Surety Bonds and their benefits
In the most basic definition, bonds are off balance sheet transactions that allow you, the bond policy holder to grant an indemnity to the entity that requires a bond from you via your Insurance Bond underwriter.
Project Managers and owners
By making the right choice to mitigate and manage risk on construction projects, it is important to select the most suitable contractor who will ensure that timely project completion is imperative to a successful project. Taking unnecessary risk on a contractor or subcontractor whose level of commitment is uncertain, or who could become bankrupt halfway through the job, can be an economically devastating decision, and if this is a public procurement contract then it is the tax payer who loses.
Performance and Surety bonds offer the optimum solution: they offer outside assurance that the contractor is capable of completing the contract. With a surety bond the project owner has the peace of mind that a sound risk transfer mechanism is in place, the burden of construction risk is shifted from the owner to the Underwriting surety company.
How can underwriters accept the risk?
Underwriters are able to accept the risk of contractor failure based on the results of a thorough, rigorous and professional process in which sureties pre-qualify the contractor. The pre-qualification process is an in-depth look at the contractor’s business operations. Before issuing a bond the underwriting surety company must be fully satisfied that the contractor has, among other criteria:
- Good references and reputation
- The ability to meet current and future obligations
- The experience matching the contract requirements
- The financial strength to support the completion of the contract
- A good to excellent credit history
- An established bank relationship and line of credit
Proving the above criteria may seem straightforward, but the bond market has changed, and for the foreseeable future the ability of a contractor to get capacity is a real issue. Capacity is the term used by underwriters for the availability of bonds for a particular client. With many of the surety providers moving to reduce their exposure or exiting jurisdictions where the climate is financially difficult this is proving a challenge, allied to the reluctance of banks to provide bonds for contractors at a time when employers are asking for the added security that a bond provides, such bonds are becoming more and more difficult to obtain.
Until recently in Ireland for example what was assumed to be the main issue was the conditions pertaining to public procurement contracts; which were deemed by surety providers to have onerous terms, 25% bond on contract amount with a 450 day maintenance period and no evaluation process by public procurement to confirm that the contractor could financially complete the contract. The move by the Government to reduce bonding requirements to 12.5% on contracts under €10m and 10% on contracts over €10m is to be welcomed; however it has not fixed the problem and without further intervention bonding supply remains a serious concern.
Then why is capacity still an issue?
There are some major external economic factors at play. The sector has contracted, balance sheets have followed suit affecting credit rating, and Irish companies are feeling the pressure. Ireland Inc. has had a negative international image which has resulted in a reduced ability of surety providers to lay off a portion of their risk onto the international reinsurance market. For many of those contractors left standing, the size of their requirement or their company is too small for the London markets. Many London markets will not generally deal with companies with net worth of less than €20 – €25 million and have a requirement of no less than €5million in bonds a year. There are alternative markets which will provide bonds, but generally they are not acceptable for government contracts so therefore the best advice is to know the provider you are dealing with; get their financials, rating and regulatory status.
On the flip side, the problem for many contractors is a lack of understanding of surety and the requirements of surety providers. Contractors do not seem to understand that bonding capacity is a reflection of their financial strength, financial reporting, cash flow and management team strength. A surety underwriter looks at many factors when underwriting a case, the main three are Capacity, Capital & Character.
- Capacity – The ability to handle all the work in the contractors schedule
- Capital – Does the contractor have enough money to complete the project?
- Character – What kind of company is this, who are the directors etc.?
Bonding Capacity – A key business strategy?
Most business owners would not know that every company in Ireland is listed on at least 10 credit rating agencies and 8 credit insurer databases. A company’s credit rating is their businesses’ most important calling card. If they do not meet a sureties criteria, the meeting is over before it has even started. It is now time for contractors to stop seeing bonds as a commodity insurance product and realise it is a strategic financial product which is built on relationships, and when successful, has many advantages.
A bond facility should be deemed as important as a bank loan or overdraft facility. The relationship a business owner has with their bank manager should be mirrored with their bond provider. Contractors should note, that bonds provided by underwriters have a huge advantage over bank bonds, because there is no impediment on the company’s ability to obtain further credit or affect existing banking credit lines – this allows for better use of financial resources elsewhere.
Contractors who can obtain bonds have an immediate competitive advantage over other contractors.
What should contractors do?
Firstly they must understand that if they are going to be assessed on an in-depth basis including their credit score, financials, experience, banking relationships etc., to be successful they will need to prepare for this examination. Take steps to do the following:
- Have your audited accounts completed early, do not wait until September/October
- Keep up to date management accounts
- Improve your balance sheet, keep liquidity in the business
- Increase your share capital – may seem like a small thing to do but shows your vested interest
- Purchase credit insurance, you need to know you can get paid
- Engage with credit rating agencies to try to improve your score
- Building relationships with surety providers, credit insurers and credit rating agencies must be seen as a priority and part of the overall businesses strategy
Once the above have been achieved it will be easier for contractors to maximise relationships with their clients and providers.
