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Surety Bond 101

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A detailed look into Contract Surety and the process of obtaining Surety support.

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Surety Bond 101

  1. 1.  Cannot bid or sign contract without the support of a bonding company.  Bid bonds needed during the acquisition stage.  Performance and Payment bond guarantees performance of the contract and payment of bills for suppliers of labor and material.  Bonding must be arranged in advance. Takes 2 – 4 weeks or longer to set up a new account.
  2. 2.  Public contracts (federal, state, local municipalities) are funded with tax dollars.  Bonds provide a guarantee that projects will be completed as expected – even if the contractor fails.  It is likely that defaulted contracts will not ultimately be completed for the original amount.  Bonds are an inexpensive way to protect the public interest and assure contracts are completed on time, for the agreed upon price.
  3. 3.  Insurance is written with an expectation of loss Losses are not expected on bonds.  With Insurance, 2 parties are involved, you and the insurance company. With bonds, there are 3 parties: You, your client, and the bonding company.  Bond is a promise that something will happen  The bond you obtain is for the protection of the party with whom you have a contract.
  4. 4.  Project is announced and the bid date is advertised in the local newspaper. Bid security is required.  Contractor prepares bid proposal, bid bond is issued  Contract is awarded, Performance and Payment bond is issued, contract is signed, and Notice to proceed is issued.  Upon completion and acceptance of the work, the bond is released.  Bond stays with the contract and is released when the contract is completed and accepted.
  5. 5.  Bid Bond guarantees the bidder’s sincerity. It guarantees one of two things will happen: You will either accept the award of the contract, file the required documents and proceed with the project – or – pay the difference between your bid and bidder above you.  Performance Bond guarantees the contractor’s performance in compliance with every aspect of the written contract  Labor and Material Payment Bond guarantees suppliers of labor and material will be paid. This prevents liens against the project, which would be to the detriment of the obligee.  Also, on public work, suppliers cannot lien the project. Therefore, the Payment Bond provides a means of protecting their financial interests.
  6. 6.  Principal: Applicant for bond Your company is the applicant. The bond concerns your performance on the contract. Your obligation is to perform the contract and protect the interests of the bonding company.  Surety: Co-guarantor Bonding company joins with you, the Principal, in your obligation to perform the contract. In the event you are defaulted, the surety must complete the contract or pay the bond amount to the obligee.  Obligee: Protected Party You are working for this entity. They are paying the contract amount. In the event of your failure to perform, they are entitled to make claim against the bond. If the claim is paid, it is paid to this entity. This is the party requiring the bond.
  7. 7.  Insurance is written with an expectation of loss: Fires, storms, accidents. Premiums are high enough to cover these expected costs, cover operating expenses and yield a profit.  Bonds are attractive to public bodies because they are inexpensive.  To remain in business, bonding companies must avoid claims and defaults.  Bond premium rates are static and do not reflect the expectation of loss on each client. High-risk applicants are simply avoided.  This means, in order to qualify for bonds, you must present your company in a manner that creates confidence with the bond underwriters.
  8. 8.  Bond application is similar to applying for bank credit.  Bond Line functions like a Working Line of Bank Credit.  A maximum dollar amount is established for each bonded contract. An aggregate amount is also established for all contracts collectively.
  9. 9.  Standard and Specialty bonding companies  Standard markets will only accept companies that are long established, profitable, well balanced and operating within their prior experience.  Specialty markets accept smaller, newer firms that may show some areas of weakness but still warrant support.  Specialty markets may require a reduction in exposure such as collateral.  Collateral means you put cash or a cash equivalent with the bonding company to make them feel secure in handling your account.
  10. 10.  Who is the applicant and what are their prior experiences?  Financial condition and 3 year historical review  Banking and other credit relationships  Current Work On Hand  Size, nature, location of proposed work
  11. 11. Contractor’s Questionnaire Articles of Incorporation Prior Owner References Resumes of Company Owners
  12. 12.  Who is the applicant and what are their prior experiences?  Financial condition and 3 year historical review  Banking and other credit relationships  Current Work On Hand  Size, nature, location of proposed work
  13. 13. 3 Years of CPA prepared corporate Financials Internal Interim Financial Statement Personal Financial Statement for owners Proof of Cash (bank statements) Corporate and Personal Tax Returns
  14. 14.  Who is the applicant and what are their prior experiences?  Financial condition and 3 year historical review  Banking and other credit relationships  Current Work On Hand  Size, nature, location of proposed work
  15. 15. Current Bank Lines of Credit Terms and Conditions Supplier References
  16. 16.  Who is the applicant and what are their prior experiences?  Financial condition and 3 year historical review  Banking and other credit relationships  Current Work On Hand  Size, nature, location of proposed work
  17. 17. Open Projects Status of Billings Degree of Completion Original and Revised Profit Projections
  18. 18.  Who is the applicant and what are their prior experiences?  Financial condition and 3 year historical review  Banking and other credit relationships  Current Work On Hand  Size, nature, location of proposed work
  19. 19. Size Nature Location Project Details Specific Bonding Requirements (Mandatory Bond Forms)
  20. 20. 1. A surety bond is like an insurance policy – True or False? 2. How many parties are there to a surety bond? Name Them! 3. What is the name of the bond that accompanies your initial proposal? 4. What is the name of the bond that assures suppliers of labor and material will be paid? 5. Why do bond underwriters review company financial statements? 6. Bond underwriters do NOT expect claims or losses –True or False? 7. Is personal financial info required by sureties? 8. Is the ability to bond a project viewed as a sign of strength? 9. In order to have your company bonded, will further action be required on your part?

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