What is funds control? And when is it necessary? As a contractor, can it be advantageous to understand this concept before applying for a bond?
In this article, you’ll learn how funds control works and how it protects contractors and sureties during the bonding process.
What is funds control?
Funds control is a process that allows a surety company to monitor and control the flow of funds on a construction project. This is done by requiring the contractor to receive their funds from a third party, such as a funds control agent or a trust account.
The third party then acts as an intermediary between the contractor and the surety, ensuring the funds are used for its intended purpose and disbursed according to predetermined guidelines.
Funds control can be used to protect and reduce risk for both the contractor and the surety during the bonding process.
How does funds control work for contractors and sureties?
When a surety requires funds control, the contractor will be instructed to deposit all project funds into a designated account. A third party will control this account. This third party (a funds control agent or trust company) will then be responsible for disbursing funds to the contractor per the surety company’s instructions. They’ll verify that the funds are allocated appropriately, such as for payment of labor, materials, and subcontractors.
All parties involved must sign an agreement about the funds control plan. The contractor must also pay the funds control company to manage the process for them. The cost is typically between 0.5% and 1% of the contract value.
Why is it necessary?
Funds control is a risk management tool for the contractor and the surety.
- For the contractor, it provides an opportunity to demonstrate financial responsibility and gain access to bonding capacity that might otherwise be limited.
- It ensures that project funds will be used appropriately, reducing the risk of mismanagement, project delays, or default.
- It helps protect all parties involved and maintains the integrity of the bonding relationship.
When should a contractor use it?
Funds control may be required when the surety has concerns about the contractor’s financial stability, previous performance, or ability to manage project funds responsibly. It is typically more common for contractors with lower bonding capacity or those facing financial challenges. The surety makes the decision to implement funds control based on their assessment of the contractor’s risk profile.
Here are several scenarios where it may be appropriate:
- It can protect the surety if someone files a claim against the contractor’s surety bond.
- It can prevent contractors from using funds from one project to complete a separate contract.
- It’s typically required on larger or more complex construction projects. This is because these projects are more likely to be at risk of default.
- It can also be required on smaller projects, depending on the surety company’s risk assessment.
Pros and Cons of Funds Control
Pros
- Protects the surety company from financial loss in the event of a default
- Helps ensure the project is completed on time and within budget
- Ensures project funds are appropriately allocated, preventing misuse or diversion
- Empowers contractors to secure bonding capacity that may otherwise be challenging to obtain due to financial limitations
- Provides peace of mind for both the contractor and the surety company
Cons
- Could be an added administrative burden for the contractor, requiring them to coordinate with the funds control agent and adhere to additional guidelines for fund disbursement
- Can increase the cost of the project for contractors (i.e., administrative fees)
- May cause a slight delay to the start of the project due to the involvement of a third-party agent (which could impact cash flow)
Funds control is a risk management tool that protects contractors and sureties during bonding. By understanding this concept, contractors can better navigate the surety bonding requirements and improve their access to bonding capacity. Contact the experts at ZipBonds for more information.
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