Overview

Owners and general contractors both share in the financial exposure defaulting subcontractors have on their projects, and while the general contractor bears the greatest burden it is in the best interest of both to manage that risk as best as possible. The larger the project the more likely significant defaults will cause material financial losses, and could even undermine a general contractors ability to sustain the impact. Given the current economic climate, and considerations for what reduced construction activity has on profit margins and the strain a number of companies will experience as a result of reduced revenue, the risk of subcontractor default needs to be managed as efficiently and cost effectively as possible.

On projects large enough general contractors can purchase "Subguard", a risk management product that allows the general contractor to insure against some of the costs associated with a defaulting subcontractor. While effective in managing and mitigating a catastrophic loss it requires substantial financial participation by the general contractor, and is a form of “risk retention”. A significant benefit of Subguard is the internal flexibility it provides the general contractor in managing a situation that could result in a default. There is no potential adversarial relationship that is often associated with sureties of non-performing subcontractors which often affect a surety’s ability to respond satisfactorily.

On projects that do not meet the size requirements of Subguard, or a general contractor that prefers risk transfer over risk retention for certain subcontract risks, an alternative is to bond those subcontractors. An historical weakness in bonding the subcontractors was the communication of the ongoing progress of the “risk” to the surety that wrote the bond so they were aware of a potentially deteriorating situation that could result in default. Getting that information to the surety has been limited by the constraints of a paper based system. That, coupled with the negative implications such communications have on the general/subcontractor relationship, have often resulted in situations where the surety is the last to know a problem exists. By the time the surety is notified the situation has often deteriorated to the point where the time required for the surety to understand the obligation is longer than the general/owner has and the delays further adversely impact the project and compound the dispute. A common criticism of surety bonds are they are merely a right to sue, or a source of recovery after years of litigation, and not an effective partner at a critical time.

Simply put, the surety based risk management program uses evolving technology to improve the communication to the surety so that they can be an effective partner at that critical time because they were engaged instead of absent. With effective engagement with sureties participating on a project, and the shared objective of risk mitigation, comes effective risk transfer.

Because the surety based risk management program has no minimum size requirements it can be implemented by any size general contractor on any size project, based on individual risk management strategies.

Effective risk transfer benefits the general contractor, and by extension the owner. Effective communication and engagement benefits the surety. Collectively the program will improve access to surety credit for all subcontractors, particularly small and emerging contractors, which benefits all. Subguard does not provide any of these benefits.