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Subguard Insurance - A General Contractor’s Risk Management Option for Defaults by Subcontractors

Subcontractor defaults often cause major problems for construction projects which, in turn, cause problems for the General Contractor vis-à-vis the Owner.  A potential solution comes in the form of Subguard Insurance.  It provides the General Contractor a way to cover a subcontractor default without the need for the General Contractor to finance the default from the contractor’s own funds, which is normally the situation in a project involving a performance bond.  And so, if a General Contractor wants insurance coverage for the costs associated with a default by a Subcontractor on an enrolled project, there is an alternative to subcontractor surety bonds


Subguard Insurance is an insurance policy that indemnifies the General Contractor for direct and indirect costs incurred as a result of a default of performance by a Subcontractor.  In the Subguard policy, a “default of performance” means a failure of the Subcontractor to fulfill the terms and conditions of the construction subcontract, which results in a loss to the General Contractor.   This is broad language that can afford broad protection.


The Direct Costs that are covered under the Subguard policy are the costs of completing a Subcontractor’s obligations, sums a Subcontractor is required to pay to third parties, and the cost of correcting defective or nonconforming work.  Direct Costs also include fees of attorneys and consultants, as well as expenses associated with the investigation, adjustment, and defense of disputes.  The Indirect Costs that are covered under the Subguard policy include extended overhead, job acceleration, delay costs, liquidated damages, and other expenses associated with a default of performance. 


Consider an illustration of the type of coverage that a Subguard policy could conceivably provide to a General Contractor who expends money to maintain the schedule and complete/correct the defaulted Subcontractor’s work.  Suppose a Pile Driving Subcontractor defaults after 1,000 of 2,000 piles are driven.  In our hypothetical, Subguard would indemnify the General Contractor for the cost overrun to finish the remaining 1,000 piles, for the cost of re‑work, for payment to unpaid sub-subcontractors and suppliers, for the cost to accelerate the project with respect to other trades, and for extended overhead due to inefficiencies caused by the Subcontractor’s default.


This type of coverage sounds expensive.  Fortunately, the General Contractor has two options to consider when purchasing a Subguard policy.  The GC can either enter into a retrospective premium agreement or purchase a policy with a high deductible.  If the contractor manages risk well and does not experience a high frequency or severity of subcontractor defaults, there is an opportunity for premium to be returned to the General Contractor with a retrospective premium agreement.  If the General Contractor chooses to carry a high deductible on its Subguard policy, the cost of Subguard Insurance is less than the cost of subcontractor performance and payment bonds. 


Some additionaladvantages of Subguard Insurance versus surety bonds for a General Contractor are the following:  the insurer is contractually obligated to pay within thirty (30) days of receipt of a proof of loss; there is no dispute resolution process required to trigger coverage; and indirect costs are covered.  All of which increases the likelihood of completing projects in a timely manner and within the budget. 


In addition to the advantages for the General Contractor who purchases Subguard insurance instead of requiring surety bonds from its Subcontractors, there are corresponding advantages for Subcontractors.  The most obvious is that Subguard Insurance eliminates the need for a surety bond from a Subcontractor, potentially preserving the subcontractor’s surety capacity for other projects.  It also eliminates the need for an indemnity agreement or personal guarantee from the Subcontractor.  It allows the General Contractor to default the Subcontractor without terminating the subcontract, thus allowing the Subcontractor to continue to work on the project. (It is interesting to note that the GC has complete control of the default process.  The insurer cannot request the GC to withhold funds owed to the Subcontractor to cover the costs of the default.  This allows the GC, if it is to the GC’s benefit, to continue paying the Subcontractor to prevent the Subcontractor from stopping its work on the project.)   Because there is no surety bond, it gives the Subcontractor control of its claim defense without the surety’s involvement in the project.  Note that, at first blush, Subguard Insurance appears to eliminate the competitive advantage of a Subcontractor with a favorable surety program (price and capacity).  While it is true that a worthy but unbondable Subcontractor can be selected by the General Contractor to do work on the project, the General Contractor would be wise to select a Subcontractor with a favorable surety program, good financial strength, and a reputation for operational excellence because a default by a Subcontractor will affect the Subguard policy premium during the term of a rolling retrospective premium program. 


A Project Owner also receives some advantages when the General Contractor purchases a Subguard policy.  One such advantage is that Subguard Insurance is looked on favorably by lending institutions that finance large projects.  Another advantage is that the Project Owner is less concerned with defaulting subcontractors because the Subguard policy provides funding in the event of a subcontractor default.  A third advantage is that the Subguard insurance policy provides cash for curing the Subcontractor default which has the salutary effect of keeping the project on‑time and on‑budget.  A fourth advantage is that the Subguard policy provides coverage for latent defects caused by a defaulting contractor for ten (10) years after substantial completion of the project. Finally, the Project Owner benefits by the fact that a General Contractor can often secure a performance bond under favorable terms if the Subguard policy is in place. 


Subguard Insurance is not for every General Contractor.  The GC must be a substantial commercial or industrial general contractor to qualify for the insurance coverage.  The GC must be a contractor who understands, accepts and manages risk as part of the normal course of its business.  The GC must have a revenue base that includes a high volume of subcontracted values.  Typically, $75 million of enrolled subcontractors’ values annually would be the norm. 


Subguard Insurance is a first-party insurance policy.  As such, it does not cover third‑party injury claims.  Accordingly, the General Contractor needs a general liability insurance policy and other traditional coverages.  Additionally, the Subguard policy excludes professional services provided by the General Contractor.  It is not an Errors and Omissions policy.  Subguard Insurance is written on an “occurrence” basis (risk attaching) and not a “claims made” basis.  A proof of loss must be made at the earlier of the expiration of any applicable statute of limitations, expiration of any contract limitations period, or ten (10) years after substantial completion of the subcontract. 


In conclusion, Subguard Insurance offers a cost‑effective alternative to requiring the purchase of surety bonds by the subcontractors on the construction project.  It increases profitability so long as losses are controlled.  It promotes on‑time and on‑budget projects.  Finally, in the event of a subcontractor default, control of the project continues to remain with the General Contractor.