About surety bonds
What are surety bonds?
A surety bond is an agreement in which the endorser (usually an insurance company) guarantees the obligee (usually the client) that the principal (the contractor) will perform the work and fulfill all of its contractual obligations.
As such, a surety bond is more a financial tool than an insurance product. Unlike insurance contracts, surety bonds always involve three parties: the endorser, the obligee and the principal.
What is the origin of surety bonds?
The use of surety bonds became widespread in 1935 when the Miller Act required the U.S. government to obtain guarantees for all public works construction contracts worth more than $2,000. This requirement was later adopted by other American states and municipalities. A similar situation exists in Canada. Consequently, the majority of public sector clients require that construction contracts be bonded.
In the public sector, surety bonds are mainly required to ensure prudent management of the public funds used to finance construction projects.
The use of surety bonds is not as widespread in the private sector as in the public sector. However, private sector clients are realizing that a surety bond can be a useful tool for managing risks inherent to construction. As such it represents an important benefit for a very reasonable cost. Furthermore, lenders involved in construction projects are more likely to require their clients to obtain a surety bond.
What are the advantages of surety bonds for contractors?
Bonded contractors have greater flexibility to negotiate more advantageous prices and credit terms with subcontractors and suppliers since payment is guaranteed.
As opposed to other guarantees such as certified cheques or a bank's letter of credit, surety bonds allow contractors to adjust tender prices up to the last minute. They can be used as a development tool enabling access to sectors of the market that are usually reserved.
The qualification and certification process contractors go through in order to obtain a surety bond may facilitate their access to an operating line of credit from the bank.
What are the advantages of surety bonds for clients?
Essentially, the surety bonds used by the construction sector provide assurance to clients that the lowest compliant bidder will perform the work for the quoted price and that the work will be completed and the suppliers paid, regardless of any financial difficulties that the contractor may have.
Surety bonds also facilitate the client's negotiations with a lender, since the "construction cost" portion of a project feasibility study is guaranteed by the bonding company in the event of the contractor's inability to absorb any unforeseen cost overruns. In these situations, it is reassuring for the lender to know that any legal hypothecs registered on the building under construction by unpaid suppliers will be settled by the bonding company, thereby protecting the lender's hypothec guarantee received for granting the loan.
What are the advantages of surety bonds over certified cheques?
The personal guarantees required by the insurance company that issues the bond are the same as those required by your financial institution. The bonding service fees are approximately the same as those for a certified cheque.
What are surety bond risk factors?
The fundamental reason for the use of surety bonds in the construction sector is the risky nature of this industry. There are many reasons why construction contractors can experience problems leading to insolvency, rendering them incapable of fulfilling contractual commitments. It's important to realize that the majority of construction companies are small- or medium-sized businesses that are vulnerable to the many risk factors inherent to the construction industry.
What must a company's net worth be in order for us to consider an application?
A company's net worth must be positive. If it is positive, no minimum amount is required. The surety determines an authorized bond limit based on the financial capacity of the contractor.
Does L'Unique require a business to incorporate?
No. Registered companies may also qualify with L'Unique.
Does L'Unique require the company to have existed for a minimum of three years?
No. A start-up company may also qualify with L'Unique.
Is it necessary for the company to have its financial statements prepared by a chartered accountant (CA)?
No. The required financial statements may also be prepared by a Certified General Accountant or a Certified Management Accountant. They can consist of Audited Financial Statements (CA) or a review engagement (CA, CGA or CMA). Furthermore, it is not necessary that the interim financial statements be prepared by an outside accounting firm.
What does our Follow-up Centre do?
L'Unique's flexible underwriting criteria are tailored to the reality of small- and medium-sized construction companies. This flexibility increases the risks of issuing a surety bond. A follow-up process has therefore been put into effect in order to carefully manage this risk. Developed by construction specialists, this process takes into account the specific financial reality of targeted companies. It was designed with flexibility in mind in order to adapt and keep pace with the needs of these companies.
The information required monthly is no different than that requested by clients or professionals.
This follow-up process allows L'Unique to minimize incurred risks after issuing a surety bond while maintaining quality service.
What is a compensation agreement?
A compensation agreement is a contract by which contractors and their guarantors undertake to compensate the surety in the event that the latter is required to take action under the issued bonds.
The purpose of a compensation agreement is to protect the surety against any losses or expenses. It constitutes a movable hypothec on the accounts receivable and property of the bonded business, affiliated businesses and the guarantors personally.
Signing this type of agreement assures L'Unique that the principal (contractor) will do everything possible to resolve any difficulties that could arise during the execution of a bonded project.
These agreements are approved by the Surety Association of Canada.
Who claims in the case of a bid bond?
Insofar as the tender complies with the invitation to tender documents, contractors have little leeway for withdrawing from their obligation to sign the construction contract at the quoted price. If the tender was not compliant, it will normally be rejected by the client. If a bid is accepted, generally contractors must agree to sign the contract even if they realize there was an error made in calculating the price.
Who claims in the case of a performance bond?
The contractor must have defaulted, and the default must be declared by the client in order to file a claim under a performance bond. The client must promptly advise the bonding company. The nature of the default must be clearly stated in writing.
Upon receiving a notice of default, the surety will investigate the circumstances of the default and consult the contractor for his or her version of the facts.
What types of action are available to the surety?
In practice, the surety may choose one of three types of action in order to fulfill its obligations under performance bonds:
- Allow the contractor to remedy the default by obtaining the financing needed to become solvent and remain in business
- Fulfill the contract as the surety, using the defaulting contractor's resource people or by hiring another contractor, who becomes the surety's subcontractor
- Obtain bids for completion of the contract and pay the additional costs incurred to the client by directly signing a contract with a new contractor
Who claims in the case of a labour and material payment bond?
Claims filed under labour and materials payment bonds are easier to manage than those under performance bonds. They are, nonetheless, the main source of losses for bonding companies in the event of a contractor's default caused by the insolvency of the bonded business.
Is L'Unique authorized to issue bonds in favour of major public and private clients within Quebec?
Yes. L'Unique holds all required licences issued by the Inspector General of Financial Institutions in Quebec. It is therefore qualified for the majority of clients within the province of Quebec. It is possible that the list provided with an estimate has not been updated recently.
L'Unique has been on the B.S.D.Q.'s list since April 2006.
With respect to other clients, L'Unique is in a position to qualify as an acceptable and recognized surety.
Is L'Unique authorized to issue sureties in favour of the federal government and majour public and private clients in Canada?
Yes. The Treasury Board of Canada Secretariat publishes a list of insurance companies whose bonds are accepted by the federal government. L'Unique is included in "Appendix L — Acceptable Bonding Companies," published in September 2010. See Section 2: Provincial Companies: authorized for the ten (10) provinces and three (3) territories: NL, NS, PE, NB, QC (Surety only), ON (Surety only), MN, SK, AB BC (Surety only), NU, NT, YT