Unlike insurance, where the insurance buyer exchanges their premium for a transfer of their risk to the insurance market, in the Surety world, there is no transfer of risk. When/if a surety loss occurs, the surety, via the indemnification agreement that was signed prior to bond issuance, is repaid for any loss paid on behalf of their bonded principal.
In much the same way that suretyship is different than insurance, surety underwriters behave differently than their insurance underwriting counterparts. Surety underwriters are primarily concerned with making sure that their bonded principal has sufficient net worth to repay any losses the Surety may incur. With every underwriting decision, surety underwriters are constantly looking at the downside risk of their extension of surety credit and they are looking to verify the net worth/liquidity of their principal. If the surety underwriter can not verify/rely on the net worth of their principal, they will simply decline to extend surety credit.
Since the contractor’s financial statements are the surety underwriter’s primary underwriting tool when it comes to measuring net worth/financial resources of their principal, the surety usually demands that the contractor supply them with CPA prepared financial statements. Depending on the size of the work program required by the contractor, the surety may request either compiled, reviewed, or audited financial statements.
Financial statements which are prepared directly by the contractor or by the contractor’s accounting system are referred to as “internal” financial statements and they are generally unacceptable to most surety underwriters. The reason for this is that internal financial statements do not provide the surety with the necessary independent third party valuation contained in CPA reviewed or audited financial statements. (CPA prepared compiled financial statements are generally equated with “internal” financial statements since, in a compiled set of financial statements, the CPA firm simply recreates the statements given to them by the contractor without verifying/checking balances.)
The importance of CPA prepared financial statements is not limited to the surety underwriter’s analysis and verification of net worth. In addition to this, a good CPA prepared set of financials will include a Work In Progress, or “WIP”, schedule that ties in to the financial statements. The WIP schedule is very important to the surety underwriter as it allows them to track things such as underbillings, overbillings, profit fade/gain, and pure job borrow. The WIP gives the surety underwriter a predictive tool to analyze future performance, future gross margin, and cash flow in the contractor’s remaining uncompleted work.
To draw a mining analogy; if a contractor seeks surety credit in the same way that a miner seeks gold, the miner must use a pick and shovel to get to the gold and, in the same way, the contractor must use CPA prepared financial statements to get to his gold = surety credit.
Tim Hutton, CPCU, AFSB
timothyjhutton@gmail.com
703 220 7771 mobile
Showing posts with label surety. Show all posts
Showing posts with label surety. Show all posts
Sunday, December 13, 2009
Sunday, November 1, 2009
Overlooked Advantages of a Surety Line
Unlike insurance, in which the buyer purchases the product for their own protection, a performance/payment bond is ‘purchased’ by the buyer for the owner/client’s protection. In other words, the bond is a hurdle put in place by the owner. In order to work for the owner, the contractor (the Principal) must pass the hurdle. (The owner, (the Obligee), is the entity requiring the bond and could be the actual ‘owner’ or another contractor.) So, one may assume that the only beneficiary of a surety relationship is the owner. This ‘one-sided’ view of suretyship is misguided and bonded principals need to know the benefits they receive as a result of their surety relationship.
Since bonded principals must pass through a rigorous level of underwriting prior to establishment of their bond line, the surety (with all of the resultant underwriting knowledge) should be viewed as a business ally and contacted frequently for advice and direction. In this way, the surety operates as an ‘extra set of eyes’ in matters regarding the principal’s business plan, their competition, and the local business environment. To only call on one’s surety for advice/direction when a bond is needed, is missing the chance for advice and guidance from a business ally. (Remember: the surety is a
for-profit entity that wants to write many bonds for you. By routinely seeking their input/direction, you ‘cement’ your relationship with the market and you can gain valuable information with which to better your company.)
Another overlooked benefit of an established surety relationship is in new business acquisition. Too often, contractors only react to bond requirements (hurdles) when they can/should be proactive and offer a bond to potential owners even when a bond is not required. (The premium for the bond can be passed on to the owner in your bid.)
Let’s assume: Contractor A established a bond line because Owner B required a bond of Contractor A. So, Contractor A sought the services of an experienced surety broker who assisted in establishing a surety line with Surety C. The contract was signed, the work was completed, and the bond was released. Now, let’s further assume that Contractor 1 is in negotiations with Owner D and Owner D’s contract makes no mention of a performance bond requirement. With an established bond line, Contractor A may have an advantage over his competition. (If the competition is not bonded and/or bondable, then bring that to the owner’s attention!) Why not offer Owner D a letter of bondability from your broker that glowingly states that you are bonded and backed by a highly rated surety and that your surety would look favorably on providing a bond for the job in question if asked. By bringing to the attention of the owner the fact that your firm is bondable, you immediately drive a wedge between your competition and the owner. (“Why doesn’t this other company have one of these ‘bondability’ letters?)
