As a condition for maintaining an active contractor’s license in California, all contractors must file a $15,000 license bond with the Contractors State License Board and this amount has generally increased over time to keep pace with inflation. An exception to this rule allows contractors to post $15,000 cash with the CSLB in lieu of a bond, subject to certain restrictions. Is this a viable strategy, and if so, under what circumstances should contractors consider this alternative? Let’s look at the pros and cons of each option to see which solution is most advantageous for contractors.
Pro’s of Posting Cash In Lieu of a License Bond
Potential Cash Savings
Posting cash in lieu of a bond will save a contractor the amount of their annual bond premium. Bond premiums can range from anywhere around $100 per year for contractors with good credit, to well over $1400 for those with bad credit or other licensing issues. Some contractors with exceptionally poor credit or unpaid bond claims may have trouble obtaining a bond at any price. Clearly those individuals with poor credit have much more to gain in the way of bond premiums by posting cash vs. those with good credit, though this is a high risk, high reward trade-off.
Potential Cash Flow Stability
The cost of bonding can fluctuate greatly from year to year based upon many factors, with credit being among the most important. When posting cash with the CSLB, the cost of a bond alternative will always be $15,000, which is refundable in the event a contractor remains claims free. In addition, if a contractor posts a certificate of deposit or passbook savings account, they do maintain rights to any interest earned during the period in question.
Con’s of Posting Cash in Lieu of a License Bond
Lack Of Liquidity
Contractor’s considering posting cash with the CSLB should be aware that their $15,000 deposit will not be released by the CSLB until the earlier of three years after the expiration of a contractor’s license, or three years after a contractor’s license becomes inactive. The three year waiting period is implemented by the CSLB to cover claims that may occur against a contractor at a future date, including after a contractor ceases operations. This time constraint is a huge detriment when factoring in the time value of money and is likely a deal breaker for most contractors considering the option of posting cash, even for those with poor credit.
Time Value of Money
Contractors with good credit will pay a little less than 1% of the face value of a bond in premiums per year, while those with poor credit will pay a little more than 10%. When considering whether to post cash or a bond, a contractor with $15,000 liquid cash should carefully consider what return on investment they could get with their cash if they choose to invest the principle and purchase a bond at market rate. For those with good credit, investment returns exceeding 1% (the cost of 1 year’s bond) might be manageable, while those paying 10% or more in bond premiums as a percentage of a bonds face value have much more to gain by posting cash. Put another way, what interest rate would a contractor have to pay, assuming they have poor credit, if they tried to get an unsecured loan for $15,000 from a financial institution to use as collateral with the CSLB in lieu of a bond? This gives a clear cost of funds analogy and assuming an unsecured loan was provided, the interest rate would likely be well in excess of 10%, the approximate cost of bonding.
What Happens In the Event of a Claim?
Contractors and sureties share a common objective in wanting to avoid bond claim payouts whenever possible as it’s financially detrimental for both parties. However, attorneys hired by a surety to investigate a potential bond claim are much better equipped to validate or refute a potential claim as compared to a contractor that has posted cash. Contractors posting cash are responsible themselves for defending potential bond claims. With this in mind, contractors posting cash may have to invest significantly in both time and money to protect their $15,000 deposit in the event of a claim, giving sureties a natural advantage in this area.
While each contractor should carefully weigh the benefits of posting cash as compared to the cost and associated benefits of purchasing a bond, for some contractors bonding may be a better alternative as a result of the liquidity restrictions with posting cash, and the foregone associated benefits of bonding. This seems to play out predictably in reality as the overwhelming majority of contractors choose bonding as opposed to posting cash. While posting cash may make sense under certain circumstances, contractors looking to post cash should carefully review the rules and guidelines established by the CSLB before making any final decisions. Contractors may want to seek legal or professional advice prior to drawing any of their own conclusions.
For more information on the requirements of posting cash with the CSLB, please click here.
By Jeremy Schaedler