May 10, 2023
By: Cornelius “Con” F. Riordan
Federal, state, and local governments require surety bonds from contractors to manage risk on construction and development projects and to protect taxpayer dollars. Private construction project owners likewise often stipulate bonding requirements on their projects. Prime contractors may require their major subcontractors to obtain performance and payment bonds. In today’s competitive construction environment, a contractor’s ability to obtain the necessary surety bond has a significant effect on that contractor’s ability to acquire work.
The first step for the contractor is to contact a professional agent or broker—sometimes known as a surety bond producer–who specializes in contract surety. A professional surety bond producer guides the contractor through the bonding process, helps establish and foster a business relationship with a surety company, and assists in managing the contractor’s surety capacity. A professional surety bond producer can offer sound business advice and technical expertise, such as contract document review. The producer can introduce the contractor to other professionals or consultants when appropriate.
Surety bond underwriting is guided by numerous factors that influence the decision to issue a surety bond to a contractor. Contract surety bonds are underwritten as an extension of credit. The underwriting considerations are similar to those used by banks in evaluating borrowers.
Each surety company has its own underwriting requirements, but there are shared fundamentals common to most surety companies. The contractor typically undergoes a prequalification process. The producer collects information, answers questions the surety underwriter may have, and verifies information. The surety must be satisfied that a contractor has the ability to meet current and future obligations, has a good reputation, has experience meeting the requirements of the construction projects to be undertaken, and has (or can readily obtain) the equipment necessary to perform the work. The surety also looks for contractors who run a well-managed, profitable enterprise, keep promises, deal fairly, and perform obligations in a timely manner.
Bond underwriters talk about the “Four C’s”
- Capital. The bond underwriter analyzes the contractor’s financial position. Financial statements show the current state of the company, including working capital, the relationship of debt to equity and how profitable the company is. The surety company would prefer to have Audited Contractors Financial Statements which have had an opinion expressed on the presentation of the financial statements by a public accounting firm.
- Capacity. The surety underwriter must evaluate the contractor to become comfortable with the ability of the contractor to perform the project. The surety company will review non-financial information including organizational charts, detailed resumes of key employees, current work in progress and a history of largest projects completed.
- Credit. The surety underwriter will review credit reports to gain an understanding of how the contractor handles his financial obligations. Capital provides an understanding of the contractor’s ability to meet his financial obligations. Credit provides an understanding of the contractor’s willingness to meet its financial obligations, including the structure of principal’s debt and financing, i.e., bank debt or loans from equity holders, willingness to enter into subordination agreements and principal or principal’s owners past history and bonding experience–prior claims and workouts with other sureties.
- Character. This is the most difficult to evaluate, although it is likely the and probably most important “C”. Underwriters like to meet their clients face-to-face in an effort to evaluate this C. The reputation of the contractor and the credibility of the bonding agent are key components.
The surety underwriter will require that a contractor provide:
- An organization chart of key employees and their responsibilities;
- Detailed resumés of key employees;
- A business plan outlining the type and size of work sought, prospects for such work, the geographic area in which the company operates, and growth and profit objectives;
- Current work in progress as well as a history of the largest completed jobs, including the name and address of the owner, the contract price, date completed, and the gross profit earned;
- A continuity or completion plan outlining how the business will continue in the event of the owner’s death or disablement;
- Evidence of a bank line of credit to augment working capital and to handle temporary cash flow deficits or strains;
- Letters of recommendation or references from subcontractors, owners, architects, and engineers on completed projects; and
- Financial statements for three years.