Contract Surety Bonding for Public Procurement Contracts with Surety Bonds
When the Construction Procurement Reform Initiative was launched in 2006 risk management was the key driver. The government was willing to pay for ‘cost certainty better value for money and a more cost effective delivery of public work contracts’.
This risk transfer was facilitated by a project owner providing comprehensive information in the tender documents which the contractor could price from. The contract which is then agreed based on the tender passes almost all risk of construction onto the contracting firm, while the contracts are in essence flexible, they allow for designs to be incomplete at tender stage and for clients to change their minds at construction phase, clearly an unfair mitigation of risk.
The main features of paramount importance in achieving the objective of cost certainty under the Government form of contract are:
1) Contracts are fixed price lump sum
2) No Prime Cost sums (also known as PC sums
3) No Provisional sums
4) No Provisional quantities
5) No Nominated subcontractors
6) Transfer of specified risks on a project to project basis.
While the government may have been willing to pay for cost certainty with an expected average cost increase of 10%, the opposite took place due to the financial recession. The conclusion in the “Review of the Performance of the Public Works Contract” was that risk was not being priced in. This is due to a combination of factors; competition for work, less contracts available and lower labour cost. The downside when risk arises is that it leads to disputes which in turn lead to increased costs negating cost certainty. In recessionary times many contractors could not afford to incur the additional costs which were due to lack of design information at tender stage adding to their financial difficulties.
Half of the total construction activity that took place in Ireland in 2013 was carried out on public contracts, amounting to a combined value of around €4bn. One major issue with public procurement contracts under this Department of Finance document “Value for Money and Policy Review of the Construction Procurement Reform Initiative” is that generally lowest price wins. This drive for value has created a race to the bottom with margins at 1-2% or below. This has proven unsustainable and leads only to a lose–lose situation for all parties concerned. As the work being performed uses public funds, such funds are at risk, depending on the capability of the contractor performing the work. Therefore most, if not all, public agencies have turned to bonding as a means of protecting tax payer money. In this regard a contractor’s bonding capacity is critical to winning public contracts and in turn their financial strength and fiduciary strategy helps them get their bonds.
Surety bonds have been utilised for decades for government construction contracts and in other public works contexts. During the current economic climate and various government bailouts, you did not hear of such funds being utilised for uncompleted public works projects, that’s because taxpayers are protected against losses caused by contractor failure through the use of surety bonds.
For project owners, making the right choice to mitigate and manage risk on construction projects by selecting the most suitable contractor who will ensure timely project completion are imperative to a successful project. Gambling 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’s the tax payer who loses. Contract surety bonds offer the optimal solution: they offer outside assurance that the contractor is capable of completing the contract. Mandating the bond requirement not only reduces the likelihood of default, but 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 surety company.
It is my opinion that contract surety bonds in Public Procurement Contracts are just seen as an additional cost by many contractors and for those that can obtain them they are not identified as giving them a competitive advantage over other bidders. By utilising a surety over a bank guarantee or letter of credit they are also freeing up their credit lines, this allows for better use of financial resources elsewhere. For a contractor to maintain an advantage over its competitors managing a long-term relationship with a surety will be key to winning contracts.
Colm McGrath, Managing Director, Surety Bonds
An independent bonding intermediary. Surety Bonds, Insurance House, Main Street, Carrick on Shannnon, Co. Leitrim.
T: 071 9623228 E: email@example.com www. suretybonds.ie