Deposit Protection Insurance: DPI Unpacked

Deposit Protection Insurance: DPI Unpacked

By Peter Williams

 

Every year a significant amount of new home transactions are pre-sales. This is especially true in the multi-unit markets around our provinces’ urban centres. Pre-selling gives developers a level of revenue certainty, gives banks comfort that the product has committed buyers and from that, allows construction financing to flow once agreed-upon sales targets are achieved. Pre-selling a significant amount of the total units has become a standard practice in our market. 

Prior to 2005, all funds received as deposits for purchases of homes had to be held in trust until the project was completed and the unit was delivered to the new homeowner. Millions of dollars sat idly in trust accounts for years while projects came out of the ground and were eventually completed. 

What changed on January 1, 2005, were sweeping changes to the Real Estate and Development Marketing Act. The changes allowed developers to now use those pre-sale deposit funds to pay for direct project costs for the projects themselves. This was a landmark change and allowed all that hard-earned capital to be put to work building the project it was earmarked to buy. Not only did these changes make sense, but they were also embraced by the industry. 

Despite the obvious benefits to the developer, uptake on the product was slow at first. It took some time for all stakeholders to become familiar with and comfortable with this new form of project financing. There was a learning curve. Now we can say, deposit protection insurance (DPI) is mainstream; it is a box to be checked for most brokers arranging the capital stack for their developer clients. 

For the developer, the economic benefits are compelling. They will save the spread between the annual premium rate of the DPI and the costs of capital of the debt replaced by the deposits. The savings are significant and are there every year until project completion and the unit turned over to the homeowner. For the banks, the credit ratios are improved and some projects on the line may move forward with the improved financial metrics. 

To apply, it is recommended the developer use an experienced broker to assist in putting together the information. The information itself is fairly straightforward with most of it mirroring what the developer has already provided to the primary lender. This along with a questionnaire and construction lending agreement are generally what is required to move forward. The underwriting process of DPI follows a similar path to that of the other lender(s).

This includes reviewing the viability of the project from a financial perspective. Examining the overall budget and proforma’s, along with key credit metrics, are important in determining the financial wherewithal of a project. This is done in conjunction with reviewing the developers overall financial strength and project experience. 

The development team is an important factor when a project is reviewed for DPI. This includes: project lenders, general contractor, subtrades, architect, consultants (structural, geotechnical, building envelope, mechanical, electrical), lawyer, marketing firm, mortgage and insurance brokers. A strong development team assists in mitigating the challenges that arise on projects. This provide stakeholders with an increased level of confidence that solutions are found swiftly and implemented effectively.  

As with all forms of construction, issues can arise during the different stages of the building process. The construction approach to that risk is assessed at the outset. This includes the developer’s project experience and key staff if they’re self-performing. If an arm’s-length general contractor or construction manager is hired, the merits of the form of contract are considered (fixed price vs construction management). Subtrade risk is an important factor, as the quality of subtrades can have a substantial impact on a project and its schedule. Contract performance risk and subtrade payment risk can be further mitigated and managed through construction bonding. Performance and Labor & Material’s bonds are an important tool developers can utilize to manage construction risk and control major cost components. 

Your broker’s experience is important through the underwriting phase and ultimately in the Facility Agreement you ink with the DPI provider. Some of the key aspects of your facility are the security provided, the premium charged and the deposit release terms. The earlier funds are released, the sooner economic benefits are realized and for a longer period. Once terms are agreed upon and finalized, security is then drafted up in conjunction with the lenders in the capital stack. When the security is finalized funds can then flow into the project according to the agreed-upon release terms. 

The savings are substantial and the product has evolved into an important and mainstream component of development financing. It’s a competitive and dynamic market out there and your broker will guide you through the process and ensure you get the best deal.

 

The views expressed in this article are exclusively those of the author; they do not necessarily reflect the views of Trisura Guarantee Insurance Company, its affiliates or partners.

Federal Government Support for Construction amid COVID-19: A Surety Perspective

Federal Government Support for Construction amid COVID-19: A Surety Perspective

Federal Government Support for Construction


COVID-19 Impact on the Construction Industry

The construction industry is a significant part of the Canadian economy representing 7% of the country’s GDP and employing over 1.4 million people in 2019. In the past, governments have mitigated the impact of economic slowdowns through fiscal stimulus, including funding infrastructure and construction projects as a means to stimulate the economy. The 2008 financial crisis is a recent example of fiscal stimulus focused on “shovel ready” projects supporting the construction industry. Support for these projects created employment, economic activity and helped to mitigate potentially more severe consequences of the financial crisis.

