Introduction to Surety Bonding for Contractors

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Introduction to Surety Bonding for Contractors
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1. Suretyship

• The principles of suretyship have been used to
  guarantee the performance of obligations since
  the advent of the written word.

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2. Surety Bonds

• A surety bond is an instrument under which one
  party guarantees to another that a third will
  perform a contract.
• Contractor or Subcontractor Principal
• Project Owner, General Contractor Obligee
• Surety Company - Guarantor

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3. Types of Construction Surety Bonds

• Bid Bond
• Performance Bond
• Payment Bond
• Lien Release Bond

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A. Bid Bonds

• Guarantee that the bidder, if awarded the
  contract, will enter into the contract at the bid
  price and furnish the prescribed performance
  and/or payment bond(s). Bid bonds perform an
  essential function as a filter to exclude
  frivolous and unqualified bidders.

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B. Performance Bonds

• Assure the performance of a written contract and
  protect the obligee from financial loss if the
  principal does not perform. If the principal does
  not complete the project in accordance with the
  terms of the contract, the surety can be
  requested to take control of the project and
  secure completion.

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C. Payment Bonds

• Guarantee payment to certain subcontractors,
  laborers and suppliers for the labor and material
  used in the work performed under the contract.

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4. Prequalification

• Three essential traits of a contractor

• CAPACITY
• CAPITAL
• CHARACTER

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a) Capacity

• Can the contractor perform the obligations of the
  contract?

• Technical skill
• Management
• Qualifications of personnel
• Employee retention
• Exposure and progress on other contracts

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b) Capital

• Does the contractor have the financial strength
  to fulfill the terms of the contract?

• Financial condition
• Audited financial statements
• Working capital
• Debt structure
• Liquidity
• Leverage
• Credit history
• Banking relationship and line of credit

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c) Character

• Historically, how has this contractor performed?

• Experience and reputation
• Industry niche
• Length in business
• Relationships with subcontractors, laborers,
  material suppliers, architects, engineers and
  owners

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5. The Services of a Surety

• Assurance of project completion
• Pay for project completion, up to the amount of
  the bond
• Arrange for project completion
• Take over construction project

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5. The Services of a Surety (cont.)

• Financial protection
• Most comprehensive risk management tool to
  address construction default
• 200 protection 100 payment and 100
  performance
• Subcontractor default
• Guarantees subcontractor payment to laborers and
  suppliers

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5. The Services of a Surety (cont.)

• Proactive claims handling, which often averts a
  default
• Financial assistance to contractors
• Project support
• Deters cronyism in procurement
• Ensures level playing field for all contractors

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5. The Services of a Surety (cont.)

• May lead to lower costs for construction
• Subcontractors may consider the protection
  offered by a payment bond(which is generally
  supplied at no extra cost when purchased in
  tandem with a performance bond) and not include a
  contingency for non-payment
• No cost for administration of payment affidavits
  or lien rights procedures

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5. The Services of a Surety (cont.)

• Protects small, emerging, minority- and
  women-owned businesses in particular, as they are
  the most likely to be devastated by nonpayment on
  a single project
• Relieves owner from risk of loss arising from
  liens filed by unpaid subs
• Protects public funds
• Unencumbers government personnel who dont have
  to manage the claims process of subcontractors
  and suppliers

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6. Miller and Little Miller Acts

• Heard Act (Federal predecessor to Miller Act)
• Reference to usual penal bond
• Additional obligation of prompt payment for labor
  and materials (contemporary payment bond)
• Public owners valued and used surety as
  protection long before they were required to do
  so.

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6. Miller and Little Miller Acts (cont.)

• Miller Act (Federal current)
• Bonds are required on all federal construction
  projects exceeding 100,000.
• Payment protection is required on all federal
  construction projects exceeding 25,000.
• Little Miller Acts (States)
• Mostly lower bond thresholds than federal law -
  but varies by state.

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7. Surety versus Alternative Products

• SURETY BONDS

• DEFAULT INSURANCE

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Prequalification and Underwriting Services

• Surety
• Impartial, rigorous process performed by surety
  to screen out unqualified contractors and
  subcontractors

• Default Insurance
• Prequalification performed by owner or contractor
• Subcontractors have no assurance of ability of
  contractor to performs the work

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Coverage

• Surety
• Performance and payment bonds each cover 100 of
  contract price or deductible
• Premium is only charge (fee for services)

• Default Insurance
• Limited to aggregate limit, each qualifying loss
  limit and indirect sub-limit
• Deductible and co-payment apply
• Losses below qualifying loss threshold not covered

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Coverage (cont.)

• Surety
• No sublimits on covered damages
• Surety pays loss

• Default Insurance
• Liquidated damages, acceleration and delay costs
  are treated separately and subject to separate
  limit
• Owner or contractor must pay losses initially,
  then seek reimbursement from insured.
• No protection for subcontractors

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Exclusions

• Surety
• None

• Default Insurance
• Purchase orders / subcontractors
• Losses by inaccurate warranties or covenants
• Defaults prior to issuance, but during contract
  term

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Term of Coverage

• Surety
• Not cancelable by any party
• Provides protection against legitimate claims
  until time expires as stated in contract or until
  statute of limitation or response expires

• Default Insurance
• Insurer may cancel policy for certain reasons
• Restriction on length of coverage

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Claims

• Surety
• If default occurs, the surety completes, arranges
  for, or pays for contract completion up to the
  amount of the bond

• Default Insurance
• Owner or contractor must manage completion of the
  contract then file claim with the insurer

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Risk

• Surety
• Surety holds the risk for the contract completion
  and payment to subs and suppliers

• Default Insurance
• Owner or contractor retains portion of the risk
  through deductibles and co-payments

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Legal

• Surety
• Required by federal and state law on public
  projects
• Established history of case law
• Terms and conditions defined in statutes,
  regulations and case law

• Default Insurance
• Not required by federal or state governments
• No history of case law, legal precedents or
  claims history
• Terms and conditions not defined outside of the
  policy

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8. Cost of Bonds

• The surety views the premium as a fee for the
  suretys underwriting. Specifically, the surety
  charges the contractor for the rigorous, in-depth
  financial and personnel analysis that a surety
  undertakes in order to assess a contractors
  bondability. Generally, the surety bond premium
  is 0.5 to 1 of the total contract price. For
  large projects, the percentage of the contract
  that is charged as a premium decreases.