Unauthorized bonds, issued by fake sureties, continue to create problems all over the country. Small and minority-owned contractors are especially vulnerable to these nefarious companies and individuals who prey on un-bondable contractors as well as unsophisticated project owners.
If bond claims are left unsatisfied, projects are delayed or unfinished and subcontractors and suppliers go unpaid. But how can you determine if a bond is a valid obligation or a worthless piece of paper?
In the corporate surety system, surety bonds protect the project owner from contractor default and also guarantee subcontractors and suppliers are paid. Contractors are screened through the surety underwriting process that is designed to weed out unqualified contractors. In order for this system to work properly, some contractors will be denied bonding for a variety of reasons: poor credit, lack of financial strength or inexperience.
Certified Vs. Unauthorized Sureties
Corporate sureties must be licensed by each state in which they conduct business. They are subject to strident regulation at the state and federal levels. Minimum capital levels must be maintained to ensure the continued solvency of each corporate surety.
An authorized surety must be certified by the U.S. Treasury Department. This certification is a financial stress test that indicates the maximum single bond amount a surety can issue. This is known as a “Treasury Limit.” The larger the surety’s net worth, the larger its treasury limit. Sureties that are not certified by the U.S. Treasury are not authorized to issue bonds.
A legitimate surety will also have a financial rating from AM Best Company. This rating system is designed to measure a company’s financial stability. Some states and project owners require a surety to carry an “A” rating.
Unauthorized sureties operate outside of this tightly regulated structure. They have not been vetted, by either the U.S. Treasury or AM Best, nor are they licensed by any state insurance department.
Confusing the issue of unauthorized surety, the federal government rules allow “individual surety” bonds so long as the bonds are backed by sufficient assets. And because the decision to accept an unauthorized bond is at the contracting officer’s discretion, it can be relatively easy for a fraudulent bond to be used. This unfortunate legal loophole has all too often given a green light for unauthorized sureties to promote their bonds as valid obligations. Imagine the disaster if individuals were allowed to provide loans without the strict regulations required of banks?
Know what surety writes the company’s bonds and verify they are legitimate. Note that the surety is not the agent who sold the bond. Look for the bond company name on the indemnity agreement and the bonds provided. Check to make sure the surety is registered on the U.S. Treasury Circular 570, which lists each surety’s contact information, Treasury limit, and the states in which they are licensed.
Is the Bond Any Good?
Sometimes, it’s the bond agent who gets greedy and commits fraud. Here are some red flags that indicate the agent has sold a phony bond.
- The bond form is completed by hand. The only thing more unprofessional is if they used a crayon.
- The bond does not include a power of attorney. All corporate surety bonds have a power of attorney attached which authorizes the agent to execute, or bind, the obligation.
- The power of attorney is invalid. Check to make sure the information on the power of attorney is correct and makes sense – date matches the bond date, name is the same as the person signing, company seal present.
- The bond does not have the surety’s corporate seal. Only properly licensed and appointed agents are provided with surety company seals. These are embossed, or raised, seals that may contain the surety’s name, logo or other information about the company.
Is the Surety Company Legit?
It doesn’t take a bond expert to detect an unauthorized surety company. Following are a few ways to spot surety fraud schemes.
- There is no bond agent involved. Most sureties only work through their licensed agents. If the surety seeks out directly, proceed with extreme caution. This is the MO of most unauthorized sureties.
- There is little or no underwriting process for a large bond. Large bonds (over $400,000) will require standard information, including financial statements, to be submitted and reviewed. If the bond approval is based on minimal information and the applicant’s credit is bad, chances are it is not a legitimate surety.
- The bond premium is very high. Most sureties use rates ranging from 1 percent to 3 percent of the contract amount. If the bond premium is larger than 3 percent, it probably is a fraudulent bond company.
Just Give me the Bond!
Unfortunately, the fake bond company will try to take advantage of a contractor that needs work badly and doesn’t want to lose the contract. A smart contractor won’t let these pressures cloud business judgment. Following are just a few examples of what can happen if the bond is unauthorized.
- The bond is rejected. Giving a fraudulent bond to a governmental entity is a game of Russian Roulette. The obligee may accept the bond and the project completed without a claim. But if the obligee performs any type of due diligence, which only takes a few minutes online, it will reject the bond. To keep the contract, the bond will have to be replaced, which will be difficult or even impossible.
- The bond premium is not refundable. If the bond is not acceptable, forget about getting any money back. The unauthorized surety doesn’t have a return policy.
- The bond is accepted. Even if a fraudulent bond is accepted initially, the project owner may need to contact the surety and if they don’t respond an investigation could be triggered. If the bond is found to be fraudulent, it will need to be replaced. Replacing a bond after the work starts is seldom possible.
- Legal expenses. A bogus bond can cause all sorts of legal problems and financial duress. The project is delayed. Subcontractors and suppliers sue for non-payment, while at the same time, the project owner stops payments and may sue for default.
- Criminal charges. Believe it or not, a contractor that knowingly posts a fraudulent bond is subject to felony charges that can carry large fines and even jail time.
Issued for unsuspecting contractors and accepted by uninformed project owners, fraudulent bonds continue to wreak havoc in construction. While not all fake bonding schemes can be detected, most fraud is preventable with the use of a little caution, due diligence and common sense.