As touched on above, another benefit of an established bond line is the ally you have in your surety. When/if a dispute and/or claim should arise, the surety will not simply ‘pay’ the owner. The owner’s claim must be proved and the surety is there, as your ally, between you and the owner seeking to settle the claim. This alliance should not be underestimated…the surety wants your firm to succeed. When you succeed, the surety succeeds, when you lose, they lose. As a for-profit entity, the surety has a vested interest in making sure your firm is around for a long time and that you will continue to win new bonded work which will result in new bond premiums for the surety.
Don’t overlook the advantages of your surety line!
Tim Hutton, CPCU, AFSB
timothyjhutton@gmail.com
(703) 220-7771
Since bonded principals must pass through a rigorous level of underwriting prior to establishment of their bond line, the surety (with all of the resultant underwriting knowledge) should be viewed as a business ally and contacted frequently for advice and direction. In this way, the surety operates as an ‘extra set of eyes’ in matters regarding the principal’s business plan, their competition, and the local business environment. To only call on one’s surety for advice/direction when a bond is needed, is missing the chance for advice and guidance from a business ally. (Remember: the surety is a
for-profit entity that wants to write many bonds for you. By routinely seeking their input/direction, you ‘cement’ your relationship with the market and you can gain valuable information with which to better your company.)
Another overlooked benefit of an established surety relationship is in new business acquisition. Too often, contractors only react to bond requirements (hurdles) when they can/should be proactive and offer a bond to potential owners even when a bond is not required. (The premium for the bond can be passed on to the owner in your bid.)
Let’s assume: Contractor A established a bond line because Owner B required a bond of Contractor A. So, Contractor A sought the services of an experienced surety broker who assisted in establishing a surety line with Surety C. The contract was signed, the work was completed, and the bond was released. Now, let’s further assume that Contractor 1 is in negotiations with Owner D and Owner D’s contract makes no mention of a performance bond requirement. With an established bond line, Contractor A may have an advantage over his competition. (If the competition is not bonded and/or bondable, then bring that to the owner’s attention!) Why not offer Owner D a letter of bondability from your broker that glowingly states that you are bonded and backed by a highly rated surety and that your surety would look favorably on providing a bond for the job in question if asked. By bringing to the attention of the owner the fact that your firm is bondable, you immediately drive a wedge between your competition and the owner. (“Why doesn’t this other company have one of these ‘bondability’ letters?)
As touched on above, another benefit of an established bond line is the ally you have in your surety. When/if a dispute and/or claim should arise, the surety will not simply ‘pay’ the owner. The owner’s claim must be proved and the surety is there, as your ally, between you and the owner seeking to settle the claim. This alliance should not be underestimated…the surety wants your firm to succeed. When you succeed, the surety succeeds, when you lose, they lose. As a for-profit entity, the surety has a vested interest in making sure your firm is around for a long time and that you will continue to win new bonded work which will result in new bond premiums for the surety.
Don’t overlook the advantages of your surety line!
Tim Hutton, CPCU, AFSB
timothyjhutton@gmail.com
(703) 220-7771
Wednesday, July 15, 2009
Insurance Market Cycles and Surety Reinsurance: How Do They Impact a Contractor’s Surety Line?
Insurance markets tend to run in cycles of ‘hard markets’ and ‘soft markets’. Simply stated, a ‘hard market’ exists when underwriting terms and conditions favor the insurance provider and a ‘soft market’ exists when underwriting terms and conditions favor the insurance purchaser. These hard and soft market cycles can last years and can change slowly or quickly depending on a number of issues. One thing that is certain: the cycles always occur.
When a given insurance market is ‘hard’ and capacity is tight, the following takes place: prices increase, underwriting rules become more conservative, and losses moderate. Eventually, new capacity enters the market. As excess capacity grows and becomes overabundant, a ‘soft’ develops with the following characteristics: prices will decrease, underwriting will become more liberal, losses will increase and the market begins to harden; launching a new cycle.
