Contract Bond Process

Each surety company has different criteria for deciding which contractors it will bond. Since the surety guarantees the contractor's performance, the surety needs to decide whether the contractor has the ability and resources to perform. A surety's means of evaluating a contractor to decide if it will issue bonds is the underwriting process. This process sometimes is described as evaluating the 4 C's-Character, Continuity, Capital, and Capacity.

Character of the Business and Key Personnel

A surety would like to guarantee the performance of those contractors that have shown that they are honorable, dependable businesses that can be counted on to perform. A surety is interested in how long the contractor has been in business and its reputation in the industry among owners, architects/engineers, general contractors, subcontractors, and suppliers. With a new business, a surety may look to the experience and reputation of key management personnel.

A surety will look at the contractor's management structure, the length of time current management has been in place, and the experience and track record of the managers. The contractor's experience in the construction industry is important, but the surety is also interested in the contractor's management skills. Basically, a surety looks for the characteristics common to any well-run business: a management team experienced in the industry, with a proven track record of success; an adequate accounting system with appropriate financial controls and reporting capabilities; and a history of stable, profitable business. Finally, a surety probably would want to see that the contractor has identified its strengths, and sticks to the types of construction projects it does best.

Working Capital in the Business

A surety is interested in the contractor's net worth, amount of uncompleted work, cash flow, accounts receivable, and accounts receivable aging information. A surety also looks at the contractor's credit history, working relationships with subcontractors and suppliers, and bank account information. A surety is interested in evaluating all of a contractor's capital assets as a way of learning the financial strength of the contractor, including the personal assets and liabilities of the owner's of the business.

Capacity of the Business

A surety must decide how much work a contractor can perform profitably in order to set a bonding limit.  The capacities of the contractor's available equipment, and personnel are factors in reaching this decision. Considering these and other factors, a surety will set an upward dollar limit for a maximum individual project that it will bond, and an upward dollar limit for the total of all projects it will bond for that contractor. A surety's interest is to prevent the contractor from becoming over-extended by taking on more work than the contractor can handle.

  Common Provisions in Indemnity Agreements

The surety will not issue bonds unless it has received agreements from the principal and other indemnitors with sufficient assets, in the surety's opinion, to secure the surety from any claims that may be made against the bonds. This is done by an indemnity agreement to be signed by the principal and the individuals who will serve as indemnitors. The agreement is a contractual obligation that provides security for the surety. The indemnity agreement sets forth and expands upon the obligations between the principal and the surety. Typical provisions in such a general indemnity agreement are explained below.

Indemnification of the Surety by the Indemnitors

The indemnitors (the contractor and individuals who have pledged their assets to support the bonds) agree that they will indemnify (completely reimburse) the surety for any liabilities, attorney's fees, expenses, or damages the surety may incur as a result of its issuance of a bond to the principal. The written indemnity agreement confirms the principal's obligation and extends the obligation to all the indemnitors.

Not surprisingly, a very broad form of indemnification typically is provided to cover all types of anticipated costs. Frequently, the indemnification provision will say that it includes all damages incurred by the surety's reliance upon representations by the principal or indemnitors concerning defenses available to the surety in any claims made against the bonds. Thus if the surety asserts a defense based on representations by the indemnitors or the principals, and the defense ultimately is found to have been frivolous, the indemnitors would be required to reimburse the surety for any damages or sanctions sustained by the surety.

 

Brock Insurance Agency
823 Chickamauga Avenue | Rossville, GA 30741
706-866-3394

218 Manufacturers Road | Chattanooga, TN 37405
423-362-5745

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