1. Surety Bonds &Construction Risk Name of Event Organization Date

2. I – Construction Risk

3. “Then You Shall be his Surety” William Shakespeare Merchant of Venice

4. Construction Risk 2015  Construction Risk = Risk of Contractor Failure.  The number and severity of contractor failures increased in recent years.  Recent Challenges:  Reduction of available work; oversaturated market = tighter margins  Onerous contract conditions. Downloading of risk  Paradigm Shift: AFP’s, P3’s

5. Construction Risk 2015  From 2010-14, the Surety industry paid out almost $800 million in claims; more than all of the previous decade.  2013 a year to forget:  Loss ratio; 52% - industry unprofitable  Premiums flat after two years of decline  Across all lines and all sectors of the country  2014 showed improvement with lower loss ratios and premium growth … but….  2015 ? Impact of Oil Prices in western Canada and political and economic instability

6. Construction in Canada 2015  Canada the new construction “mecca”.  Ongoing commitment to infrastructure Federal commitment $48B over 10 years.  By 2020 Canada to be world’s 5 th largest construction market (9 th in 2010)  Increased foreign investment from depressed areas (e.g. Europe)  Larger and longer projects  Challenges to small and mid-sized contractors

7.  Unqualified Contractors; the lowest “irresponsible” bidder  Insolvency of Contractor  Contractor default for non-financial reasons:  Over Extension  Inability to complete  Incapacity of Key people  Unpaid subs and suppliers resulting in liens  Warranty problems Why Contractors Fail

8. Protect Against Construction Risk  Surety Bonds  Performance Bonds  Labour & Material Payment Bonds  Liquid Security  Irrevocable Letters of Credit  Cash/Negotiable instruments on Deposit  Default Insurance Products

9. II – Surety Bonds What are They? How do they Work?

10. Surety is not Insurance

11. INSURANCE  2 party agreement; Insured & Insurer  Premiums actuarially determined  Losses anticipated  No recourse against insured in the event of loss SURETY  3 party agreement; Principal, Surety & Obligee  Premiums only a service charge  No losses anticipated  Recourse against the Principal via indemnity agreement

12. Surety Bonds: 2 Essential Services  Prequalification:  Assurance that the bonded contractor is qualified for the job for which they are contracted.  Security:  Financial Protection in the event that the bonded contractor should default on its obligation.

13. Prequalification Ongoing, Thorough & Value Added  Intensive:  Ongoing  Comprehensive:  Value Added

14. Standard Construction Bonds Prequalification Prequalification Letter Bid Bond Consent of Surety Security Performance Bond Labour & Material Payment Bond Renewable Multi-Year Bonds (service contracts)

15. Prequalification Letter  Not a bond but a letter from bonding company to the project owner confirming “bondability”.  Used during the pre-tender phase; i.e before contract terms, scope or pricing details are known.  Non-binding – surety and principal reserve the right to review the details before firm commitment.  Typically refer to the project at hand.  SAC standard form available on SAC website.

16. Bid Bonds  protection from the “lowest irresponsible bidder”  provide assurance that contractor will:  enter into contract  provide the required security  Typically required in the amount of 10% of tender  if contractor defaults, surety pays the difference between successful bid and second bidder  Tender must be accepted within time frame set out in tender documents  seven months to file suit

17. Consent of Surety  Not a bond at all; a letter of commitment from the Surety to the Obligee to execute performance and/or payment bonds  No penal sum set out; payment not an option  Typically, bonds must be required within 30 days following award  No standard (CCDC) form in existence, many variations in wording

18. Performance Bonds  Guarantees Contractor will perform contract in accordance with its terms & conditions.  Contractor must be in default and the default must be declared  Owner must perform their obligations  4 options available to Surety:  Remedy the default  Complete the Contract  Arrange for new contractor to complete  Tender Payment  Two years to file suit

19. Labour &Material Payment Bonds  Guarantee that the contractor will pay all direct subcontractors, suppliers for materials and services provided to bonded project.  Obligee is trustee on behalf of the claimants  Claimant must have a direct contract with the Principal  Claimants may only claim for goods and services supplied to the bonded job  Claim must be filed within 120 days of the last day worked or the date material shipped  One year to file suit

20. III – Surety Bonds How are they Obtained?

21. Who Obtains the Bond?  Consultant and Owner are not responsible for obtaining the required bonding or other contract security.  Consultant only has to include bonding requirement in tender documents or contract specifications  The contractor obtains the bonding  Selects a professional surety bond broker or agent who assists in submitting case to a surety underwriting company

22. How is a Bond Obtained?  Contractor Submits Financial Statements and other background information to Surety  Participates in prequalification process: an in-depth look at contractor’s business operations and financial structure.

