You may have heard these terms used in connection with Performance and Payment Bonds. They are similar in some ways, but have different purposes. Let’s talk about their purpose and how they can help you as a surety bond producer.
Also called Funds Administration or Escrow is a procedure that always originates at the request of the surety. The contractor applying for the bond (the Principal) is receiving a conditional approval. The underwriters are confident that there is expertise, labor, equipment sufficient to perform the bonded contract, but the contractor has some financial issues. The underwriter is willing to bond the contract, but has reservations regarding the handling of money and payment of bills. Funds Control can provide a level of protection for the surety and allow the bond to be approved.
In a normal contract, the project owner (Obligee on the bond), is required to pay the contract funds to the Principal. This is usually in monthly payments, each for the work recently performed.
Under Funds Control, the money handling is taken away from the contractor and moved to a party chosen by the surety and empowered by the Principal. The surety will require that the contractor execute a letter of instructions directing the obligee to pay the Funds Administrator instead of them. The administrator becomes the paymaster on the project paying all suppliers of labor and material, and paying the principal, too. This procedure eliminates most of the risk for claim on the Payment Bond. (*Why not 100%?)
There are companies that are professional Fund Administrators. They may be well known to the surety and handle a series of contracts that the surety wants to bond. A dedicated bank account is opened for the contract, and checks are issued each month which are then distributed by the principal to the vendors. In some cases, the surety may perform the Funds Administration in house.
This arrangement also involves the contract funds being redirected to a third party, instead of being paid to the contractor. And similar to Funds Administration, the point is for the Tripartite Administrator to be the paymaster on the contract.
The primary difference between the concepts is that there is no bond when a Tripartite Agreement is used – it is in lieu of a P&P bond and actually only replaces the Payment Bond.
Federal regulations regarding Tripartite Agreements: A tripartite escrow agreement. http://www.acquisition.gov/far/html/Subpart%2028_1.html
“The prime contractor establishes an escrow account in a federally insured financial institution and enters into a tripartite escrow agreement with the financial institution, as escrow agent, and all of the suppliers of labor and material. The escrow agreement shall establish the terms of payment under the contract and of resolution of disputes among the parties. The Government makes payments to the contractor’s escrow account, and the escrow agent distributes the payments in accordance with the agreement, or triggers the disputes resolution procedures if required.”
This procedure may be used for contracts between $30,000 and $150,000. The Performance Bond can be waived at the contracting officer’s discretion.
These procedures have different advantages for each party. Let’s examine them.
FC= Funds Control
TA= Tripartite Agreement
- FC – means they are getting a Payment protection and a Performance Bond. The surety will monitor the project and step in to keep things on track (and prevent a claim or default) if necessary.
- TA – Even unbondable contractors can be awarded work. A TA may be less expensive than a bond with FC.
- Both processes result in the contractor not handling the project funds.
- TA – No need for personal or company indemnity, or collateral for the surety. Financial reporting, legal fees and other expenses may be less.
- Limitations: Only permitted on small contracts. Fails to build a track record of “performing under bond.”
Subs and Suppliers:
- With both procedures they are paid by a professional intermediary, which may be more dependable and faster.
- However, there is no opportunity to claim against a surety bond if they are unpaid, or not fully paid. What is their recourse?
Agent and surety:
- TA – No Bond!
- FC – there is a normal P&P Bond