FAQ Surety Bonds
What is a surety bond?
Who is the surety?
The surety is a company licensed by a state department of insurance to provide surety bonds to third parties to guarantee the performance of a principal.
Who is the Principal?
The principal is the person or entity (in construction, the contractor or subcontractor) on whose behalf the bond is given. It is the principal’s obligation that the surety guarantees.
Who is the Obligee?
What documents will I have to provide for bonding?
A Contracto's Questionnaire
Past 3 fiscal year-end financial statements
Current interim financial statement and aging receivables and payables report
Copies of any bank loan agreements, including lines of credit
A current personal financial statement
A current statement of work in progress
Resumés of owners/key employees
Letters of recommendation about the accomplishments of your company
A capability statement with company's qualifications Certificate(s) of insurance
A contractor’s questionnaire
What is a bid bond?
A bid bond provides financial protection to the obligee (who can be the owner when the general contractor provides the bonds, or the general contractor when the subcontractor provides the bonds) if a bidder is awarded a contract but fails to sign the contract or fails to provide the required performance and payment bonds. The bid bond also helps to screen out unqualified bidders, as a surety will not issue a bid bond on behalf of a contractor that it believes cannot fulfill the contract obligation. Prequalification means that the surety has investigated the contractor and determined that the contractor has the ability to carry out the work under the construction contract. The surety’s specific obligation under the bid bond is set forth in the bond itself. The surety is usually obligated to pay the owner the cost of having to repeat the bid process if the awarded bidder is unable or unwilling to perform. The surety’s liability is generally limited to the face amount, or penal sum of the bond, which is in the range of 5 to 20 percent of the contract price.
The bid bond is only 5% of the total contract. Why do I need to be approved byt the surety for the entire contract amount?
The bid bond is both a percentage of contract security and evidence of prequalification for the ultimate contract value. Thus, consideration of the full contract amount on bid day is necessary at the same time the bid bond is being considered. If the contractor is deemed qualified to perform the contract, the bid bond is issued. If the contractor is deemed unqualified to perform the work, the bid bond will not be approved, notwithstanding that the bid bond is only a small percentage of the contract amount
What is a performance bond?
A performance bond provides an obligee with a guarantee that, in the event of a contractor’s default, the surety can be called upon to complete or cause to be completed the contract in accordance with the plans and specifications. Bonds differ in terms of the types of options available to the surety, and to the obligee, in the event of a default. If the bonded contractor fails to perform its work in accordance with the plans and specifications, the owner, which has performed its contractual obligations, has a right of action against the surety to obtain completion of the contract and enforce the owner’s rights under the contract.
What should I expect to pay for bonds?
The cost of a bond is based on rates filed with the state insurance department. The cost of a bond can vary, from less than 0.5% to as much as 3%. For a small and emerging contractor with minimal experience, a contractor can expect the rate to be between 2-3%. There are always adjustments to the bond premiums based on the final contract price. If the price increases, there’s an increase in premium; and if the price decreases, the premium is reduced as well and refunded. A contractor should always include the cost of its bond in all proposals and in its change orders, no matter how small because bond premiums are generally reimbursed by the owner. Several small change orders over time can turn into a large increase in the contract, which will result in an increase in premium. A contractor wants to avoid the premium coming out of its profit. If a surety requires a U.S. Small Business Administration (SBA) guarantee or funds control/escrow as a condition of approval, the cost of the bond can increase up to an additional 1.6% of the total contract price. These fees are paid to the SBA and/ or escrow company and are in addition to the premium paid to the surety.
What is a payment bond?
A payment bond ensures that certain subcontractors and suppliers will be paid for labor and materials incorporated into the project, if the bonded principal fails to pay for labor and materials supplied for the project. A laborer or supplier that has a right to make a claim against a payment bond is referred to as a “claimant.” Who is a proper claimant under a payment bond is typically restricted or limited by statute, the contract, or the bond. Most payment bonds require a claimant that does not have a contract with the principal to give the principal or surety, or both, written notice of its claim within a specific period of time after furnishing the labor or materials for which the claim is made. It is critically important to meet these deadlines, in the bond or any statutes governing the bond, or the claimant will lose its rights under the bond.