During the COVID-19 crisis, many construction projects have been identified as an essential service to ensure the completion of vital infrastructure, housing and healthcare projects. Unfortunately, other significant, but ‘non-essential’ projects have been shut down or progress has been significantly impaired. In Quebec, almost all construction work has been completely shut down. Contractors will face severe economic hardships as a result of COVID-19 resulting from revenue impairment, delay costs and input cost escalation. They will face challenges including supply chain interruptions, labour shortages and contaminated job sites. At the same time revenues have decreased, they will bear unplanned safety costs, costs associated with temporary site closing and security. Contractors who have borrowed to finance their operations also face interest expenses that accrue even during periods of inactivity, as well as principal repayments unless their lenders are willing to defer those payments.

A large proportion of Canadian construction companies are small to mid-sized businesses, in many cases family owned. The reduction in revenue and increased costs will weaken the balance sheets of small businesses disproportionately vs. their larger peers. Many will need financial assistance to weather the COVID-19 pandemic.

It is important that these essential businesses remain solvent. Once pandemic restrictions end, Canada will need these construction companies ready to employ Canadians to complete existing projects and undertake anticipated “shovel ready” stimulus work. Alberta announced a $1.4 billion commitment for capital maintenance and renewal for 2020-21, and it is speculated that the federal government will accelerate the $180 billion ‘Investing in Canada’ plan that remains largely unspent.

As Canadians emerge from social distancing, construction companies will need assistance to finance the costs of re-mobilization. This includes payroll in advance of project revenues, and working capital to take on new projects and secure surety bonds.

Surety Bonds in Canada

The majority of publicly funded construction contracts require that surety bonds (performance and labour and material payment bonds) be posted by the contractor to the public authority. Ontario’s Construction Act requires all such public projects are bonded in the province. Most other provinces are currently in the process reforming builders’ lien acts, are addressing prompt payment concerns and are contemplating the mandatory use of surety bonds on all public projects as they are in Ontario.

Surety bonds are a form of performance security where a Performance Bond guarantees the contractual obligations of a contractor and a Labour and Material Payment Bond guarantees labour, subcontractors and suppliers will be paid. Contractors qualify for surety bonds based on their creditworthiness. The credit assessment is similar to that for a commercial loan. Balance sheet strength, working capital, prior experience and capacity are all elements of the surety’s assessment of a contractor. Generally, contractors with stronger balance sheets and working capital will qualify for higher levels of surety support. However, unlike a bank, a surety is not collateralized for the surety credit they authorize and the surety bond liability they assume.

In 2017, the Canadian Centre of Economic Analysis (CANCEA) published a study called the Economic Value of Surety Bonding in Canada [CANCEA Report]. The CANCEA study concluded that the benefits of surety bonds in high risk economic conditions are as follows:

  • $25 of economic activity is recovered per $1 of premium paid
  • $3 of tax revenue is recovered per $1 of premium paid by all levels of government
  • 200 job-years recovered per $1 million of premium

As a result, in these extremely difficult economic times, surety bonds will be instrumental to help ensure the integrity of publicly funded stimulus projects.

Following the COVID-19 crisis, many construction contractors will face significant financial difficulties; some may face insolvency as a result of the pandemic. Those that survive will struggle with an impaired ability to re-start their business and may not qualify for conventional loans. Qualification for surety bonds is based on the creditworthiness, so any significant impairment of financial strength will negatively impact a contractor’s ability to both finance construction projects and to qualify for surety bonds. As stimulus projects are tendered, a healthy marketplace will require a diverse and active pool of contractors bidding the work.

Government Financial Assistance for Construction

Financial assistance for the construction industry will ensure that contractors survive the shutdown period and are positioned to re-start their business, employ workers and qualify for surety bonds once restrictions are lifted. The federal government has announced strategies for financial relief for businesses through loans, guarantees and wage subsidies. We urge the federal government to consider a specific strategy for the construction industry, given the importance of the sector to stimulate the Canadian economy. We suggest that this could be a two-stage process:

Stage 1 – Pandemic Restrictions & Economic Shutdown:
During the period of slower economic activity, contractors may need support to remain solvent. Federal government loans or guarantees to commercial lenders, coupled with relaxed credit assessment criteria and deferred repayment terms, will help contractors survive while revenues stall. If guarantees are made to commercial lenders, separate “pandemic” loan facilities can be established to keep relief proceeds separate from previous commercial loans. However, the terms and conditions of such loans must be uniform and consistent across all lenders and for each of their clients. Both BDC and EDC are vehicles available to the federal government to offer such financial assistance.