23. Surety’s Financial Analysis  Balance Sheet  Working Capital / Net Worth  Ratio Analyses  Receivable/Payables aging analysis  Work on hand; profitability, maturity, trending  Income Statement  Profitability  Revenue  Trend Analysis; 3 to 5 years  Cash Flow Analysis  Accountant’s Opinion/Explanatory Notes

24. What Else does a Surety Need?  Complete details on Affiliated / Related Companies; ownership, financial information, etc.  Detailed Work on Hand Schedules  Aged Listing of Receivables and Payables  Organization Chart of Key Employees  Detailed Resumes of Principal & Employees  Business Plan & Contingency Plans  Subcontractor & Supplier References

25. What Else does a Surety Need?  Details of construction operations; areas of expertise, list of key projects, key people, etc.  Letters of Recommendations from Owners  Evidence and details of a Line of Credit from a Financial Institution  Details of business continuity plans in the event of death or incapacity of owners/key people  Reports on Similar Completed Projects  Owner, contract price, date completed, profit earned

26. IV– Surety Bonds Myths & Misconceptions

27. Myth #1: Sureties Don’t Respond to Claims.  A surety bond will provide:  Professional prequalification to weed out unqualified contractors.  True performance security; i.e. provides owners with a completed project in the event of default.  Payment protection to subs and suppliers.  A surety bond will not provide:  Cash-on-demand. There MUST be a default.  Dispute resolution.  A “magic lamp”.  Protection beyond the scope of the contract.

28. Myth #1: Sureties Don’t Pay Claims. Also….  Owner must have fulfilled its contract obligations  L & M Claimants must comply with the terms of the bond and be prepared to document claim  Problems or questions? Contact the Surety Association of Canada  Phone:905-677-1353  Fax:905-677-3345  email:sness@surety-canada.com Myths & Misconceptions

29. Myth #2: A 50% Bond only provide 50% Protection 50 percent bond gives you 100 percent protection up to the bond amount Example:  Contract Price = $ 1 million  50 % Performance bond ($500,000)  Contract is 50% complete  Surety arranges completion for $ 700,000  Surety’s loss is ??? Myths & Misconceptions

30. Myth #3: Bonds are a “Barrier” (especially to small contractors).  Barrier? Bonding companies need to write bonds.  Sometimes a time problem – for contractors without a bond company it takes time to establish a facility.  Some sureties will ONLY bond small contractors, others have small contractor divisions  Small firms will secure bonding for jobs within their realm of expertise  Bonds are a barrier to unqualified contractors Myths & Misconceptions

31. Myth #4: Payment Bonds Don’t Help Owners  Ensure that subs working on your jobs will be paid. Many are local rate payers.  Ease the Administrative burden in the event of default.  Reduces the Owner’s Legal Exposure.  More competitive prices from subs who are now certain of being paid  Speedier resolution of a default; continuity of team. Myths & Misconceptions

32. Myth #5: We don’t need a bond; our contractor is huge. Excerpt from “Why Contractors Fail” by Hugh Rice and Arthur Heimbach, FMI Corporation 2007 “Recent history has shown that construction firms are not too big to fail even though they may have annual revenues ranging from hundreds of millions to several billions of dollars.” “There are bonding safeguards to protect project owners and others when a contractor fails.”

33. V – Surety Bonds What Happens when a Contractor Defaults?

34. Before a Default is Declared  Surety has extensive experience with contracts and solving construction problems.  Surety has intimate knowledge of contractor and its operation  Can provide informal assistance to solve problems that can lead to a default  Will convene meeting or teleconference among the parties to address problems.  Assist in formalizing solutions.

35. Claims When A Contractor Defaults:  Surety will promptly acknowledge notice of default and being to gather information.  Surety will begin an investigation as soon as possible.  Surety will conclude the investigation as soon as possible.  If requested by owner, surety will provide periodic written updates on investigation status and best estimates as to completion date.

