Bid and Performance Bond Facility Terms and Conditions Letter

It is always surprising to me how many prospective clients have never seen or heard of the Bid and Performance Bond Terms and Conditions Letter (T&C). Unfortunately in our industry, this critical document is often overlooked by surety brokers. Too often brokers will discuss rates and rough limits, but don’t go into greater detail that is outlined in the T&C letter. Clients are simply not given the opportunity to review the terms of their facility and as a consequence do not fully understand how their contract surety facility works.

To illustrate the importance, I like to compare your bond T&C letter to a bank lending commitment letter. Would you enter into a lending agreement with your bank without knowing the terms? Would you build a new school without knowing the terms of the contract? Of course not, so why do the same with your surety facility. Reviewing this document not only helps you understand what types of bonded jobs you can bid on, but it engages an important conversation that helps you understand how bonding works.

So then, what is in the Terms and Conditions letter?

1. Bond Facility Limits

The first section of the T&C and the most obvious is the bonding limits that your bond company is willing to extend to you. These limits are made up of a single contract limit and an aggregate contract limit.

The single contract limit is the maximum bonded contract value that your surety company will support you on. Typically, the single contract limit is determined by looking at your previous largest jobs and discussing your goals for bidding and growth.

The aggregate contract limit is calculated by adding the total value of the cost to complete all of the contractor’s bonded and un bonded contracts.
In other words, at any given date, take your contracts in process and add up the cost to complete each contract. As long as the sum of this uncompleted work is less than the aggregate contract limit, you have room in your bond facility to bid on more projects. From a financial standpoint the aggregate contract limit is based on a leveraging of your working capital.

Working capital is a financial ratio on your balance sheet and is equal to your current assets less your current liabilities. Depending on the type of contractor you are, aggregate limits are multiples of working capital and range from 7:1 for contractors who self-perform up to 20:1 for general contractors who sub out all their work.

2. Rates & Fees

The second section of your T&C is the rate and fee’s section which outlines the costs associated with your facility and are labeled as follows:

Administration Fee – Sometimes referred to as an underwriting fee, this is an annual fee that is charged regardless of how frequently you use bonding. It’s generally in the range of $1,500 to $2,500 per year and it is important to note that this fee includes the cost of bid bonds throughout the term.

Bonding Rates – The bond rates are the rates that are charged if you are awarded a bonded contract that requires performance and/or labour & material (L&M) bonds.

How are Bond Premiums calculated?

In the above example, if your company is awarded a $1,000,000 contract with a 50% performance and 50% L&M bond requirement with a 24 month warranty period for workmanship, the bond premium would be calculated as follows:

($1,000,000 + HST) * (($7 + $3 + $1.50)/$1,000)

= $1,130,000 * ($11.50/$1000)

= $12,995

3. Reporting

The third section deals with financial reporting.

In order to maintain a bond facility in good standing, you will be required to report financial information to the bond company to show that you are maintaining profitability and continuing to capitalize the company to support your bonding limits. The reporting section outlines these requirements. There is an annual fiscal year-end reporting requirement and typically you will be required to report interim financials at a quarterly or semi-annual interval. The following is a list of the documents the bond company will generally require you to submit.

• CPA prepared year-end financial statement of the contractor
• Aged payables and receivables listing of the contractor
• Work on Hand report

4. Financial Covenants

The fourth section of the T&C deals with financial covenants.

Your bond facility is based on two main financial ratios: Working capital (WC) and Tangible Net Worth (TNW). Your bonding limits are determined based on these ratios and in order to maintain these limits, your financials must demonstrate that they are being met.

This section states where you currently stand in terms of WC and TNW and outlines the levels of WC and TNW you are required to maintain in order to keep your bond facility in good standing.

This is important for you to understand so you can plan appropriately without negatively impacting your limits. It is also highly recommended that you share these covenants with your accountant so that they can do your tax planning with these covenants in mind.

This is important for you to understand so you can plan appropriately without negatively impacting your limits. It is also highly recommended that you share these covenants with your accountant so that they can do your tax planning with these covenants in mind.

5. Indemnity & Security

Lastly, is the indemnity and security provision section of your T&C.

Each and every bond facility is predicated on entering into an indemnity agreement. This agreement between the contractor, shareholder(s) and the bond company states that if the contractor causes a loss to the bond company by way of a claim, the bond company would seek to be reimbursed by the parties of the agreement.

The corporation will always be expected to enter into the indemnity agreement and in most cases the majority shareholders will also be required to give their personal indemnity too. In some cases the shareholders may not be required to sign the indemnity agreement if the corporation’s financial position is strong enough to stand alone.

In conclusion, the terms and conditions letter is extremely important and we would not recommend getting into business with a bond company without reviewing this document in its entirety. As always if you have any questions, please feel free to contact us at any time.