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Is Bonding Capacity a Sign of Financial Strength?

When a government contractor fails to perform, goes bankrupt or delays a project, who pays? By law, contractors must post a performance bond to protect against contractor default prior to beginning work on federal projects and most state or local projects exceeding a certain dollar amount.

Despite this, local governments may not verify that a contractor has secured a bond. Furthermore, government institutions may not be aware of the financial status or past performance of a contractor. The ability to obtain a surety bond gives contractors an edge over non-bondable contractors on public projects and increases opportunities to compete for market share.

What is a contract bond?

A contract surety bond, whether it be a bid bond, a payment bond or a performance bond, is meant to guarantee that contractors fulfill their obligations. These contract bonds cover the different stages of any federal project and protect the project owner and subcontractors from possible harm.

Such harm includes misinformation about the contractor’s capacity to actually perform a certain work; a contractor’s failure to perform the work as stated within the contract; and a contractor’s failure to pay subcontractors, laborers or material suppliers. As such, contract bonds are an essential part of any public project.

Does lack of a contract bond signal problems?

Lack of a contract bond does not necessarily mean that a contractor will default. However, it may mean that a contractor either can’t get bonded due to financial or other problems, or isn’t willing to make the effort. Unfortunately, many local governments still struggle with enforcement and oversight. A recent NASBP SmartBrief poll found that only one-third of local governments know and understand this connection with certainty.

distinguish a stable contractor from one THat might fail

There are a number of warning signs that surety bond obligees (i.e., government institutions) should heed when working with a particular contractor. The Surety Information Office’s (SIO) Why Do Contractors Fail? brochure explains what project owners should look for, including:

  • a contractor’s ineffective financial management system;
  • bank lines and credit borrowed to their limit;
  • poor estimating and job cost reporting;
  • poor project management;
  • no comprehensive business plan; and
  • communication problems.

Financial problems are not the only signs that a contractor may be in trouble, but they are certainly at the top of the list. Stable contractors generally avoid these pitfalls by managing cash flow, paying bills on time and knowing how to manage debt while growing the business.

If failure to obtain a surety bond can signal financial problems, how does obtaining a surety bond signal financial stability? While having a surety bond is no guarantee that a contractor won’t default, it is far less probable because any good and reliable surety bond company or agency thoroughly analyzes a contractor prior to issuing a bond.

The protection of a surety

A surety professional will analyze the financial stability of a company, including financial statements, cash flow, capital, credit score, bank relationships and other. Because the surety will be liable if the contractor fails, it scrutinizes contractors very carefully.

There’s a clear correlation between financial stability and the presence or absence of a bond. Local governments should always verify that contractors have obtained the required bonds and contractors should provide copies of those bonds, even if the public owner neglects to request them. As stated in the SIO brochure, “According to BizMiner, of the 986,057 general contractors and operative builders, heavy construction contractors and specialty trade contractors operating in 2011, only 735,160 still were in business in 2013 – a 26.24 percent failure rate. These businesses leave behind unfinished private and public construction projects – and still worse, millions of dollars in losses to project owners and taxpayers. Public and private construction project owners can mitigate the risk of contractor failure by requiring bid, performance and payment bonds.”

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