Like all other insurance markets, the surety reinsurance market runs in cycles. In fact, the hard/soft status of the surety reinsurance market affects the hard/soft status of the overall surety market. To understand the impact of surety reinsurance on a given contractor’s surety line, one must first examine and understand reinsurance in general. A quick definition of reinsurance is, simply, insurance purchased by and for the benefit of insurance companies.
Through the purchase of reinsurance, an insurance company cedes some of its overall exposure and transfers some of its risk to the reinsurer. Thus, reinsurance serves to protect the ceding insurer from exceptionally large, unanticipated losses. Reinsurance also helps insurers diversify their books of business, it enables insurers to provide increased capacity, and it ‘smoothes out’ underwriting results.
Surety reinsurance is one form of reinsurance that is purchased by sureties to back a given surety company’s surety results. It is usually purchased in one of two forms:
>Facultative – surety reinsurance written on a per risk basis, or
>Treaty – automatic protection for an entire class of business/covers the portfolio. Reinsurance is further broken down into the two following classes:
>Pro Rata – here, the reinsurer assumes a portion, or pro rata, share of each loss, and,
>Excess of Loss – the reinsurer assumes losses only over a mutually agreeable dollar threshold.
When a contractor’s supplier/subcontractor increases rates for their product/service, contractors will ‘pass through’ to an owner, the increased costs placed on them by the suppliers and/or subcontractors. Similarly, the surety industry will ‘pass through’ to contractors the increased rates, the more stringent underwriting criteria, and the many exclusions/restrictions placed on them by the surety reinsurers.
As you review the terms and conditions of your surety line with your agent/broker, keep in mind that the terms are, at least in part, reflective of the surety reinsurance marketplace. Insurance cycles are dynamic and in a constant state of flux. As surety results improve/decline...new surety reinsurance capacity will emerge/contract, terms and conditions will be relaxed/strengthened and these conditions will be passed on to the surety markets who, in turn, will pass them on to the contractors…and the cycle will continue....
Timothy J. Hutton, AFSB, CPCU
mobile (703) 220 - 7771
timothyjhutton@gmail.com
When a given insurance market is ‘hard’ and capacity is tight, the following takes place: prices increase, underwriting rules become more conservative, and losses moderate. Eventually, new capacity enters the market. As excess capacity grows and becomes overabundant, a ‘soft’ develops with the following characteristics: prices will decrease, underwriting will become more liberal, losses will increase and the market begins to harden; launching a new cycle.
Like all other insurance markets, the surety reinsurance market runs in cycles. In fact, the hard/soft status of the surety reinsurance market affects the hard/soft status of the overall surety market. To understand the impact of surety reinsurance on a given contractor’s surety line, one must first examine and understand reinsurance in general. A quick definition of reinsurance is, simply, insurance purchased by and for the benefit of insurance companies.
Through the purchase of reinsurance, an insurance company cedes some of its overall exposure and transfers some of its risk to the reinsurer. Thus, reinsurance serves to protect the ceding insurer from exceptionally large, unanticipated losses. Reinsurance also helps insurers diversify their books of business, it enables insurers to provide increased capacity, and it ‘smoothes out’ underwriting results.
Surety reinsurance is one form of reinsurance that is purchased by sureties to back a given surety company’s surety results. It is usually purchased in one of two forms:
>Facultative – surety reinsurance written on a per risk basis, or
>Treaty – automatic protection for an entire class of business/covers the portfolio. Reinsurance is further broken down into the two following classes:
>Pro Rata – here, the reinsurer assumes a portion, or pro rata, share of each loss, and,
>Excess of Loss – the reinsurer assumes losses only over a mutually agreeable dollar threshold.
When a contractor’s supplier/subcontractor increases rates for their product/service, contractors will ‘pass through’ to an owner, the increased costs placed on them by the suppliers and/or subcontractors. Similarly, the surety industry will ‘pass through’ to contractors the increased rates, the more stringent underwriting criteria, and the many exclusions/restrictions placed on them by the surety reinsurers.
As you review the terms and conditions of your surety line with your agent/broker, keep in mind that the terms are, at least in part, reflective of the surety reinsurance marketplace. Insurance cycles are dynamic and in a constant state of flux. As surety results improve/decline...new surety reinsurance capacity will emerge/contract, terms and conditions will be relaxed/strengthened and these conditions will be passed on to the surety markets who, in turn, will pass them on to the contractors…and the cycle will continue....
