Why are some surety bonds better than others? Why can small ones be harder to get than big ones?
Construction companies are among a bonding company’s most important clients. They are the source of Performance and Payment bonds which guarantee their construction contracts. For a bonding company (surety), these are probably the largest and most lucrative transactions. So why would the surety risk losing a client by giving tough terms on an obviously small bond?
There are many different types of surety bonds, and contractors may need a variety of them: Bid bond, performance, payment, maintenance, license, permit, court, are a few. In this article we will discuss why the big ones (large dollar amount) can be easier to get than small ones – even for the same applicant.
The answer to this question lies in the nature of the obligation, not the dollar amount. A good way to illustrate this is to compare a Performance bond to a Wage and Welfare bond.
Performance Bond
Performance and Payment (P&P) bonds concern construction contracts. They guarantee that the applicant will perform the project in accordance with all aspects of the written contract, and they will pay the related bills for suppliers of labor and material.
Wage and Welfare Bond
This type of bond is needed by union contractors (companies that employ union workers.) The W&W bond guarantees that the construction company will pay the union wage rate as required and make the related periodic contributions to the union benefit plans such as the pension and health insurance program.
It’s Just Not Fair!
P&P bonds range in amount from a couple hundred thousand dollars to tens of millions, whereas a W&W bond is often under $100,000. So why can it be easier to get the big one? Why can a $500,000 performance bond be easier to get than a $50,000 union bond?
The answer lies in the nature of the obligation – and the worst case scenarios.
Let’s assume the contractor goes out of business. With a performance bond, the surety steps into the contractors shoes. They must make arrangements to complete the project in accordance with the contract. The beneficiary of the performance bond (aka the obligee, the owner of the contract) continues to pay out the remainder of the contract amount as work progresses. Now they pay the surety performing the completion. This is called the “unpaid contract amount.” Even if the contractor falls flat and has no money personally, the unpaid contract amount is a resource the surety can depend on – and hopefully avoid a net loss on the claim.
The union bond is a promise to pay funds at a future date. It is a financial guarantee – the toughest type of surety obligation. The underwriters will look into their crystal ball… Oh, sorry, we don’t have one.
The surety is guaranteeing the future solvency of the construction company, not an easy task. And if they are wrong, if the contractor cannot make their union payments because they have no money, then there is no money for the surety, either.
Q. Who is likely to pay the wage and welfare claim?
A. The surety (a net loss)
It is the tough nature of some small bonds (wage and welfare, release of lien, supersedeas) that makes them exceptionally hard to get – often requiring full collateral. On the other hand, the surety may give the same applicant a $300,000 performance bond based primarily on just their credit report!
Bottom line: It just ain’t fair, but we never promised it would be – because the nature of the obligation differs. That is the deciding factor, even more than the dollar amount of the bond.
