The Surety Safeguard
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 do not hear of such funds being utilised for uncompleted public works projects.
That’s because taxpayers are protected against virtually all losses caused by contractor failure through the use of surety bonds.
Surety bonds companies provide the resources necessary to complete contracts in the event of default. Obtained by contractors from surety bond companies, surety bonds transfer the risk of failure or non-performance to the surety bond company.
When a government entity awards a contract to the lowest bidder, it knows that the surety bond company stands behind the contractor’s promise to complete the job according to the owner’s specifications and terms of the contract.
The idea behind surety bonding is simple and direct. One person guarantees to another that a third person will perform.
Today, surety bonds protect almost every public construction project across the country. In 2014, approximately €300 Billion in public works projects were under construction throughout the European Nation States including c. €11 Billion in Ireland with surety bonds providing valuable protection against contractor failure.
For beneficiaries, making the right choice to mitigate and manage risk on construction projects and selecting the fiscally responsible option to 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, if this is a public procurement contract then it’s the tax payer who losses. Specifying bonds not only reduces the likelihood of default, but with a surety bond the 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.
Sureties 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 prequalification process is an in-depth look at the contractor’s business operations. Before issuing a bond the 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 – excellent credit history
• An established bank relationship and line of credit
Many contractors seem to lack an 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, management team strength and how it is presented to a bonding company. A surety looks at many factors when underwriting an account; the main three are Capacity, Capital & Character.
In order for a contractor to be bondable they must:
• Have their audited accounts completed early within 90 – 120 days after year end
• 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 (for private clients)
• 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
The fall out of not having accounts completed in a timely fashion has many repercussions, take the recent failure of Fairhurst Ward Abbotts in the UK which collapsed with estimated debts of £20million. The company was in trouble and directors were working tirelessly to obtain investment, their downfall ultimately was due to late returns to Companies House which saw the firm marked as a late return, this unnerved credit scoring agencies, which gave FWA a nil credit rating resulting in insurance agencies pulling credit insurance. This contributed to funds drying up and triggered a winding up petition from a nervous creditor owed £225,000, which FWA was unable to defend. I don’t know if this triggered any bond call but a surety would have stepped in to complete or finance the completion of existing contracts for any bonds in place.
In conclusion the message from the market is for contractors to get their finances completed early, keep them in order, improve their understanding of bonds and take the process seriously. This will make an underwriter’s job easier and enable them to provide bonds and facilities in a more efficient manner.
Surety Bonds, Insurance House, Main Street, Carrick on Shannon, Co. Leitrim.