Timothy J. Hutton, AFSB, CPCU
mobile (703) 220 - 7771
timothyjhutton@gmail.com
Tuesday, June 30, 2009
State & Local Contracts – Understanding Surety Bond Requirements
In order to succeed in any given business environment, contractors must be uniquely aware of the peculiarities of a given market. The State & Local Government marketplace is no exception to this rule. Within the State & Local Government marketplace, contractors are likely to encounter a contractual requirement that they do not often face in the private marketplace: a surety requirement.
Unlike customers within the private marketplace, many states and local governments are required by local codes/ordinances to require bid and performance guarantees in the form of surety bonds. In order to best understand how to meet these various surety requirements, contractors should become well versed in the language of surety bonding and fully understand why bonds are required and how sureties underwrite surety bonds.
A surety bond is a three party agreement between:
1. Obligee
2. Principal
3. Surety.
In exchange for a fee and a ‘hold-harmless’/indemnity agreement from the Principal to the Surety, the Surety agrees that, in the event of a default on the part of the Principal, the Surety is required to perform the terms of the contract between the Principal and Obligee. Each party to this three party agreement has unique roles, rights, and responsibilities.
Obligee – The Obligee is the entity protected by the Surety bond against loss. The surety bond ‘runs to’ the Obligee and the Obligee has the ability to set the language of the surety bond.
Principal – The Principal is the entity obligated, with the Surety, to the Obligee. The Principal pays the fee for the bond and, via the indemnity agreement, holds the Surety harmless for its failure to perform the terms of the contract.
Surety – The Surety is the entity obligated, with the Principal, to the Obligee. Generally*, the Surety is an unsecured creditor relying only upon the ‘promise to be made whole’ contained in the indemnity agreement. (*Surety does have a security interest in receivables and equipment on bonded jobs.)
The most common surety requirements faced by contractors operating within the State & Local Government Marketplace are bid, performance, and payment bond requirements.
Bid Bond – A surety bond given by a bidder on a contract; it guarantees that the bidder, should they be selected, will enter into the contract and furnish the prescribed performance bond. The bid bond is usually a small percentage of the overall contract.
Performance Bond – A surety bond which guarantees faithful performance of the terms of a written contract. Performance Bond amounts can vary from 100% of contract price to a smaller percentage of the contract price. (Performance bonds frequently incorporate Labor and Material and Maintenance liability.)
Payment/Labor and Material Bond – A surety bond given by a contractor to guarantee payment for the labor and material used in the work which he is obligated to perform under the contract.
As mentioned above, Obligees within the State & Local market are frequently required by law to require surety bonds from contractors bidding on public work. From the Obligee’s standpoint, the benefits of requiring surety bonds are numerous. For example, through the requirement of a bid bond, the Obligee ensures that only qualified bidders will bid the job and, if a low bidder ‘walks away’ from their bid and does not enter into a contract with the Obligee, the Obligee recovers the bid penalty which will cover the costs of rebidding the job. The second benefit enjoyed by the Obligee through the surety requirements is that of prequalification. By requiring bid and performance bonds, the Obligee ‘pushes off’ to the Surety industry, the necessary prequalification work that must be undertaken to ensure that a given contractor has the capacity to perform the given task. In this example, the surety requirements are like ‘hurdles’ put in place by the Obligee; only those contractors able to clear the ‘hurdles’ are deemed capable to work for the Obilgee. Lastly, and perhaps most importantly, through requiring a Performance Bond, the Obligee protects the public from the downside risk of contractor failure. Should a bonded contractor fail to perform the terms of the bonded contract, the Surety is required to perform on behalf of the defaulted Principal. Therefore, the public funds are protected and the project is guaranteed to be completed as contracted.
When underwriting a given contractor, the Surety will examine the contractor’s character, capacity, and capital. (This is commonly referred to as the three C’s of surety underwriting.)
Character – Does the contractor have a good reputation as an upstanding business?
Capacity – Does the contractor have the capacity to perform the contract? Have they done this work before? Have they successfully handled a job of similar size?
Capital – Should the contractor default, is there sufficient capital ($$$) within the company to make the surety whole for the costs they will incur to remedy the contractor’s default?
Insurance policies are underwritten with the expectation that losses will occur and the premium charged for the policy contains a provision for expected these losses. Unlike insurance underwriting, the surety underwrites to a zero loss ratio. If the surety underwriter can not become satisfied with the contractor’s character, capacity or capital, he/she will simply decline to offer surety credit.
