Tuesday, April 22, 2014

Researching Bonds and Bonding Companies

Bonding companies (also known as sureties) play an important role in public works construction contracting.  Sureties issue bonds for the following:
  • Bid Bonds: The bonding company agrees to pay the public agency a specified dollar amount or percentage of the bid amount if the bidder is awarded a contract by the the public agency, but fails to execute or sign the contract.  Click here for a previous blog posting on limitations on the bid bond amount.
  • Payment Bond:  A payment bond is a guarantee by the surety that the contractor will pay their subcontractors, suppliers, and workers on the project. If the contractor fails to do so, an unpaid party may file a claim against the payment bond and collect from the surety.
  • Performance Bond:  With a performance bond, the surety stands behind the contractor and guarantees that the contractor will faithfully perform according to all of the terms and conditions of the construction contract.  In the event the contractor fails to do so, the surety agrees to pay for the completion of the project.
  • Warranty Bond:  A warranty bond, also known as a maintenance bond, is the guaranty of the surety that the contractor will perform and pay subcontractors, suppliers, and workers during a warranty period.  The payment and performance bond will typically cover a one year warranty period after the substantial completion date of a project.  A warranty bond may be required by a public agency if the agency desires a warranty period for longer than one year.
Is the surety financially strong?  Public agencies require bonding companies to make guarantees to ensure the contractor performs.  But how do we know that a surety will be able to fulfill its financial obligations?  One indicator of a bonding company's financial capacity comes from ratings given by an independent private company, A.M. Best.  A.M. Best rates sureties on two factors that should be considered together:
  • Financial Strength Rating:  A.M. Best assigns letter grades to sureties with scores of A++, A+, A, A-, B++, and B+ representing secure bonding companies.  Sureties that are rated B through F (or S for suspended) represent vulnerable sureties.  Many public agencies require that the bonds submitted by contractors be from bonding companies with a specified minimum rating.
  • Financial Size Category:  A.M. Best also rates sureties based on their financial size using what is referred to as "adjusted policyholders' surplus" (PHS).  The higher the Roman numeral rating, the larger financial capacity of the bonding company.  For example, a surety rated as "class I" has an adjusted PHS less than $1 million, while a firm rated as "class VII" has an adjusted PHS of $50 to $100 million.  Like the Financial Strength Rating, many public agencies require that the bonds submitted by contractors be from bonding companies with a minimum Financial Size Category rating.
What is a good surety rating?  I frequently see public agencies requiring that bonds be from a sureties with an A.M. Best rating of A- VII, or something similar.  Do your bid and contract documents require a minimum A.M. Best rating for sureties? 

How can you verify a surety's A.M. Best rating?  A.M. Best makes their ratings available online at http://www.ambest.com/.  To access the ratings, you do need to sign up on their website.  The registration and access to the information is free. 

Does the government rate sureties?  The federal government maintains a list of approved sureties and state agencies often have lists of sureties authorized to do business in that state.
  • Federal:  Public agencies can verify that a surety is on the federal list by going to the U.S. Department of the Treasury's Listing of Approved Sureties (Circular 570) at the following website:  http://www.fms.treas.gov/c570/c570_a-z.html.
Is a bond legitimate?  With advanced technology today, there are more and more cases of forged bonds.  Click here to read a previous blog posting discussing verifying bonds and referencing a number of forged bond cases.  It is a prudent business practice for public agencies to verify with the bonding company that a bond has been issued.  Bonding companies authorize others, known as an "attorney-in-fact" to obligate the surety.  The attorney-in-fact must, however, report to the surety when they have issued a bond.  
  • Research the surety's phone number:  Independently research the surety's phone number.  Do not rely on a phone number that may be on the bond.
  • Call the surety:  Call the surety to verify the legitimacy of the bond.  
  • Verify for all or some contractors:  Some public agencies do not verify bonds for well-known contractors they have done business with for years, and that pose a low risk.  However, researching the legitimacy of a bond for a new or unknown contractor is a good idea.
Mike Purdy's Public Contracting Blog
© 2014 by Michael E. Purdy Associates, LLC

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