Components of Surety Bonding Facility Letter
Whether you are reviewing your first surety facility, or are a seasoned purchaser of bonds reviewing their existing terms, the core of your surety terms letter will consist of four main components. While it is your surety broker’s job to ensure the items below are as competitive as possible, the four items listed below are where most of the time will be focused as these items are the most crucial to any contractor’s decisions as it pertains to their bonding terms.
There are two components to your bonding limits, both are equally important to understand:
- Single Job Limit: your single job limit equates to the largest single job that your company has been approved by the surety to secure bonding for. This figure is not based on a simple calculation. This figure is derived from a combination of financial health, previous contracts completed, experience of key staff and the security that is taken to secure the surety facility. It is important to note that the surety industry understands that contracts can arise that are attractive to bid and may be larger than the single job limit in place. In these instances, it is crucial to find a surety focused broker than can work with you to prepare the business case to present to the surety company.
- Aggregate Limit: a contractor’s aggregate limit represents the maximum costs remaining on all bonded and un-bonded contracts underway (including all outstanding bids) that are acceptable to the surety. While this figure is derived from a contemplation of numerous criteria, the aggregate limit is arguably more “financials” based. The reason for this is that when we discuss the amount of work a contractor has on the go, the largest threat to that overall backlog is an inability to remain liquid and cashflow their projects. Typically, most general contractors and sub-trades will see their aggregate limit tied to their working capital. A large exception is heavy civil contractors; these contractors usually see their aggregate limit tied to their tangible net worth, AKA, equity.
While limits are established at the outset of any surety relationship, it is important to note these are fluid figures that will grow with the needs of the business based on financial strength and growth of the company’s resources.
Rates (and fee)
Rates in the surety industry are reflective of a dollar figure per thousand dollars of the contract value inclusive of HST. A scheduled breakdown usually includes the following sections:
|Labour and Material Payment Bond
Your bond rating is important to know as you must understand how these rates are applied in order to accurately price your jobs. Your bond costs will typically be a line item included in your bid and failing to accurately reflect this may cause challenges down the road. A strong surety broker should always be able to provide assistance at the tender stage in pricing out the expected bond cost.
Similar to a banking arrangement, a surety company takes security in various forms to protect themselves in the event of a claim. The most common form of security taken is a guarantee by the company and its owners to repay the surety in the event of a claim. This is provided in the form of an “indemnity agreement”. Indemnity agreements are standard fair in the surety marketplace and are signed as a part of the establishment of every facility. The parties required to sign the indemnity agreement are where most negotiations occur.
Other frequently used forms of security include:
- Subordination Agreements: these agreements are signed when a shareholder has lent money to the business and would like it to be included as part of the equity and working capital calculation. The subordination agreement, in essence, is a promise to leave that money in the company and not repay it without the consent of the surety. It gives the surety priority to that money in a claim scenario, so the surety in turn provides the flexibility of access to larger limits than the client previously would have qualified for.
- General Security Agreement: these agreements are registered under the Personal Property Security Act (“PPSA”) and gives the surety a formal position as a secured creditor in the event of an insolvency. General Security Agreements are frequently used in scenarios where contractors have large equipment fleets. One question we often get asked is “how will this affect my financing moving forward for equipment and any future banking relationships?”. Surety companies are very familiar and understanding of the need contractors have to secure 3rd party financing and regularly postpone their secured position to enable contractors to re-finance equipment or secure an operating line. A strong bond broker will be able to advise on acceptable postponement wordings for all parties.
When determining whether a security package is acceptable or not, strong consideration is given to the needs of the business, while also balancing the needs of the business with the risk tolerance of the company and its owner’s assets.
Financial Reporting Requirements
Financial reporting is typically provided in two forms – externally prepared and internally prepared. Annually, the surety will request externally prepared financial statements by a CPA level accountant, usually in the form of either a Notice to Reader (lower quality) or Review Engagement (higher quality). The frequency of bond usage, bonding limits and financial strength will factor into whether they require a higher or lower quality statement.
Internal reporting is required as needed based on similar factors. This would be financial documents that are produced by an internal accounting system such as QuickBooks or a similar tool.
While the terms above are the tangible items that can be placed on paper, these are table stakes in the negotiation of a surety facility. A strong surety broker should always be able to obtain the most favorable outcomes for each of these items. Where you see the true value of a surety focused broker will be in their ability to roadmap future improvement of those terms, assist in overall risk mitigation for your business and provide certainty that your services will be provided in a consistent manner.