In order to establish a bond line with a surety market, contractors should work with an experienced surety agent that will assist them in demonstrating to the surety markets that the contractor has the aforementioned 3 C’s required to gain the surety’s approval. Basic underwriting information required includes several years of CPA prepared financial statements, background materials on the contractor, as well as scope of work/rfp’s for the bonded job(s) in question.
The contractors that view their surety as an important member of their ‘team’ will enjoy more success and bond approvals than those that treat the surety as an outsider or a ‘necessary evil’ within the State & Local Government marketplace. Not only will the surety be more responsive to their needs and requests, however, the contractor can and should use a strong surety relationship as a competitive advantage over their competitors that may not be as readily ‘bondable’.
Timothy J. Hutton, CPCU, AFSB
Cell: 703-220-7771
timothyjhutton@gmail.com
Unlike customers within the private marketplace, many states and local governments are required by local codes/ordinances to require bid and performance guarantees in the form of surety bonds. In order to best understand how to meet these various surety requirements, contractors should become well versed in the language of surety bonding and fully understand why bonds are required and how sureties underwrite surety bonds.
A surety bond is a three party agreement between:
1. Obligee
2. Principal
3. Surety.
In exchange for a fee and a ‘hold-harmless’/indemnity agreement from the Principal to the Surety, the Surety agrees that, in the event of a default on the part of the Principal, the Surety is required to perform the terms of the contract between the Principal and Obligee. Each party to this three party agreement has unique roles, rights, and responsibilities.
Obligee – The Obligee is the entity protected by the Surety bond against loss. The surety bond ‘runs to’ the Obligee and the Obligee has the ability to set the language of the surety bond.
Principal – The Principal is the entity obligated, with the Surety, to the Obligee. The Principal pays the fee for the bond and, via the indemnity agreement, holds the Surety harmless for its failure to perform the terms of the contract.
Surety – The Surety is the entity obligated, with the Principal, to the Obligee. Generally*, the Surety is an unsecured creditor relying only upon the ‘promise to be made whole’ contained in the indemnity agreement. (*Surety does have a security interest in receivables and equipment on bonded jobs.)
The most common surety requirements faced by contractors operating within the State & Local Government Marketplace are bid, performance, and payment bond requirements.
Bid Bond – A surety bond given by a bidder on a contract; it guarantees that the bidder, should they be selected, will enter into the contract and furnish the prescribed performance bond. The bid bond is usually a small percentage of the overall contract.
Performance Bond – A surety bond which guarantees faithful performance of the terms of a written contract. Performance Bond amounts can vary from 100% of contract price to a smaller percentage of the contract price. (Performance bonds frequently incorporate Labor and Material and Maintenance liability.)
Payment/Labor and Material Bond – A surety bond given by a contractor to guarantee payment for the labor and material used in the work which he is obligated to perform under the contract.
As mentioned above, Obligees within the State & Local market are frequently required by law to require surety bonds from contractors bidding on public work. From the Obligee’s standpoint, the benefits of requiring surety bonds are numerous. For example, through the requirement of a bid bond, the Obligee ensures that only qualified bidders will bid the job and, if a low bidder ‘walks away’ from their bid and does not enter into a contract with the Obligee, the Obligee recovers the bid penalty which will cover the costs of rebidding the job. The second benefit enjoyed by the Obligee through the surety requirements is that of prequalification. By requiring bid and performance bonds, the Obligee ‘pushes off’ to the Surety industry, the necessary prequalification work that must be undertaken to ensure that a given contractor has the capacity to perform the given task. In this example, the surety requirements are like ‘hurdles’ put in place by the Obligee; only those contractors able to clear the ‘hurdles’ are deemed capable to work for the Obilgee. Lastly, and perhaps most importantly, through requiring a Performance Bond, the Obligee protects the public from the downside risk of contractor failure. Should a bonded contractor fail to perform the terms of the bonded contract, the Surety is required to perform on behalf of the defaulted Principal. Therefore, the public funds are protected and the project is guaranteed to be completed as contracted.
When underwriting a given contractor, the Surety will examine the contractor’s character, capacity, and capital. (This is commonly referred to as the three C’s of surety underwriting.)
Character – Does the contractor have a good reputation as an upstanding business?
Capacity – Does the contractor have the capacity to perform the contract? Have they done this work before? Have they successfully handled a job of similar size?
Capital – Should the contractor default, is there sufficient capital ($$$) within the company to make the surety whole for the costs they will incur to remedy the contractor’s default?