Additionally, the Canadian Construction Association is advocating an Emergency COVID-19 Construction Cost Relief Program that will be critical alongside expanding the eligibility criteria of the government’s wage subsidy program to aid contractors in maintaining key staff to be prepared when the shutdown period end.

Again, these contractors will be needed once the shutdown period ends to employ workers and build shovel ready projects.

Stage 2 – Stimulus Period:
Once pandemic restrictions lift and business operations resume, contractors will require access to working capital to fund the cost of re-booting their business. Such financial assistance from the federal government could be in the form of loans/guarantee with favourable interest rates and repayment deferrals.

Access to Surety Bonds:
Contractors will require access to surety bonds to bid new projects while pandemic restrictions are in place and more importantly, once restrictions end and the stimulus period begins. Unfortunately, contractors’ financial strength will be impaired and financial information reflecting the impact of recent shut downs may not be immediately available. EDC often structures reinsurance arrangements on behalf of Canadian companies and provides guarantees to primary surety companies in the event normal market capacity is not available. We understand that EDC’s “domestic powers” have been extended due to the pandemic. Reinsurance support from EDC to licensed surety companies could be an efficient way to maintain construction companies’ access to surety bonds during these uncertain times.

Government assistance specific to the construction industry will ensure Canada is well positioned during the stimulus period while the construction market stabilizes. Consensual time extensions to existing contracts and assistance with loans/guarantees from BDC and EDC to help with liquidity during the start-up period will aid construction companies, and additional initiatives to support contractors encountering increased costs will provide further assistance. However, companies will ultimately need revenues restored for when deferred liabilities such as taxes, workers compensation premium, debt payments and deferred costs materialize. Government stimulus through investment in shovel ready contracts during the recovery stage will be critical. For contractors to begin work, sufficient working capital and access to surety bonds will necessary and the government can bridge these issues.

Trisura’s Commitment

Trisura supports initiatives championed by the Canadian Construction Association and many other federal, provincial and local construction associations. With the support of federal government-backed loans with adequate repayment deferrals, Trisura would consider such assistance as part of the contractor’s own equity as opposed to debt that must be serviced. This will favourably boost underwriting ratios that are used to assess creditworthiness.

In addition, with the support of EDC, Trisura is willing to commit a dedicated pool of risk capital to back surety bonds for contractors negatively impacted by COVID-19.

Trisura stands ready to work with the construction industry and with all levels of government in developing practical solutions to the challenges that will be faced by all stakeholders as we emerge from the COVID-19 crisis. Reinsurance offered by EDC is one such method which is familiar to the surety industry and would increase the available bonding capacity in the marketplace.

Trisura is a proud Canadian owned Surety company. We primarily support the small to medium sized businesses which are critical to the Canadian economy. Further, we are committed to innovation and delivering solutions to boost both the industry and the economy. We developed an online Contractor Bond Portal to qualify surety for small contracts, as well as Trisura Bond Portal for non-construction commercial surety products. In addition, we are the only surety in Canada to have developed its own technology to deliver electronic bonds as project procurement methods continue to evolve.

Trisura is committed to meet the challenges ahead and do our part to ensure the Canadian construction industry is successful in helping to stimulate the economy post COVID-19 and restore the market to a stable environment.

What happens when a construction project is delayed by the owner?

What happens when a construction project is delayed by the owner?

By Samin Bidhendi

 

The notion of delay in construction projects has been the subject of many discussions and debates. When can an owner be deemed to have delayed a project and what happens next?

Before a contractor can assert that the owner has delayed the project, several boxes must first be ticked. The result not only depends on when the delay occurred, but also when the contractor became (or should have become) aware of the delay and took corrective measures.

What happened, what must happen and what will happen are all contingent on numerous variables. What is eminent, however, is that the contractor cannot “walk off” the project on the account of owner-imposed delays without taking appropriate and reasonable actions that are specified in the contract and are in accordance with applicable laws governing the project.

Alleviating impact costs from this sort of delay, depends on the timing, language and terms and provisions of the signed contract between the contractor and owner. The contractor’s rights and remedies in recovering its impact costs varies significantly depending on the time in the project timeline. The terms of the  contract with the owner also governs the contractor’s entitlement and its ability to recover potential impact costs. It must be kept in mind the contractor has a duty to mitigate these impact costs as well.

 

What happens if an owner delays a project just after tender closing?

What happens if an owner delays a project just after tender closing?When an owner delays a project just after the time of tender or defers the award of the contract and delays the commencement of the work, the contractor is bound to the terms and conditions stipulated in the Form of Tender or any other tender document(s) provided to all bidders. The tender documents typically comprise an “acceptance” period, during which the owner can review and select the bids and award the project based on its prescribed tender terms but most likely to the lowest price bid. Although most tender documents are quite one-sided and only speak to the owner’s rights and remedies in the event of a failure by a bidder, the contractor can rely on the same timelines and the stipulated period of validity of the bid to invalidate the tender agreement. Contractors need to be mindful of any overlap between the proposed period of Work and the Tender Acceptable period specified in the Contract documents.