While there are mixed messages in the market (and those messages are driven by different interest groups) ultimately the truth is the majority of larger sureties have either reduced capacity or pulled out altogether leaving a massive void. Their message is for contractors to get their finances in order, improve their understanding of bonds and take the process seriously, and then they will be taken seriously. We will see new entrants to the market very soon but they will not be there as provider of last resort, or to provide solutions for overly distressed balance sheets. The days of 1%-3% rates are also gone, new entrants are going to look for an increased rate for taking on risk. Contractors who want to be ahead of the game should embrace the requirements of bond underwriters, it will reap rewards in the medium to long term.
TYPES OF BONDS WE OFFER:
A Performance Bond is a tripartite agreement that backs up a Commercial Contract, commonly used in the Construction Industry. It gives comfort to the Employer / Beneficiary in the event of the Contractor failing to perform or in the event of a breach of Contract.
As with any surety bond, if there is a default which results in loss by the Surety Company, the Surety will expect the Contractor to repay any monies paid out by the Surety in the event of a claim. Surety Bonds are NOT insurance and therefore security may be required prior to the Bond being issued.
Contact one of our Contract Bond experts today for a free consultation.
In many cases, a main contractor could hold 3 to 5% of the Contract value for a period of up to 12 months. The sub contractor would then have to wait for the retention funds to be returned at the end of the agreed period, this can seriously affect business cash-flow. A Retention Bond will provide the main contractor with the same level of comfort as the retention, but the sub-contractor has the real benefit of retaining the cash in their account.
Advance Payment Guarantees
An Advance Payment Bond is a guarantee, supplied by the party receiving an upfront payment, to the party advancing the payment. It guarantees that the advanced sum will be returned if the agreement under which the advance was made, cannot be fulfilled. These are also known as Advance Payment Guarantees.
Advance Payment Bonds provide significant cash flow benefits to the contractor, giving them the opportunity to purchase materials or high value plant before any works are undertaken and also provides a level of comfort for the beneficiary of the Bond.
Road & Sewer Bonds
Road and Sewer Bonds are required in connection with agreements under the Highways, Water and Planning Acts and other statutory provisions. These bonds / section agreements guarantee the completion of roads and sewers to enable them to be adopted by the relevant authority. The Section Engrossments are usually produced by the relevant authority or their legal representatives and should be sent to the Surety for their approval and execution.
Local Authority Bonds
Examples of Section Agreements:
- Section 38 – Highways Act 1980, Adoption of New Highways
- Section 40 – Water Industry Act 1990
- Section 98 – 101 – Water Industry Act 1990, Sewer Requisition
- Section 104 – Water Industry Act 1990, Sewer Adoption
- Section 106 – Pre-planning Agreement
- Section 278 – Highways Act 1980, Works Within The Highway
An NHBC Bond is required where a house builder wishes to join the NHBC Building Warranty programme, or where they have exceeded their allocated annual quota of eligible units. A NHBC Bond protects the NHBC against the failure of the client to maintain properties within the 10 year post-construction period covered by the NHBC’s Building Warranty. NHBC Bonds are typically required by developers operating in the house building sector and sometimes the NHBC require a guarantee from a bank, Lex Risks Solutions can supply this type of bond, usually required for 5 years and 6 months.
A Restoration Bond can also be known as a Reinstatement Bond or a Remediation Bond. This type of Bond is usually issued in favour of Local Authorities or Commercial Land Owners. It provides a guarantee to the beneficiary that land will be returned to its original and agreed condition upon the expiry of the relevant operating licence.
This Bond is issued in favour of a local authority which guarantees in the event that a private sector company, who has taken on one of their former employees, fails to continue making payments to the employees local authority pension scheme should they choose to continue being members of it.
Rent Guarantees / Rent Deposit Bonds
Lex Risk Solutions can arrange Rent Guarantee Bonds and Rent Deposit Bonds in favour of commercial Landlords. Like any Surety Bonds, this is not an Insurance Policy and therefore security is required from the Tenant prior to any Guarantees being issued.
When a tenant fails to pay the rent it can cause significant loss to a landlord. Having a Rent Guarantee in place can help solve these issues and will not only protect the rental income of the property but also protects the capital value of the property.
Duty Deferment Customs Bonds
A Duty Deferment Bond is usually required by companies involved in the importing and exporting of goods and services and it guarantees payment of the contractor’s deferred payment obligations in respect of their VAT and/or Duty liabilities to HMRC. These Bonds are issued by an insurance company or by a bank and it is provided by companies that wish to defer the payment of VAT and/or Duty liabilities to HMRC, until the relevant goods or services are sold.
Deferred Consideration Payment Guarantees
This is a guarantee that a future payment(s) will be made and is often used in connection with the purchasing of commercial property or company acquisitions and Management Buy Outs. Lex Risk Solutions can arrange Deferred Consideration Payment Guarantees in favour of Vendors and issued on behalf of the Purchaser. This type of Bond is imperative to complete deferred payment transactions.
Some Other Surety Examples:
- Air Freight Bonds / Cargo Bonds
- Petrol Retailers
- Oil Suppliers
- Environmental Agency
- Transfrontier Shipment / Waste
- Supplier Payment
- Trade Credit
Surety Bonds can assist in many areas of Commerce. Lex is always willing to discuss your requirements and if possible, bespoke a solution to your problem.
Please contact firstname.lastname@example.org for any bond enquiry. For best advice download and complete the Application Form and Work in progress forms and attachment to your enquiry email.