting power? They will ask for all of your financial documents, and they will interview the principals of the company. If a company has not had bonding in the past it is probably a small company, so they will have to show personal financials for all the principals as well as the professional résumés for all the management.

“The bonding agent is looking for character, so the interview process is very important and needs to be a serious event. Treat it in a professional way. You’re selling yourself. Your job in that interview as a small company is to convince the agent you have lasting power and know what you’re doing.”

Protect Yourself
Over the past three fiscal years, the Justice Department has filed more than 10,000 financial fraud cases against nearly 15,000 defendants including more than 2,700 mortgage fraud defendants.

Visit StopFraud.gov to learn more.

Don’t be Bullied

Bonds may help the general contractor ensure project completion, but they can be a burden for many contract glaziers. Miller, in fact, likens surety bonding to a necessary evil.

“There are financial standards, indemnity agreements and quite a process of underwriting. You need a [good] track record,” he says. “Not just anyone can get a bond over a certain level. It used to be you could easily get up to $250,000 without much trouble. But with the economic downturn, the agents had to pay out on a bunch. They can be very skittish now.”

He explains that companies can’t do certain work unless they are bondable for the amount required. “Companies have a bonding line for which they qualify. Those limits, though, are stretchable and changeable.”

Miller is also quick to point out that bonding is not just for the subcontractor. The general contractor may also have to give a bond to the owner—or should.

“You want a complete circle of trust. If the general contractor is not bonded to the owner, then I’m the only one holding the bag. So you need a case where everyone depends on everyone,” says Miller.

One concern for Feinn is that bonding can restrict a contract glazier’s business.

“Eventually they will run out of bonding. At a certain business level, you can’t go forward anymore,” he says. “That’s always in the back of your mind … you’re always thinking ‘will my agent bond this for me?’”

He adds that, for his company at least, bonding is critical.

“If we don’t have bonding, we don’t have a company. Ninety percent of what we do is bonded, and pricing varies with the size of the project,” Feinn says. “If you line up five contract glazing companies [and look at their] line-of-credit interest rate, you’d likely get five different numbers. You’d probably find it lines up to their general financial health of the company. My bonding percent is different from the next guy, and the lower the amount bonded on a particular project, the higher the bond percent.”

And there are plenty of other concerns. For Hale, this includes personal worth.

“The bond obligates the person filing the bond to commit personal assets. As the owner [of this company] I’m on the line; my personal assets are on the line for my company, and I don’t take that lightly. So I’m very careful about [bonds] and will try all other avenues to avoid one when possible.” These measures could include, for example, pre-qualifying on a greater depth than usual and showing financial performance.

She continues, “You’re obligating yourself, and there is nothing that can be any more serious.” And as Hale points out, “Not everyone is even capable of getting a bond. If you have nothing a bonding company could take, then you’re not going to be insurable.”

To protect herself, Hale looks for language in the contract that can be changed.

“There are usually clauses that general contractors issue to subcontractors saying they can request a performance or payment bond at any time during the progress of the project, and I always cross that out and write ‘non-negotiable,’” she says. “For one, I don’t have an unlimited capacity for bonds. So if I’ve already utilized my limit on other projects, I don’t have the capacity [for this one]. But more than that, bonding companies are not likely to write a bond after the project begins. If you’re halfway through and now the project has run sideways and the general contractor says you agreed to file a bond at any time, you won’t be able to get an insurance company to do that.”

Get to Know Your Surety Company
The following organizations publish lists
of ratings of surety companies:

• A.M. Best;
• Dun & Bradstreet;
• Fitch Ratings;
• Moody’s Investors Service;
• Standard & Poor’s; and
• Weiss Ratings Inc.

Making the Grade

Gaining a surety bond doesn’t always come easy. And there are times when agents are quicker to write one than others.

“Before the economic crash it was simple. It was probably the easiest time [as] companies were not nearly as diligent on underwriting,” says Maher. “Then when things crashed there was much more underwriting involved. Right now it’s right where it should be. Underwriting is going on, there’s flexibility with markets and, if anything, I see it becoming a little more lenient than it should be.”

Now, with the construction market getting busier and busier, what does that mean for contract glaziers?

Maher suggests, “You can increase your gross margins, but you must be careful on the amount of backlog you take. We are hearing that there is a shortage of qualified glaziers since the apprenticeship programs are not teaching young people like in past years.”

And what about fraudulent bonds? Will more construction activity spur more dishonesty? Maher doesn’t think so. “I do not think there is a correlation with the fraudulent bonds. In my opinion, an uneducated obligee can take fraudulent bonds in any market if they don’t review the bonding company and agent before they choose their surety professional.”

Which goes back to even more maternal advice: Do your homework.

the author
Ellen Rogers is the editor of USGlass magazine. Follow her on Twitter @USGlass and like USGlass on Facebook to receive updates.

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No reproduction of any type without expressed written permission.