Surety Bonding Solutions

Borrowing Capacity – For the most part, Performance and Payment bonds are issued on an unsecured basis.  That is, they are provided on the strength of unsecured and unregistered personal and corporate covenants.  The issuance of bonds has no effect on the contractor’s bank line of credit.  Quite the opposite is usually the case with letters of credit.  Almost without exception, the bank will reduce a contractor’s operating line by the amount of any outstanding letter of credit.  Having assets tied up, or an available line of credit diminished, is counterproductive from the standpoint of the owner as well as the contractor.

Cost of Protection – From a cost standpoint, the contractor may find that the letter of credit is more expensive – especially if it must be obtained in an amount that is double the contract price or must remain in force for a number of years after the substantial completion of the construction work to cover contingencies.  On the other hand, a surety bond premium is based on the contract price and is paid when the bond is issued and adjusted accordingly if the contract price is modified.

Sureties’ Underwriting – The surety’s prequalification judgement is also important to the contractor.  If the contractor is unable to find a surety company that is willing to provide Performance and Payment Bonds, it is likely that the contractor may be attempting to undertake a project in which it may fail.  Thus, a surety company’s support of a qualified contractor is very beneficial to the contractor.

Enhanced Credit – Subcontractors and material suppliers may be more willing to extend credit to the contractor or offer credit at better terms if they know they are protected by a Payment Bond.  Since under a letter of credit, financial protection is questionable or nonexistent, subcontractors and material suppliers may be reluctant to extend credit.  This puts a greater demand upon the contractor’s financial resources which may already be limited by the letter of credit’s collateral requirements.

Prequalification – Prior to issuing a performance and payment bond, the surety company attempts to make certain that the contractor has adequate financial resources, the necessary experience and management skills to carry on the business and successfully complete the project for which the bond is required.  In authorizing the bond, the surety company underwriter is saying, “I believe to the best of my judgement, that this contractor can perform this job.”  By contrast, when issuing a letter of credit, the banker will probably be interested only in the adequacy of the collateral available to the bank in case there is a call on the letter.  If the banker is satisfied that the contractor can reimburse the bank should demand be made upon the letter, no further prequalification investigation is done.

If/When the Contractor Defaults – With a Performance Bond, the surety has several alternative methods of responding should the owner of the project declare the contractor in default.  The surety may step in and finance the original contractor or provide other support necessary to allow the contractor to finish the project.  Or, the surety may arrange for a new contractor to come in and perform the contract.  Another alternative may be to have the project owner award the remaining work to another contractor with the surety agreeing to pick up any difference in cost.  If none of these alternatives prove feasible, a surety may pay the sum of the bond.  Under a letter of credit, upon default of a contractor, all the bank will do is pay the project owner a sum of money.  The tasks of administering the completion of the contract is left to the owner.

Labour and Material Claimants – When a job is bonded, the rightful claims of direct subcontractors, labourers and suppliers are paid by the surety under the Payment Bond.  Before making such payments, however, the surety assures that such claims are for the correct amount and are for the work provided or material supplied to the bonded contract.  Under a letter of credit arrangement, the unpaid contractors, labourers and material suppliers may be forgotten.  At that point, the owner must decide whether or not to voluntarily allocate some of the letter of credit proceeds to these claimants.  If it is decided to honour the claims, someone has to determine the validity of each one, which will be paid and which will be rejected.  Aside from making all of these decisions, the owner will face considerable administrative burden and may wind up in litigation whenever a party disagrees with the decision.

Duration of Suretyship – Performance and Payments Bonds remain in force subject to the terms and conditions of the bond, the contract documents and conditions of common law.  The project owner does not have to make a decision on the release of the Performance Bond.  With a letter of credit, the owner is faced with a difficult decision as to when the letter can be released.

Amount of Coverage – Performance and Payment Bonds are generally each in an amount equal to 50 percent of the contract price and often in the amount of 100 percent.  This gives the project owner as much as 100 percent protection for the performance of the contract and an additional 100 percent to Payment Bond claimants.  To afford comparable protection, the letter of credit would have to be provided in an amount of 200 percent of the contract price.  The cost of such a letter of credit would be prohibitive – not to mention the difficulty in obtaining credit facilities for such a significant amount.

As previously mentioned in the above tabs, letters of credit provide little, if any, protection to subcontractors, labourers or material suppliers who have put their work or goods into the contract.  Surety bonds provide this protection.  In fact, surety companies spend more of their claims dollars under the Payment Bond than they do under the Performance Bond.