February 15, 2009
By Richard Sarabando
Director of construction risks, Sinclair Cockburn Financial Group

In the construction business, there comes a time where every contractor runs into the infamous ‘S’ word, or what is formally known as surety. Initially, a less experienced contractor will have many questions. What is surety bond? When and why do I need it? Who requires it? And more importantly, how much does it cost?

All of these are important questions, but there are others that should be asked, like: How do I obtain a surety facility? What is required to qualify? What kind of information are the bond companies looking for? What is involved in the process and what is the normal time frame? Contract surety is a form of insurance, however, it is insurance for the project owners rather than the contractor. It really is more like credit for the contractor. For this reason, it is much more involved than insurance. Unfortunately not everyone will qualify.  

As an introduction, let’s address some of the first questions. A surety bond is an instrument required normally by the project owners. Written by a third party, usually an insurance company, it is normally only for government, or public sector work, but sometimes private sector owners will ask that a surety bond be included in the bid. The bond is written on behalf of a contractor and either guarantees the contractor’s bid or the performance of a contract, or the payment of a supplier or subcontractor.

There are different types of bonds. The ‘bid bond’ is required during the bid stage and is usually in the amount of 10 per cent of the tender amount. This ten per cent covers the difference between the lowest and second lowest bidder, should the lowest bidder not sign the contract once it is awarded. An agreement to bond is also required during the bid stage and commits the surety company to provide performance and labour and material bonds should the contractor be the lowest bidder. The performance bond guarantees performance of the contract, while the labour and material bond guarantees that the subcontractors and suppliers will be paid. A typical bond facility will have an annual administration fee of $2,500 and bond premiums will be typically one per cent of the contract amount. These costs may vary, depending on risk. It is important to note that these costs should always be carried in your estimates.  

A surety facility or operation can be obtained by calling a surety bond expert, who also acts as an insurance broker. Not all insurance brokers are surety specialists, so it is important to have someone represent you who knows and understands the market. You will need a surety bond facility if your business plan is one that will have you bidding on municipal or other government level works. Some commercial jobs may also require that bonding be in place. How do you set up a bonding facility? The bond company will have a list of questions ranging from the type and size of work you are pricing, your company’s history and experience, financial condition of the company and business plan going forward. More specifically, things like a questionnaire, largest job references, a bank terms and conditions letter, work in progress schedules, personal net worth statements and financial statements for the operating and affiliated companies will be required. The most important part of this list is the financial statements. These must be prepared by a chartered accountant and without this it is extremely difficult to secure a bond facility. There are also certain capital requirements, as well as minimum cash flows that the company must have and maintain.

Once this information is obtained, there may be clarifications required on some of the information and often a meeting with the bond company will be organized. This is always a good idea so that both parties can get to know one another. Surety relationships should be viewed as long term and it is important that your surety company knows you and is comfortable with you.  

This may sound like a lot of time and effort, however, once the facility is in place, it is simply maintenance of information. With the help of a knowledgeable broker it should be a painless process. The surety facility will also allow you to eliminate a lot of competition, and bid on larger more complex projects. Being able to say you have a surety facility is also a great marketing tool, as it infers your firm meets a certain high standard. If growth in the public sector is your goal, then it is important you look into a surety bond facility to know what is required to qualify, because the ‘s’ word could one day become one of the most important parts of your company’s success.  

Aside from our very successful HortProtect insurance program, Sinclair-Cockburn can be your one stop shop for all your insurance needs.  Our offering of bonding operations is an important value added to the consumers under this program.  They do not have to deal with another bonding brokerage, we do it in house. We know our clients already and have most of their insurance details which only makes the bonding process faster and smoother. If you would like any further information, please contact me at Sinclair Cockburn Financial Group in Toronto, 416-790-2173.