WHEN YOU BUILD... BOND Surety Bonds: Financial Security Construction can be a risky business. As a building owner, risk manager, or construction lender, your goal is simple: successful completion of the project. Achieving that goal, of course, means that material suppliers, contractors, laborers, and others must honor their commitments and do the job they were contracted to do. Surety Bonds: Financial Security Construction Assurance

Requiring Surety Bonds What are surety bonds? Who issues surety bonds? What type of protection do they provide? One way you can reduce your risk and help guarantee the successful completion of your next construction project is by requiring surety bonds. In the next few minutes, you will learn about the fundamentals of contract surety bonds, what they are, who issues them and (perhaps most importantly), what type of protection they provide.

What Are Surety Bonds? A surety bond offers assurances to the owner of a construction project that the contractor will perform the work specified in the contract and pay certain subcontractors and suppliers. A surety bond offers assurances to the owner of a construction project that the contractor will perform the work specified in the contract, and pay certain subcontractors and suppliers associated with the project.

Surety Bonds Mandated on Public Works Federal Heard Act (1893) & Miller Act (1935) State & Local “Little Miller Acts” Surety bonds are nothing new. Since 1893, the U.S. government has required them for federal public works. Today the Miller Act requires performance and payment bonds for public works contracts in excess of $100,000. Most of the 50 states, the District of Columbia, Puerto Rico, and most local jurisdictions have legislation that are referred to as “Little Miller Acts,” which require contractors to post surety bonds on their public works contracts.

The 3 Cs of Prequalification Capital Capacity Character The reason to require bonds is simple, surety companies conduct a rigorous prequalification screening process before agreeing to bond a contractor. The surety must be completely satisfied that the contractor is able to perform the contract. The surety company’s prequalification process includes evaluation of the three Cs – Capital, which focuses on the contractor’s financial strength Capacity, which focuses on the contractor’s ability to perform, and Character, which looks at the contractor’s reputation among subcontractors, suppliers, and other project owners.

Types of Bonds Bid Bond Performance Bond Payment Bond Surety companies offer their full financial backing to the contractors they bond. There are three basic types of contract surety bonds that the surety company provides through professional surety bond producers. The first type of bond is the bid bond. A bid bond assures the owner that the contractor will enter into the contract at the price that was bid and will provide the required performance and payment bonds if awarded the bid.

Types of Bonds Bid Bond Performance Bond Payment Bond Next is the performance bond. A performance bond assures the owner that the contractor will perform the contract on time, on budget, according to specifications, and free of defective workmanship and materials within one year of completion.

Types of Bonds Bid Bond Performance Bond Payment Bond Finally, the payment bond assures the owner that certain laborers, subcontractors, and suppliers associated with the project will be paid.

Protection Surety Bonds Owner Developers Lenders Risk managers Attorneys Engineers Architects Regardless of the size of the project, surety bonds provide protection to everyone involved: The owner of the project, Developers Construction lenders Risk managers Attorneys Architects Engineers CPAs Subcontractors and Even to the contractor being bonded. CPAs Subs Contractor

Source: Dun & Bradstreet Contractor Failure How critical is that protection? According to Dun and Bradstreet report, mare than 10,000 contractors fail every year. Contractor failure leaves a trail of unfinished construction projects with liabilities of billions of dollars. Surety bonds provide peace of mind to owners, taxpayers, shareholders, and boards of directors that you just can’t put a price tag on. Source: Dun & Bradstreet

Peace of Mind For Owners “We often feel if the contractor qualifies for the bonds, it’s probably a stable organization and someone who has gone through a rigorous review of his financial credibility. He’s also probably capable of performing the work. We rely on the surety’s background checks of the general contractor to bring the contractors to a certain level of performance and guarantee that level of performance to us.” - Bob Knopf For Bob Knopf of Washington DC-based Quadrangle Development, peace of mind begins with the knowledge that the general contractor will be able to perform the work. Knopf says, “We often feel if the contractor qualifies for the bonds, it’s probably a stable organization and someone who has gone through a rigorous review of his financial credibility. He’s probably capable of performing this work. We rely on the surety’s background checks of the general contractor to bring the contractors to a certain level of performance and guarantee that level of performance to us.”

