What Public Officials Need to Know About Surety Bonding

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What Public Officials Need to Know About Surety
Bonding
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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. While acting as insurance, in
  the simplest terms, it is similar to an extension
  of credit by a third-party.

Contractor Principal or Obligor Project Owner
Obligee Surety Company
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3. Types of Surety Bonds

• Contract Bonds
• Statutory Bonds
• Public Official Bonds
• Court Bonds
• License and Permit Bonds

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Contract Bonds

• Bid Bonds
• Performance Bonds
• Payment Bonds

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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
  contractor does not perform. If the contractor
  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
Prequalification considers three essential traits
of a contractor

• Capacity
• Capital
• Character

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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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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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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
• Financial protection
• Most comprehensive risk management tool to
  address construction default
• 200 protection 100 payment and 100
  performance
• Guarantees 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
• Protect competitive bidding process
• Ensures level playing field for all contractors
• Deters cronyism

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5. The Services of a Surety (cont.)

• May lead to lower costs for construction
• Surety prequalification services
• Competitive bidding procedure
• Unencumbers government procurement personnel

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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 subcontractors
• Protects public funds

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6. Actions after Construction Trouble

• Notify surety of problems early
• Suretys expertise may avert a default through
  its expertise in handling troubled projects by
  providing temporary financial assistance or
  guidance to contactors/subcontractors
• Public officials should consult with legal
  advisors
• Public officials should ask surety to respond
  specifically

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6. Actions after Construction Trouble (cont.)

• Declaration of default
• Surety is obligated to respond
• Surety action after notification of a claim
• Acknowledgement
• Investigation
• Determination of obligations

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7. 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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7. 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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8. Surety versus Alternative Products

• Default Insurance
• Definitions are vague or non-existent
• No legislative support
• Untested in court no precedential case law

• Surety Bonds
• Terms and conditions are understood
• State/Federal legislative support
• Long history of clearly established case law

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8. Surety versus Alternative Products (cont.)

• Surety
• Coverage applies from first dollar
• Surety pays losses

• Default Insurance
• Deductible and co-payment required or premium
  increased by amount of deductible and co-payment
  subject to possible rebate if there are no losses

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8. Surety versus Alternative Products (cont.)

• Surety
• Surety may be called upon to take over, or
  otherwise arrange for, performance of contract

• Default Insurance
• Insured must pay losses then try to recoup
• Insured must take over and manage defaulting
  contractors obligations

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8. Surety versus Alternative Products (cont.)

• Surety
• Surety provides underwriting financial
  information and prequalification

• Default Insurance
• Owner is responsible for gathering and
  determining which contractors are responsible
  subject to case law, statutes and regulations

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8. Surety versus Alternative Products (cont.)

• Surety
• Once executed, a bond remains in force
• Owner not locked into an ongoing agreement past
  existing project

• Default Insurance
• Coverage can be voided if procedures are not
  followed or if incorrect information is provided
• Policy cannot be canceled by insured prior to its
  expiration

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8. Surety versus Alternative Products (cont.)

• Surety
• Risk of contractor default transferred from owner
  to surety
• Performance and payment bonds are each normally
  equal to 100 of the contract price, for a total
  of 200

• Default Insurance
• Only partial risk transfer
• Insurance subject to aggregate limit per loss
  limit and indirect cost sublimit

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8. Surety versus Alternative Products (cont.)

• Surety
• Surety adjusts claims directly with
  subcontractors and suppliers
• Owner dictates terms of bonds in bid package

• Default Insurance
• Owner must adjust and pay claims by allegedly
  unpaid subcontractors or suppliers
• Terms dictated by insurance policy drafted by
  insurer

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9. 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 .5 to 1 of the total contract price. For
  large projects, the percentage of the contract
  that is charged as a premium decreases.