Insurance policies are underwritten with the expectation that losses will occur and the premium charged for the policy contains a provision for expected these losses. Unlike insurance underwriting, the surety underwrites to a zero loss ratio. If the surety underwriter can not become satisfied with the contractor’s character, capacity or capital, he/she will simply decline to offer surety credit.
In order to establish a bond line with a surety market, contractors should work with an experienced surety agent that will assist them in demonstrating to the surety markets that the contractor has the aforementioned 3 C’s required to gain the surety’s approval. Basic underwriting information required includes several years of CPA prepared financial statements, background materials on the contractor, as well as scope of work/rfp’s for the bonded job(s) in question.
The contractors that view their surety as an important member of their ‘team’ will enjoy more success and bond approvals than those that treat the surety as an outsider or a ‘necessary evil’ within the State & Local Government marketplace. Not only will the surety be more responsive to their needs and requests, however, the contractor can and should use a strong surety relationship as a competitive advantage over their competitors that may not be as readily ‘bondable’.
Timothy J. Hutton, CPCU, AFSB
Cell: 703-220-7771
timothyjhutton@gmail.com
Understanding International Surety Bond Requirements
While widely recognized and utilized in the United States, internationally, suretyship has a mixed reputation. Based mainly on a given foreign country's heritage/exposure to western influence, suretyship may or may not be utilized and/or accepted internationally. For U.S. Government Contractors and Technology companies working abroad, gaining a better understanding of the peculiarities of international suretyship can greatly assist them should they encounter these surety requirements.
Before we can discuss the peculiarities of International Surety Bonding, we must first have a basic understanding of suretyship and its related terminology.
A surety bond is a three party agreement between:
1. Obligee
2. Principal
3. Surety.
In exchange for a fee and a ‘hold-harmless’/indemnity agreement from the Principal to the Surety, the Surety agrees that, in the event of a default on the part of the Principal, the Surety is required to perform the terms of the contract between the Principal and Obligee. Each party to this three party agreement has unique roles, rights, and responsibilities.
Obligee – The Obligee is the entity protected by the Surety bond against loss. The surety bond ‘runs to’ the Obligee and the Obligee has the ability to set the language of the surety bond.
Principal – The Principal is the entity obligated, with the Surety, to the Obligee. The Principal pays the fee for the bond and, via the indemnity agreement, holds the Surety harmless for its failure to perform the terms of the contract.
Surety – The Surety is the entity obligated, with the Principal, to the Obligee. Generally*, the Surety is an unsecured creditor relying only upon the ‘promise to be made whole’ contained in the indemnity agreement. (*Surety does have a security interest in receivables and equipment on bonded jobs.)
International surety requirements can be loosely categorized into two distinct categories each with their own attributes.
1. Surety bonds required by a U.S. Contractor working abroad for a U.S. Obligee
Of the two categories, these types of "international" bonds are the easier of the two to obtain. While the work covered by these types of bonds can be construed as international, to most surety underwriters, they will view this as domestic work that just happens to be occurring overseas. This view is due to the fact that, given the Obligee is a U.S. entity, the surety underwriter can safely assume that the Obligee will readily accept a bond issued by a U.S. domiciled surety and also readily accept the jurisdiction of the U.S. Courts should a claim/issue arise. The surety is concerned with the acceptability of "U.S. paper" because the surety takes on additional costs and bureaucratic hurdles when a 'fronting arrangement' has to be established prior to bond issuance. Additionally, jurisdiction is a key risk factor in the surety's underwriting decision. Generally, most U.S. domiciled sureties will not allow their bonds to be governed by the courts of another nation.
As we will see below, when the Obligee is a foreign entity, these assurances/underwriting assumptions can not be readily established.
2. Surety bonds required by a foreign Obligee
When a foreign Obligee requires a surety bond of a U.S. Contractor, the first 'bridge' that must be crossed, is one of semantics. To many foreign Obligees, the terms "bond guarantee" and "performance bond" can be and are used interchangeably with the terms "bank guarantee" and "letter of credit". Given that the classic three party surety bond is not as widely used or well known in most of the world, many foreign Obligees ask for a "bond" when the really want a "letter of credit" or a "bank guarantee"!
Secondly, as we discussed above, many foreign Obligees will only accept bonds from sureties that are domiciled in their own country. To meet this requirement, the U.S. surety must:
a. have a pre-established relationship with the given foreign surety market or
b. go to the extra expense of establishing such a 'fronting' arrangement.
