Agents increasingly advising contractors to hire bonded subcontractors

With general contractors experiencing pressure on a variety of fronts, independent agents are playing an increasingly important role on the construction site. As general contractors work to complete jobs on schedule, within budget and according to specifications, they rely on subcontractors to do the same. Unfortunately, many subcontractors are having difficulty meeting commitments due to labor and supply shortages, and even the best can make scheduling errors, mismanage payments to employees and vendors, and more.

Given the prevailing market dynamics, independent agents increasingly are advising general contractors to require subcontractors to be bonded — minimizing general contractors’ financial risks and bolstering their risk management programs.

To bond or not to bond?

If a subcontractor fails to execute, it can spell disaster for the general contractor who can ultimately be held financially responsible. Couple this with the rising costs of materials, the ongoing supply chain issues and the widespread labor shortage, and contractors could face a variety of risks in today’s market. While it very often makes sense for a general contractor to require subcontractors to be bonded, that’s not always the case, in particular, if replacement subcontractors and materials can be easily lined up. The following are key considerations of experienced agents:

1. Size and importance of the subcontract: Is the subcontractor performing a large-scale job that is critical to the completion of the project and has subsequent jobs dependent on its completion, such as electrical or plumbing?
2. Size of the bid spread between a subcontractor and other bidders: How far is the subcontractor’s bid away from other subcontractors’ bids? If the bid is significantly lower than the other bids (more than a 10% difference), did the subcontractor ensure nothing was omitted? In some instances, bids on the extremes may indicate a lack of experience or forecast a potential issue in the subcontractor’s ability to pay employees and/or suppliers if the actual cost is more than anticipated in the bid.
3. Past work experiences, financial strength and payment history of a subcontractor: Does the subcontractor have a proven history of performance, including payments to its employees and suppliers?
4. Availability of replacement subcontractors in the event of a default: Is the subcontractor performing specialized work? How easy would it be to replace the subcontractor without impacting the overall project timeline?
5. Specialty materials or equipment within a subcontractor’s scope: Is the subcontractor responsible for ordering special materials or arranging equipment rentals? What would happen if an incorrect delivery date is provided, the wrong material is ordered or materials are held for late payment, resulting in a delay in the overall project timeline?
6. Aggregation exposure: Is the subcontractor performing multiple types of work on any one job or is the subcontractor working on multiple jobs for the general contractor? What would the impact be to one or all jobs if that subcontractor unexpectedly became insolvent?
7. Previous experience with the subcontractor: Is the subcontractor considered a new working relationship for the general contractor? In some situations, a general contractor’s preferred subcontractor may be unavailable. In that case, would the general contractor want protection for new relationship’s performance?

Benefits of subcontractor bonds

By requiring bid bonds from subcontractors, general contractors can guard themselves against increased costs that may be incurred if a subcontractor does not enter the contract. At the same time, it provides assurance the subcontractors were prequalified by a surety underwriter, ensuring they have the experience and financial means to complete the project.

Subcontractor performance and payment bonds help to mitigate the financial harm associated with the risk that the subcontractor will fail to complete the project according to the contract terms, and helps to ensure bills for labor and material incurred by the subcontractor will be paid.

Requiring subcontractors to be bonded is an important step general contractors can take to mitigate their project risks. Contractors can leverage the knowledge of carriers and agencies that are deeply experienced in the intricacies of construction surety bonding. By analyzing bonded subcontractors and looking into the current state of subcontractors’ financials, current roster of projects and more, a carrier can offer important information to help general contractors protect their businesses. The Hanover can assist independent agents and general contractors in creating the right surety program for their unique needs.

James H. Kawiecki is the president of surety at The Hanover. An industry leader with more than 30 years of experience, Jim has served in a variety of leadership roles in the industry and has extensive expertise in strategy, sales, and marketing and distribution for contract surety.

Opinions expressed here are the author’s own.

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