Funds Control: A Beneficial Tool for Contractors
Funds control is a beneficial tool that aids recently developed and emerging contractors or contractors having financial difficulties. Another name for funds control is funds administration or escrow. A surety can condition approval of a bond by requiring the contractor to use the funds control tool. The surety hires a third party, “funds control administrator” to handle the monetary portion of a project, on occasion the surety will have an in-house funds control department. In addition to the signed General Indemnity Agreement the contractor already has with the surety, an agreement will be signed with the funds control company. This additional agreement defines the terms of fund administration such as how the contractor is required to submit their draw requests and the timeline of when the funds will be paid to not only the contractor, but the subcontractors and suppliers. The obligee (project owner) will also sign a disbursement agreement with the funds control company acknowledging that the payments will be directed to a proposed project specific bank account. The new bank account is opened by the funds control company in the contractor’s name (or company) to ensure payments are distributed according to the terms of the funds control agreement.
Although the process seems complex, it is quite simple; refer to the diagram below.
Funds control can be viewed in a negative light by contractors due to the cost, reputational risk, and lack of control of the funds. Sureties use funds control as a risk mitigation tool to prevent contractors from job borrowing, whereby bonded contract funds are transferred to and used across other projects. The cost of funds control is on average 0.25-1% of the project cost; with the rate being dependent on the size and complexity of the specific project.
Here’s why funds control is beneficial to all parties:
Funds control ensures the cash flow from the project stays on the project.
Funds control makes each project a stand-alone financial transaction.
Funds control helps alleviate the risk of job borrowing.
Funds control protects against payment bond claims.
If the contractor’s backlog of unbonded jobs goes bad, there is usually enough money to complete the bonded job.
Funds control can be a beneficial option in the following circumstances:
A contractor who is stretching for a project larger than their financial position would generally qualify.
A contractor who has a large amount of backlog that their financial position does not support, bonded or unbonded.
A contractor who has had recent set backs.
A contractor with open, bonded projects with other surety carriers.
Alternatives to funds control are collateral in the form of cash, irrevocable letter of credit (ILOC), or in extremely rare circumstances real estate. Alternatives can be difficult to obtain and overall can be more costly than funds control.
While Funds Control is an unfamiliar mechanism to some obligees, they can benefit in being educated the value it provides. Obligees are required to enter into an agreement to deposit the payments to the contractor through a shared project bank account. The goal of an obligee is for the project to be completed to the contract standards without liens. Therefore, obligees appreciate funds control as an additional protection.
Funds control is a beneficial tool to assist in securing bonding or additional surety capacity. It is imperative that all parties of the project understand the funds control process before agreeing to move forward.
At Parrot Surety Services we work with contractors to find the best surety options tailored to your company and projects. To establish a connection with a Parrot Surety Producer and obtain recommendations to improve or optimize your access to surety credit, give us a squawk at 615-205-5080 or info@ParrotSuretyServices.com
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