Expectedly, both a.) and b.) above add layers of cost to the surety which can diminish their interest in supporting the deal. Last, foreign Obligees frequently require that any bond they accept, must be governed by their domestic court system. Of course, this opens the U.S. surety to unknown risks, costs, etc. and also serves to diminish the U.S. surety's interest in supporting a given bond request.
Summary
When operating internationally, U.S. Government Contractors must be ready to meet the often complicated requirements of international suretyship. However, by utilizing the services of an experienced surety broker, these requirements can be planned for, managed, and achieved so the ultimate success of the contract is assured.
Timothy J. Hutton, AFSB, CPCU
Cell: 703-220-7771
timothyjhutton@gmail.com
Before we can discuss the peculiarities of International Surety Bonding, we must first have a basic understanding of suretyship and its related terminology.
A surety bond is a three party agreement between:
1. Obligee
2. Principal
3. Surety.
In exchange for a fee and a ‘hold-harmless’/indemnity agreement from the Principal to the Surety, the Surety agrees that, in the event of a default on the part of the Principal, the Surety is required to perform the terms of the contract between the Principal and Obligee. Each party to this three party agreement has unique roles, rights, and responsibilities.
Obligee – The Obligee is the entity protected by the Surety bond against loss. The surety bond ‘runs to’ the Obligee and the Obligee has the ability to set the language of the surety bond.
Principal – The Principal is the entity obligated, with the Surety, to the Obligee. The Principal pays the fee for the bond and, via the indemnity agreement, holds the Surety harmless for its failure to perform the terms of the contract.
Surety – The Surety is the entity obligated, with the Principal, to the Obligee. Generally*, the Surety is an unsecured creditor relying only upon the ‘promise to be made whole’ contained in the indemnity agreement. (*Surety does have a security interest in receivables and equipment on bonded jobs.)
International surety requirements can be loosely categorized into two distinct categories each with their own attributes.
1. Surety bonds required by a U.S. Contractor working abroad for a U.S. Obligee
Of the two categories, these types of "international" bonds are the easier of the two to obtain. While the work covered by these types of bonds can be construed as international, to most surety underwriters, they will view this as domestic work that just happens to be occurring overseas. This view is due to the fact that, given the Obligee is a U.S. entity, the surety underwriter can safely assume that the Obligee will readily accept a bond issued by a U.S. domiciled surety and also readily accept the jurisdiction of the U.S. Courts should a claim/issue arise. The surety is concerned with the acceptability of "U.S. paper" because the surety takes on additional costs and bureaucratic hurdles when a 'fronting arrangement' has to be established prior to bond issuance. Additionally, jurisdiction is a key risk factor in the surety's underwriting decision. Generally, most U.S. domiciled sureties will not allow their bonds to be governed by the courts of another nation.
As we will see below, when the Obligee is a foreign entity, these assurances/underwriting assumptions can not be readily established.
2. Surety bonds required by a foreign Obligee
When a foreign Obligee requires a surety bond of a U.S. Contractor, the first 'bridge' that must be crossed, is one of semantics. To many foreign Obligees, the terms "bond guarantee" and "performance bond" can be and are used interchangeably with the terms "bank guarantee" and "letter of credit". Given that the classic three party surety bond is not as widely used or well known in most of the world, many foreign Obligees ask for a "bond" when the really want a "letter of credit" or a "bank guarantee"!
Secondly, as we discussed above, many foreign Obligees will only accept bonds from sureties that are domiciled in their own country. To meet this requirement, the U.S. surety must:
a. have a pre-established relationship with the given foreign surety market or
b. go to the extra expense of establishing such a 'fronting' arrangement.
Expectedly, both a.) and b.) above add layers of cost to the surety which can diminish their interest in supporting the deal. Last, foreign Obligees frequently require that any bond they accept, must be governed by their domestic court system. Of course, this opens the U.S. surety to unknown risks, costs, etc. and also serves to diminish the U.S. surety's interest in supporting a given bond request.
Summary
When operating internationally, U.S. Government Contractors must be ready to meet the often complicated requirements of international suretyship. However, by utilizing the services of an experienced surety broker, these requirements can be planned for, managed, and achieved so the ultimate success of the contract is assured.
Timothy J. Hutton, AFSB, CPCU
Cell: 703-220-7771
timothyjhutton@gmail.com
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