Product Fundamental: surety bonds

Surety bonds are an alternative to bank guarantees or cash retentions that parties may procure to offer security for contract performance. Unlike bank guarantees, surety bonds do not tie up cash or assets as collateral security and as such can be a distinct benefit in the context of cashflow. They are an accepted form of collateral in commercial transactions across most sectors, including all levels of Government.  

Offering guarantees to secure performance and other security requirements is often an obstacle for parties tendering for projects. In many cases, parties required to offer such undertakings must offer security to a financial institution, or they may have reached capacity within their agreed facility limits.  

By way of comparison, surety providers view the contractor’s ability to fulfil its contractual performance obligations as a key underwriting element (along with financial analysis of the business). Subsequently, the surety market will support the obligations of the contractor without the need for tangible security to be held.  

This frees up funds to enable contractors to tender for additional work. By comparison, financial institutions will place more emphasis on assessing only the tangible security to support guarantee facilities and in doing so can weaken the contractors’ cash flow position. 

Bonds can be arranged to cover contract performance, maintenance or defect liability period obligations, bid or tender bonds, advance payment bonds, off site material bonds and rental bonds. Otherwise, there are bespoke bonds to address performance related obligations that may arise due to contractual undertakings. 

Surety is not a traditional insurance product. Whilst the security for the bond is provided by an APRA approved (and S&P rated) insurance company, in the event of a call being made on a bond by a project principal, the provider will seek repayment of the amount in full by the facility owner/ guarantor. 

Whilst surety providers do not seek direct security over assets of the business or its owners, a deed of indemnity is often required to ensure that a call may be met on demand. 

Initially, a facility needs to be approved for the applicant. Here Bellrock will assist by settling a submission to interested bond providers demonstrating the company’s trading history, experience and forecasts.  

Surety providers will review the above to consider whether the applicant has a developed core business with a solid trading history; can evidence appropriate management of company operations, has adequate liquidity, maintains sound strategy of growth, has the technical ability to meet the requirements of the work it does, and appropriately manages its exposure to existing projects. 

Most bond providers require applicants to satisfy similar criteria.  Annual turnover should exceed $70M, net tangible equity between $5M to $10M, 3 years of consecutive profit and that the applicant has operated for 5 years. 

Applications are usually assessed within 6 to 8 weeks. If a facility is offered, formal documents are prepared within 4 weeks. A total of 12 weeks is a prudent time frame to consider investigations and preparation/finalisation of documents. 

Once a facility is in place, the provider will have regard to issuance of particular bonds. Therein consideration of specifics of each bond will be considered and the expertise of the applicant in respect of the matters sought to be bonded will be considered. The preparation and delivery of individual bonds usually takes 3 to 4 business days. 

To prepare documents for the facility (including its terms and deeds of indemnity) the provider will charge you disbursements (professional fees) between $5,000 and $15,000. The range varies depending on the complexity of the facility. 

For each bond, the cost is comparable to that of a bank guarantee. They are charged on an agreed rate per annum. When the bond is returned to the provider, an adjustment is made to the amount charged based on the actual period to which the bond applies. 

Bellrock has capability to advise on, arrange and administer bond facilities. For further advice on this useful methodology, please contact our Team who can assist you in providing guarantees to your clients without significantly impacting your cashflow.