 

What happens when an owner delays a project after award?

When an owner delays a project after the issuance of the Notice of Award/Notice to Proceed and signing of the contract documents, the contractor has entered into a new agreement/contract with the owner. The terms and conditions that either party is required to follow, therefore, depend on the provisions of the contract documents and not the tender documents. Once a tender is awarded and a contract is executed, the acceptability or validity of the bid is no longer of question nor the determining factor. Once a contract is signed and a commencement date is agreed upon—whether by a Notice to Proceed or an accepted construction schedule (or perhaps submitted schedule)—both parties must begin and complete the project within the specified or otherwise agreed upon time frames including applicable milestones.

When an owner causes delays to the commencement of the project, the contractor must first establish the cause of the delay. What happens when an owner delays a project after award?If the root cause is that the owner requires changes in the scope of the work, the contractor must follow the provisions of the contract for changes in the work and satisfy any requirement regarding changes, to seek compensation and to amend the contract price for the cost associated with the changes. This also ensures the contractor’s entitlement to any necessary adjustments in the contract time to reflect the additional time required due to the delay imposed by the change in the work. This might also reflect additional time due to the seasonal restrictions of the new or original contract work.

When the nature of an owner-imposed delay is unknown or not associated with changes in the scope of the work, the contractor must follow the contract provisions for delay in the work. The contractor must follow any notice provisions in the contract to ensure entitlement for a time extension and additional compensation. Notices must be submitted in writing and must clearly identify as such. Notices covered within other forms of correspondence may not be deemed acceptable, thereby jeopardizing the contractor’s ability to pursue any rights it may otherwise have under the contract. It is also the responsibility of the contractor to ensure that a discrete notice is submitted for each individual issue.

Notwithstanding the nature of an owner imposed delay, in the event of a dispute between the owner and the contractor, the contractor must refer to the dispute resolution mechanism stipulated in the contract. The dispute resolution process will outline the steps which must be taken by both parties and what the contractor’s rights, remedies and obligations are under the contract. It should be noted that the contractor must continue with the work in dispute until and unless the contractor is instructed otherwise. In some contracts, it is stipulated that the dispute resolution process may only commence once the affected work, or the project as a whole, is completed.

Undoubtedly, the timing of the delay plays a significant role in the extent of the delay and the quantum of damages incurred. However, regardless of when the delay begins, the contractor would be in default of the contract for abandoning work and “walking off” the job if they do not adhere to proper processes and avenues granted for changes, delays and disputes in the contract. If the contractor is deemed in default of the contract, the owner can pursue damages its suffers through legal proceedings or make a claim on the contractor’s performance bond or other performance security it might hold or retain its damages from unpaid contract funds.

The contractor must always read its contract and protect its interest with prompt written notice to the owner of any changes it faces during the course of a project that are different then what was tendered.

 

Frequently Asked Questions:

Frequently asked questions1. Can a contractor walk away from a project if the owner delays award?

Most tender forms stipulate a period of validity of the bid. If an owner exceeds the specified time frame in awarding a contract without any negotiations with the bidder and the tender security facility, the contractor can either assume that its bid was unsuccessful, or open negotiations with the owner if possible. However, within the period of validity, contractors are bound to their submitted bid, and refusal to enter into a contract or perform the work may open them up to damages and claim on its bid security.

 

2. Can a contractor walk away from a project if the owner delays commencement of the work?

No. Once a contractor submits a bid, it enters into an agreement with the owner and forms a binding contract. That contract is further followed by a second agreement upon award of a project. This then forms a second contract between the owner and the contractor. Once either of these contracts are formed, neither the contractor nor the owner can walk away from the agreements without recourse.

 

3. Can a contractor walk off a job if the owner delays the work for extensive changes?

Frequently asked questionsNo. Most contracts include provisions on how to address changes in the work and what measures and remedies are available to the contractor. To reserve its right and ensure entitlement, the contractor is required to follow the contract provisions closely and provide the required written notices and other documentation to preserve its rights. Although some changes may result in a material change to the scope of work, contractors must honour their contracts with the owner and follow the stipulated procedures to terminate the contract effectively. Failure by the contractor to adhere to contract requirements regarding changes or delays in the work could result in default by the contractor, which may ultimately prompt a lawsuit and claim on the contractor’s performance bond.