Peace of Mind For General Contractors “Just as owners require surety bonds from our company, we require them of our subcontractors because they provide us two levels of assurance: First of all, that the work will be complete in accordance with the contract documents. Secondly, that they will pay for the materials and subcontractors at their level & we won’t have to pay for anything more than once.” - Jim Davis, President James G. Davis Construction Corp. Surety bonds also provide peace of mind for the general contractor. Jim Davis, President of James G. Davis Construction Corp., says, “Just as owners require surety bonds from our company, we require them for subcontractors because they provide us two levels of assurance: First of all, that the work will be complete in accordance with the contract documents, and Secondly, that they will pay for the materials and subcontractors at their level and we won’t have to pay for anything more than once.”

Who Issues Surety Bonds? Insurance companies Surety bond producers So, who exactly is it that issues surety bonds, and what happens when there is a problem with a construction project? Most often, surety bonds are provided by insurance companies through professional surety bond producers, also referred to as agents or brokers. One reason is that insurance companies have the financial resources to make good on the commitments they make when they issue surety bonds.

Surety Bonds vs. Traditional Insurance 3-party 2-party Risk transfer Duty to obligee Duty to insured Regulated by State Insurance Departments Premium fee for prequalification services Premium actuarially determined Project specific Usually term specific Penal sum Policy limits While most surety companies are subsidiaries of larger insurance companies, surety bonds are very different than insurance. An insurance policy expects losses. The purpose of a surety bond is to prevent losses. That is a very important distinction to keep in mind. If the contractor defaults, the surety will respond as quickly as possible and come up with a solution for completing the contract. With insurance, the owner is simply paid a monetary sum minus deductibles and must complete the project his or her self.

Performance Bond Protection Re-bid the job for completion Arrange for replacement contractor Retain original contractor Reimburse owner as required by the bond Surety The action a surety takes in response to a claim depends entirely on the specific facts of the case. Under the performance bond, if a contractor defaults, the surety may rebid the job for completion, arrange for a replacement contractor, retain the original contract and provide trained personnel and/or financial assistance, or reimburse the owner as required by the bond.

Payment Bond Protection Surety pays eligible subs & suppliers Protects owner from mechanics’ liens Protects subcontractors from nonpayment Surety If the contractor is in default under the payment bond, the surety will pay eligible subcontractors and suppliers up to the penal sum of the bond. This protects private owners from mechanics’ liens and subcontractors from nonpayment.

The Goal is Project Completion “We were financing the development of a retail project with a large well-known discount department store that likes to get into its projects in October so they can benefit from the Christmas season. We did have a bonded contractor on that job and when the general contractor encountered financial difficulties, the bonding company stepped in and worked with the owner to replace that general contractor so that we were able to get that anchor tenant in on time for that particular season.” - Carleen Petronio Whatever the surety’s response to a claim, the goal is simple: to complete the construction project in accordance with the terms and conditions of the contract. Carleen Petronio, PNC Bank Vice President of Corporate Real Estate Administration, recalls one project in particular that demonstrates the value of surety bonds. “We were financing the development of a retail project with a large well-known discount department store that likes to get into its projects in October so they can benefit from the Christmas season. We did have a bonded contractor on that job and when the general contractor encountered financial difficulties, the bonding company stepped in and worked with the owner to replace that general contractor so that we were able to get that anchor tenant in on time for that particular season.”

Cost of Surety Bonds Project Amount Approx. Bond Premium $1 Million $7,700 – $13,500 $5 Million $33,200 – $47,250 $10 Million $56,950 – $81,000 $20 Million $101,950 – $146,000 * Premiums may vary depending on size, type & contractors bonding capacity. Surety bonds typically cost from ½ of a percent to 2% of the contract amount, depending on the type and size of the project and the contractor’s bonding capacity. To receive the protection of surety bonds, all a project owner has to do is include the bonding requirement in the plans and specifications of the project. It’s up to the contractor to arrange for bonding through a surety bond producer.

WHEN YOU BUILD... BOND Conclusion When you consider all of the perils that could befall a construction project, and the financial protection, construction assurance, and peace of mind provided by surety bonds, it’s obvious - When you build…bond.

Surety Information Office www.sio.org | sio@sio.org For More Information Surety Information Office www.sio.org | sio@sio.org SIO is a joint initiative of The National Association of Surety Bond Producers (NASBP) and Surety & Fidelity Association of America (SFAA). To receive more information on contract surety bonds, contact SIO, the Surety Information Office. All of SIO’s material is free and can be accessed from the Web at www.sio.org. If you have a particular question on surety bonds, SIO’s staff will help you find the answers. So contact SIO, the source for information on contract surety bonds.