36. During and After the Investigation:  Surety will cooperate with the owner to protect work from damage or deterioration.  Surety will work with the owner to:  Identify and implement a solution.  Minimize delays, keep the job going and protect the rights of all parties.  Pay valid labour and material payment bond claims as promptly as possible to ensure continuity of subs and suppliers. Claims

37. How can the Consultant Help?  Ensure that you and your client have Complied with bond & contract terms! (e.g. proper notifications, payments and certifications)  Communicate: keep surety appraised of problems and provide default notice promptly.  Cooperate: Ensure surety has access to knowledgeable staff and relevant documents.  Keep expectations realistic.

38. Claim Example 1 Highway Development Project

39. Provincial Government Declares Default on Highway Project Case Background:  The Principal, a road building company, was working on a provincial transportation project when it experienced financial distress and could not complete the project, valued at $5.8MM.  The Obligee, a Provincial Government transportation department held surety security for 50% of the project amount to mitigate both contract performance risk and labour & materials payment risk.

40. Claims Example 1 Highway Development Project Surety’s Action:  The Surety Company advised the Obligee it would start preparing the tender package to complete the work.  The Obligee expressed interest to choose its own completion contractor.  The Surety Company and the Obligee settled for financial payment; where the Surety paid the Obligee the anticipated completion costs.

41. Claims Example 1 Highway Development Project  At the same time, the Surety Company paid out multiple subcontractor and supplier claims under the labour and material payments bond.  Total amount paid out by the surety on this project were $3.3MM.

42. Claims Example 1 Highway Development Project “[this] is certainly a good example of the value of having a performance bond [and labour & materials payment bond] and we were pleased that the bonding company offered flexibility in coming to a solution that met our needs. The negotiated settlement provided advantages to us, as the Owner, in that it gave us control of the work, which enabled the completion to be expedited in an efficient manner…” Owner Testimonial

43. Claim Example 2 Underground Contractor Defaults on 13 Municipal Projects

44. Claim Example 2 Case Background:  The Principal, a sewer, watermain, curb/gutter, and roadwork contractor with approximately $10 million annual sales was forced into receivership when bank called its loan.  A regional municipality was left with 12 unfinished contracts. Another municipal owner was impacted with 1 uncompleted contract as well. Total value of the contracts underway were $7.4 million.  Project contracts were anywhere from $500 thousand to $3 million range.

45. Claim Example 2 The surety:  worked with the owners to ascertain the status of each contract and identified the remaining work to be completed.  obtained quotes for completion of outstanding work, presented these to Obligees and arranged for completion contracts to be executed.  reviewed claims from unpaid 48 trades and suppliers. All claims settled within 72 hours.  total surety payout in excess of $6.7 million. All 13 Contracts completed with no loss to Obligee.

46. VI – Surety Bonds Unseen Services to Owners & Lenders

47. Unseen Services of Surety Bonds A surety can provide assistance and default prevention services to owners & lenders by:  Facilitating the resolution of construction performance issues that could lead to default  Providing management and business assistance to assist contractors with administrative issues.  Providing financial assistance to financially distressed contractors  Providing technical/engineering expertise if required

48. Confederation Bridge New Brunswick to PEI Unseen Services of Surety Bonds

49. Confederation Bridge  Fixed Link from PEI to mainland 12.9 km  3 ½ year project; cost of $800 million. Opened June 1997.  Performance & Payment Bonds provided by a three member co-surety pool.  Owner: Public Works Canada  Contractor: Strait Crossing Development Inc; a private consortium of four companies.  Senior Partner: Morrison Knudsen Inc. of Boise Idaho – 35% share.

50.  Morrison Knudsen; Established 1932, $2.86 billion in sales  1996 – MK files for Chapter 11 bankruptcy protection; threatens survival or project.  Sureties act quickly; arrange to finance MK through to completion to allow for the company to be sold.  Default prevented and project completed on time. NOT ONE DAY OF WORK WAS MISSED.  The local community, the general public unaware of any problems Confederation Bridge

51. VII - Other Forms of Contract Security

52. Liquid Security (LOC’s)  Yield cash; not performance  Provide no prequalification assurance  Available in smaller; perhaps insufficient amounts (5% to 10%)  Deplete a contractor’s borrowing power and can bring on the very problem they seek to avoid  No dedicated protection for subs or suppliers  Work well for financial risks

53. Contractor Default Insurance (CDI)  Introduced in 1996 to protect very large general contractors from subcontractor default.  Indemnity product – compensates for loss incurred  Significant deductibles and co-payment  Insured should have in house construction administration experience and strong cash flow.  Does a good job at providing the protection for which it was designed; i.e. protecting large G.C.’s against construction default.  NOT designed to protect owners from risks associated with default of prime contractor.