What is a warranty bond (maintenance bond)?
A warranty bond (sometimes called a maintenance bond) guarantees the owner that any work defects found in the original construction will be repaired during the warranty period. They are typically used when an owner wants a warranty period beyond one year. A warranty period can be extended for an annual fee, but sureties are reluctant to go beyond a few years. If the contractor is unable to resolve the warranty issue or is not in business during the specific warranty period, the warranty bond provides the owner with a remedy. The annual fee for a warranty bond is a fraction of the cost of a performance bond.
What is a general agreement of indemnity?
What are the main construction accounting methods, and what are the differences between them?
Two methods of accounting for contractors are generally accepted under accounting guidelines: (1) the completed contract method; and (2) the percentage of completion method. The completed contract method is only allowable in circumstances not resulting in a significant variation from the percentage of completion method. Under the completed contract method, all costs and revenue recognition are deferred until the contract is completed. This method is recommended where estimates are unreliable; it is contradictory to what a surety professional would typically require. It likely only applies to home builders and to contractors with seasonal work, or for contracts started and completed within the same fiscal year. The percentage of completion method of accounting for contractors is preferred and is more likely to be demanded by surety professionals. Using this method presumes that a contractor has the ability to make reasonable cost and revenue estimates and that the owner is expected and able to satisfy obligations under the contract. There are different ways to determine percentage of completion. Generally, the cost-to-cost method is used. Estimation of revenues on a contract can be complex. Key items include the original contract price, contract options, change orders, claims and provisions for acceleration payments, and liquidated damages. All must be considered to arrive at an adjusted contract price. The percentage of completion, multiplied by the adjusted contract price, establishes the amount earned as of the financial statement date. While a more in-depth discussion around the appropriate treatment of these contract adjustments would be needed, surety professionals will watch for the clarity of the disclosure in the financial statements and analyze how reliable the contractor has been in the past.
What is a financial statement and why is it important?
A financial statement is the main source of information about a contractor’s financial position, its performance, and changes in its financial position. It is important because a contractor’s financial statements provide users with the information necessary to make economic decisions about the contractor. The financial statement is used by bankers, sureties, vendors, investors, and others to make assessments about the contractor’s future risks and potential and to establish benchmark trends and relationships. They provide the basis for obtaining credit, setting capacity limits, and identifying investment opportunities. Users rely on data within the financial statements and data that can be derived from them to make their judgments, among which are: Working capital – current assets less current liabilities Net worth – owners’ investment in the contractor Debt to worth – measure of the contractor’s financial leverage Activity ratios – measure of how the contractor uses its assets Coverage ratios – measure of a contractor’s ability to meet its obligations Contract/revenue backlog – amount and quality of the contractor’s uncompleted work Clear and concise footnote disclosures are key components to a quality financial statement, providing a road map for the user to properly interpret the information in the contractor’s financial statement.
What are the differences between the three CPA services involving financial statements: compilation, review, and audit?
What factors does a surety consider in the underwriting and prequalification process?
Work in progress
Work history, including expertise and experience
Nature of project to be bonded
Character of the contractor
How long is the process for approval?
What if I have Credit Hardship?
Many surety bonds are “instant issue” meaning no credit report will be reviewed. Of those that do require a credit check and your credit has some challenges, we can work with you to get you the surety bond you need so you can continue to build equity in your business. NHC works with many secondary(rehab) surety markets to get you the best possible quote. Keep in mind we have over 80 sureties to go to. We often say if we can't get you a bond, no one can.
NIELSON HOOVER AND COMPANY
220 CONGRESS PARK DRIVE, SUITE 100 DELRAY BEACH, FLORIDA 334455