The good news is we have all heard the government stimulus package will create thousands of public projects and hundreds of thousands of jobs in the construction industry.
The bad news is what many hopeful contractors don't know-to even be considered on a publicly-funded project, a contractor must be "bondable."
As the amount of private work dwindles, it is expected there will be an influx of work on the federal, state, county and other municipal levels in the near future. In the majority of situations, bonds are required by law on public projects. The Miller Act requires certain bonds on federal projects. "Little Miller Acts" have been passed at the state and municipal level that bring about similar requirements. What does it take to become bondable? Before we answer that question, let's first understand what bonds are and why they exist in the first place.
What Purpose Does a Bond Serve?
Surety bonds are a risk transfer device similar to insurance. But they are different from insurance in that the party who has to post the bond is not protected by the bond. Bonds are a three-party agreement in which the public entity/owner passes on the risk of the contractor not completing a contract per the contract's specifications to a surety company. The surety company is able to offer assistance-technical, managerial and financial-to move the project along and reduce the chance of default or project failure. In addition, the surety company assumes the responsibility for project completion should the contractor default. For their assistance and liability, the surety company is paid a premium. This may not make sense at first blush, but suffice it to say, over time, surety bonds have proven to be a more cost-effective and efficient process than to have the taxpayer cover the additional expense that occurs to pre-qualify a contractor or as a result of a contractor default.
There are three main bonds you will need to obtain to participate in public contracts:
Bid Bonds
Bid bonds are needed when a contractor submits a formal bid to the public entity. Usually, there is no cost to the contractor in getting a bid bond. The bid bond is a pre-qualifying mechanism that provides assurance that an outside third-party (the surety) believes the contractor is capable of completing the project. It also provides assurance the contractor's bid was submitted in good faith, and if they are the low bidder they will enter into a formal contract. The bid bond penalty is usually a percentage of the bid price. Typically, the percentage is between 5 to 20 percent. If the low bidder does not agree to enter into a contract with the public entity, the surety may be forced to pay damages up to the bond penalty.
Performance Bonds
Performance bonds protect the public entity from financial loss should the contractor fail to perform the contract in accordance with the terms and conditions. If the public entity rightfully declares a contractor in default, the surety will then be called upon to fulfill their obligations under the contract.
Payment Bonds
Payment bonds on public projects are for the protection of certain subcontractors and material suppliers. Public property is not subject to lien laws, thus without payment bonds, subcontractors and material supplies would be without a remedy if they were not paid for their services.
At this point, you might be asking yourself, what if my firm defaults on a bonded obligation? Prior to releasing any bonds to you, the surety company will typically have the company president and all owners and their spouses sign an "agreement of indemnity." Basically, this document states if the surety company pays anything out of their pocket, they in turn will look to any and all indemnitors for reimbursement. This document is similar to what your bank may require, and it is very important that you understand and are prepared to sign.
How Can I Become Bondable?
Now that we understand what a bond is and why they exist, let's get back to the original question. What does it take to become bondable? In short, you must convince a surety company that your construction firm has the ability to complete all projects you take on per the contract specifications and can pay all debts associated with the project.
The first step to securing a bond for public sector work is to locate an experienced professional bond agent who can help educate you on the requirements and processes involved. This is an individual you will come to rely on greatly, so be sure to find someone you respect and trust. This person should help educate you on the Miller Act (for federal projects) and the Little Miller Acts (for state, county, city and municipal projects). Many contractors dedicate one or a few individuals within their organization to understand these requirements and communicate them to any others involved in bidding and managing public projects.
Your professional bond agent will also act as your advocate and guide you through the surety's underwriting process. Typically, a surety underwriter will tell you they are looking at three broad categories when evaluating whether or not to provide bonding to a contractor. These categories include:
- Character-Are the individuals who make up the construction firm of high moral character?
- Capacity-Does the construction firm have the people with the knowledge, experience and understanding to do the work?
- Capital-Does the construction firm have the equipment and financial wherewithal to complete the projects they desire bonds on?
To determine your level of bondability, an underwriter will typically review the following:
- The construction company's last three fiscal year-end financial statements
- The owner(s) of the construction company's current personal financial statement(s)
- A letter from the construction company's bank that indicates the revolving line of credit currently available to the contractor and how much of that line is currently in use
- A contractor's questionnaire that asks key questions about ownership breakdown, experience, other related businesses, largest jobs completed, current work in process, business succession planning, etc.
- Resumes of key individuals within the construction company
- Business credit reports
- Personal credit reports
Your professional bond agent will need a thorough and intimate understanding of your business because they then serve as your advocate to the bond underwriter throughout the process. Once your bond underwriter has reviewed your information, they will provide an indication of whether or not you are bondable, and if so, up to what levels. A typical bond line will offer a maximum single job size that the underwriter will approve for your firm and a maximum total work program the underwriter feels your firm can best handle.
Get Started Today
It is important to note this process can take a substantial amount of time because of the type and quality of information bonding companies require for bond approval. If you want to bid on public jobs in the near future, do not delay in getting this process started.
Construction Business Owner, September 2009
