Surety bonding is necessary in construction, particularly on federal and Florida public projects where the contractor is required to furnish a payment and performance bond. Even certain owners of large-scale private projects want their contractor to obtain a payment and performance bond. Understanding the nuts and bolts of surety bonding is valuable for the contractor that wants to increase job opportunities and/or increase their bonding capacity.
There are three main parties to the surety bond:
1. The surety– the entity (typically, a division of an insurance company) that issues the payment or performance bond for the contract price; the surety guarantees obligations on behalf of its principal, whether it is the performance of the contract (performance bond) or the payment to those entities working under the contractor providing labor, services, or materials (payment bond)
2. The principal – the entity (contractor) that procured the bond from the surety and who the surety is issuing the bond on behalf of; the principal along with personal and corporate guarantors will execute a General Agreement of Indemnity before the bond is issued outlining the rights and remedies of the principal/guarantors and the surety
3. The obligee – the entity (or entities) that can make a claim against the bond and who the bond is ultimately designed to benefit
Not every contactor can get a payment and performance bond. This means that not every contractor can perform public work that requires a bid bond to be furnished with the bid/proposal and then a payment and performance bond upon the award of the contract. This is because sureties undertake rigorous underwriting to best assess their risk before issuing bonds. And, many contractors, even if bonds are issued, will have a bonding capacity meaning the surety will not issue an unlimited dollar amount for the bond(s) issued or will not issue an unlimited number of project bonds at the same time. Rather, it will issue a bond or bonds totaling the bonding capacity of the contractor.
To obtain a bond, a contractor will go to a surety bond agent/broker, commonly referred to as the producer. The producer represents select sureties. Certain sureties cater to certain market niches or contractors and the producer tries to fit the contractor with the surety that best fits the needs, strengths, and qualifications of the contractor. The producer will work with the contractor to fill out required forms and review and collect the material and information that will be needed by the surety in the underwriting process. As a contractor, it is important to develop a strong relationship with a producer that understands your construction business and capabilities and can assist you with obtaining bonding capacity.
In the underwriting process, the surety will want to determine the financial strength, creditworthiness, and condition of the contractor by analyzing extensive financial documentation along with the contractor’s operational ability to perform a contract based on the contractor’s history, equipment, personnel, etc. Underwriting needs to obtain and assess financial and operational material to best assess the surety’s risk (based on the surety’s appetite or market) because if the surety has to pay out a claim on the bond it will absolutely be looking to recoup the costs it incurs from the bond principal as well as the guarantors that executed the General Agreement of Indemnity. Among other things, the surety will run a credit check for the principal and likely the owners/guarantors; will analyze balance sheets, income statements, and other financial information to understand the contractor’s cash flow, working capital, net worth, and profitability history and forecasts; will want to know of judgments and lawsuits; will likely contact references; and will want to specifically understand past projects completed and current projects underway, including the project in which the bond is being requested, from an estimating and accounting standpoint, personnel and management standpoint, insurance standpoint, and possibly a scheduling standpoint. The surety will do its homework because the very last thing a surety wants to do is pay a claim or expose itself to massive liability with a bond claim from a contractor that failed to pay its subcontractors or abandoned a job without any true recourse to recoup money expended. The surety will consider the personal and corporate guarantors it requires from a contractual indemnity standpoint per the General Agreement of Indemnity and may require cash collateral or property collateral to be pledged for underwriting approval. Again, developing the relationship with the producer that understands your business is crucial as the producer will understand the underwriting process and facilitate the transmission of information and material between the contractor and the surety.
The surety charges a premium for the issuance of the bond. Payment and performance bonds are often single premium bonds. Depending on the producer you ask, the premiums typically range from 1-3% of the bond amount. Naturally, there are contractors that will have to pay in excess of 3% of the bond amount based on the associated credit risk with issuing the bond.
Once underwriting runs its course and the contractor is approved for the requested bonds, the producer typically signs the bonds on behalf of the surety. The producer is given a power-of-attorney to sign bonds as an attorney-in-fact on behalf of the surety.
Please contact David Adelstein at firstname.lastname@example.org or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.