A critical tool to minimize construction project risk
Surety bonds are required by law for public construction projects in the U.S. and many public projects in Canada, whether municipal, state/provincial or federal. The private sector has embraced the economic value and protection that surety bonds bring to projects to mitigate the risks linked to economic uncertainty and supply chain challenges.
In today’s landscape, banks and lenders are also increasingly recognizing the pivotal role of surety bonds and requiring these bonds more often for added protection.
What is a surety bond?
A surety bond, at its core, is a financial guarantee. It is a written promise, backed by an insurance company, that a person or company will fulfill the specific obligations of the contract and, if they fail, the insurance company will compensate the primary beneficiary for any losses.
There are three parties involved in a surety bond:
- Principal: The contractor who purchases the bond and agrees to perform the work per the agreement.
- Obligee: The primary beneficiary of the bond who requires the principal to obtain a bond as a licensing requirement or for contract execution.
- Surety: The insurance company that guarantees the work of the principal and is liable for defaults up to the bond amount.
Types of surety bonds
Contract surety
- Bid bonds: Essential for government contracts, these bonds secure your bid submission. They showcase your company's financial stability and adherence to underwriting standards, instilling confidence in contractors, owners and customers.
- Performance bonds: The most common type of surety bond, performance bonds ensure that the project is completed per the contract. If there’s a default, the obligee has recourse against the principal to explore other options.
- Payment bonds: Simply put, this is a bond that guarantees payment and ensures that the subcontractors, laborers and suppliers are paid for work performed under the contract.
- Other common bond types: Many other types of bonds exist, including wage and welfare bonds, warranty or maintenance bonds, release of lien bonds, release of holdback bonds, subdivision or site improvement bonds and sales tax and use bonds.
Commercial surety
Primarily required by government entities, financial institutions and private corporations, commercial surety bonds safeguard against fraud, theft or illegal conduct by contractors. The bonds, such as license and permit, guarantee the business will comply with specific rules and regulations to operate within that state or province. There are also many other opportunities where a surety bond can be used to free up liquidity, where you are currently posting letters of credit or restricted cash on your company’s balance sheet.
Who Needs a Surety Bond and Why?
Contractors, suppliers, subcontractors and project owners all need surety bonds, which are primarily designed to protect businesses, owners, lenders and taxpayers, as they look to minimize risk during construction projects
Surety bonds are required by law for public construction projects in the U.S. and for many (but not all) public projects in Canada, whether they’re municipal, state/provincial or federal. However, the economic value and protection surety bonds bring to projects has garnered the attention of the private sector as well.
Surety Bond Benefits
Surety bonds offer significant benefits for contractors, subcontractors, and project owners, such as:
- Reducing the risk of project default
- Ensuring business continuity
- Providing technical and financial assistance
- Reducing the risks of liens filed by subcontractors
- Lowering project and construction costs through improved bidding competition
A surety bond assures your customer that once a project begins, it will be completed.
What Do You Need to Get a Surety Bond?
The “Three C’s” of surety — character, capacity and capital — are the backbone of the underwriting process. Before a surety issues a bond, they want to ensure contractors can meet these tenets:
- Character: Does the bond applicant (principal) have a credit record and business history that reflects good character and integrity, and a record of fulfilling its obligations?
- Capacity: Does the principal have the skill, experience, knowledge, staff, equipment and facility necessary to fulfill the contract?
- Capital: Does the principal have the financial strength to cover the cost of a new project, current obligations and any unforeseen problems that may occur?
It’s imperative to submit accurate and updated information to the surety to acquire the bonds you need.
A good surety partner is critical for success
To avoid unnecessary delays with your submission, it’s best to have an experienced broker to facilitate the process of securing a surety bond. Finding surety experts with experience and know-how also will provide you with access to the best resources and a variety of market options.
An experienced surety expert will guide you through the application process. They may also be able to reduce application time by understanding required documentation, the markets they partner with, and flagging risks prior to the underwriting process.
Navigating the surety bond landscape can be complex, and that's where an experienced broker becomes indispensable. An adept surety partner streamlines the process, from collecting necessary paperwork to addressing risk concerns before underwriting. This process not only avoids unnecessary delays but also ensures you have access to the best resources and market options.
Contact a HUB surety specialist to get started.