54. Large general contractors approaching owners and lenders with a “cost savings” proposal.  Sign on to G.C.’s CDI policy  “better protection, more cost effective better management of subcontractors”, etc.  Save the bond premium. The “CDI for Owners” Non-Solution

55. What they don’t tell you….  CDI is NOT an alternative to Surety Bonds  OWNERS NOT PROTECTED FROM G.C. DEFAULT  Owners have limited or no access to CDI benefits  Endorsement only responds when G.C. is insolvent.  Contracts with unpaid trades are unenforceable  If Prime Contractor should default: No Protection  “Cost Savings” are minimal or non-existent.  CDI protects Contractors; NOT Owners

56. Waiving Final Bonds  Owners Save the bond premium by calling for bid security and waiving requirements for final bonds.  Penny-wise; Pound Insane.  Contractor failure can bring catastrophic consequences if not adequately managed.  Contractor failures on the rise as the economy continues to struggle.  NO contractor; large or small is immune to financial and economic forces  Morrison Knudsen: from Fortune 500 to Chapter 11 in two years.

57. VIII – e-Bonding Did someone mention “paperless” ??!!!

58. Issues and Challenges  Commercial  Legal  Technological  SAC’s Efforts to Address the Issues & Challenges Electronic Delivery of Bonds

59. Commercial Issues & Challenges  SAC encourages and promotes electronic delivery of surety bonds.  Don’t Act on your own. Will only work with industry buy-in.  Flexibility; evaluate; establish criteria and standards, leave it to others to find a way to meet them..  Electronic equivalent of a courier.

60. Legal Issues & Challenges  PIPEDA passed by parliament in 2000. Umbrella legislation  Each jurisdiction followed with its own legislation over the next two years  Challenge: What about seals?  Deed vs Contract - “Deemed” sealed, overt act of sealing will constitute seal equivalent. Verbiage not sufficient.  Friedmann Equity vs Final Note – Supreme Court of Canada

61. Technological Issues & Challenges  Technology is in place; systems have been developed and marketed in Canada and U.S.  All systems are NOT created equal; different focus; different capabilities  Criteria:  Integrity of content;  Secure access  Verifiable / enforceable

62. SAC & e-Bonding  Publications on SAC website:  Designing Electronic Pathways Together.  Vendors Guideline.  Criteria checklist.  Position Paper: Surety Bonds in a Digital World.  Working with owners and vendors:  Mock Tender – Defense Construction  Development of template language for inclusion in tender documents.

63. Tips for Owners & Consultants 1)Consult Consult Consult: Without Buy-in from other stakeholders, the advantages can be squandered. 2)Don’t Reinvent the Wheel: Learn from what’s been done. Are you in the software development business? 3)Insist on Verifiability… whatever the approach, know that the bond is valid and enforceable.

64. 4)… But be Flexible About Everything Else: Allow vendors to find ways to meet the criteria and standards you set. 5)It’s Up to You: Initiative has to come from owners and end-users. SAC can provide guidance but only you can start the journey 6)Take the Time to Get it Right: Pilot projects; Phase-in implementation. Allow for time to work out the kinks and for the industry time to adjust. Mock Tenders. Tips for Owners & Consultants

65. IX – Surety Bonds &The New Paradigm Discount Surety Company Good News – I hear the paradigm is shifting

66. The New Paradigm There are still too many contractors in the business and there will be a shakeout, but if you are good, there will be work for you. The market has favoured larger builders over smaller ones. The smaller guys are getting squeezed because the projects themselves have grown. Five years ago, who would have heard of a billion dollar project, but now there are two in the Toronto area alone and business models are changing too. Now you have to design, build, finance and, if you are smaller it’s become tougher. Geoff Smith – President & CEO; EllisDon

67. Bigger, Longer & Tougher  New Models of Project Delivery and Procurement  P3’s, AFP’s  Bundling  Building Information Modeling (BIM)  The need and the will to address Infrastructure deficit  Already here, small to mid-sized contractors feeling the squeeze  Just Starting

68. …and Faster - Technology  Last 20 years, internet, social media…etc… revolutionize business and life.  Gen Y …Gen Z … the “WrRU” generation  Demand for instantaneous information and immediate satisfaction.  Pressure for quicker, more expedient resolution to construction and other business problems.

69. Evolving Political Environment  Globalization of the construction industry with the collapsing of trade barriers  Canada Europe Free Trade Agreement, Plurinational Trade Service Agreement  Participation of large multinationals will increase completion further.  liquid balance sheets and demand for liquid security

70. The New Paradigm The business model is changing, but there is no way to really predict how it is changing. Ask our clients what they want from us, and they aren’t exactly sure yet. I spend a lot of time at night thinking, ‘Okay, how will it all work out?’ Geoff Smith – President & CEO; EllisDon

71. X – So What are we doing about it??

72. SAC Performance Bond  SAC consultations with Owners & Contractors;  More “certainty” in the claims process.  More responsiveness to a claim  More frequent and effective communication between sureties and owners. New “enhanced” performance bond provides construction buyers with more timely &responsive claim service.  Has been used by owners across the country and will be adopted by CCDC as the new standard.  Provides more responsive services to owners by…..

73. SAC Performance Bond  Pre-Demand Conference to allow surety and owner to prevent problems from turning into a default.  Timelines for Surety’s Response:  5 days to acknowledge a response & request info.  21 days (from receipt of information) for surety to respond to owner with their response.  Emergency Remedial Work: Allows Owner to address urgent issues (e.g. safety) under the bond.  Post-Demand Conference: Mechanism to minimize or eliminate work stoppages while surety investigates.  Contact Coordinates: Contact information for all parties to facilitate notices and communication.

74. Surety Bonds & P3 Projects  Comprehensive performance & financial security against construction default on mega-P3 projects.  Sufficient capacity for mega-projects.  Broad and flexible protection packages which include:  Professional surety prequalfication  Specialty P3 bonds designed by member sureties:  Provide liquid / cash on demand protection.  Built-in “fast-track” dispute resolution  Early Response; surety involved pre-default.  Protection for trades & suppliers via the payment bond.  Called for on Infrastructure Ontario Build-Finance and Design-Build-Finance projects.

75. Renewable Multi-Year Bonds  Only applicable to service contracts; e.g. Waste Management, Snow Removal, etc.  Initial Term is open. Renewal Terms are typically 1 year periods can be extended to two.  Surety issues an annual Renewal Certificate.  Failure to renew the Bond is not a ‘default’ under the Contract or the Bond  2-year suit limitation – runs from earlier of expiry of latest bonded ‘Term’ or date default declared  Can be modified to address O&M components of P3’s

76. Headstart Performance Bond TM  Created by The Guarantee Co of N.A. to protect GCs from sub default (competitive alternative to SDI)  Industry Solution: available for use by other sureties.  Flexibility: Obligee given two mitigation options: o Traditional Option: Surety investigates and implements solution (as in standard bond); or, o Headstart Option: Obligee implements its own solution upon surety’s acceptance of Obligee’s completion proposal.  Responsiveness: o First dollar protection(no deductible or co-payment). o Surety will respond in 3 days from receipt of Claims letter. o Standard claims notice and mitigation agreement.

77. XI– Protecting your Investment

78. Unlicensed Sureties  Firms who are unlicensed have not been subjected to any regulatory scrutiny  May not meet minimum capitalization requirements for the conduct of surety business  Real risk that unlicensed firms may be unable to honour claims obligations LET THE BUYER BEWARE

79. Unlicensed Sureties Two Suggestions for Owners & Consultants:  Accept only bonds issued by duly licensed surety firms. We suggest that the this be specified in the tender specs and contract  If there are any doubts about a surety company’s status or any clarification needed, contact the Surety Association of Canada

80. Protecting your Investment A construction contract should include the following language : The contractor shall provide a performance bond in the format of CCDC 221 and a labour and material payment bond in the format of CCDC 222 each in the amount of 50% of the contract price. Bond so provided must be issued by a surety company licensed to issue surety bonds in.

81. SURETY ONLINE LEARNING CENTRE  The Surety Online Learning Centre accessible from SAC website; www.suretycanada.com.www.suretycanada.com  Five learning modules that introduce the basics of surety bonds and the suretyship process  Learn at your own pace.  Ideal for review or for colleagues who can’t attend a “live” information session.  It’s FREE

82. Contact Us Phone:905-677-1353 Fax:905-677-3345 email:surety@suretycanada.com or visit ourwww.suretycanada.com website: