Stan Halliday from Travelers Bond & Specialty Products answered questions about Expedited Dispute Resolution (EDR) bonds and what the construction industry needs to know about them.
What is a surety bond? What is an EDR bond?
Surety bonds are designed to guarantee performance in the face of a particular set of risks. A surety bond is a three-party agreement, under which one party (surety) guarantees to another party (obligee) the performance of an obligation by a third party (principal). In the construction context, a surety bond guarantees to the obligee (who is typically the owner of a construction project to be built) the performance of the construction contract that the owner has entered into with a contractor.
An EDR (expedited dispute resolution) bond is a type of surety performance bond that provides protection to the obligee if the contractor should default on its contractual obligations under the construction contract. An EDR bond combines the coverage options of a traditional performance bond with a streamlined claim investigation and adjudication process that helps address owner-contractor disputes quickly and keeps the project’s construction schedule on track, ensuring timely completion. It is treated as a credible form of performance security by lenders and ratings agencies.
When should EDR bonds be used?
While an EDR bond has some significant benefits, it is not suited for every project. It was created to address the needs of larger design-build and engineer-procure-construct projects, particularly those with a time-critical component. An EDR bond may be a good fit when:
- an owner is asking for a letter of credit;
- the project timing is sensitive and critical;
- the liquidated damages are potentially high;
- the borrowing and financing costs to the owner are particularly high; and
- the project is financed with private bond debt.
Examples of projects where EDR bonds can be beneficial include power plants, oil and gas pipeline reconstruction, manufacturing facilities, data centers, high-tech projects, private institutions and public-private partnerships. EDR bonds are not the best fit for traditional design-bid-build projects, where the design risk falls under a separate contract (an owner-architect contract) from the construction contract.
What are the key differences between EDR bonds and letters of credit?
There are some major differences between an EDR bond and a letter of credit. A letter of credit is a written financial undertaking from a bank that guarantees the contractor’s performance to a construction owner. If the contractor is unable to perform the construction contract, the owner may make a demand on the letter of credit, and the issuing bank will be required to pay the requested amount up to the full value of the letter of credit. Most letter-of-credit amounts are within three to 10 percent of the construction value.
An EDR bond offers several advantages to a construction owner over a letter of credit. It provides prequalification services from the surety company, payment of valid claims from subcontractors and suppliers, coverage limits up to 100 percent of the contract value and dedicated claims professionals to assist with project completion if needed. An EDR bond also offers some advantages to the contractor in that it does not affect a contractor’s bank-borrowing capacity or existing liquidity/working capital and it provides an independent third-party evaluation of any dispute, ensuring that both parties are treated fairly.
Are EDR bonds used in addition to performance and payment bonds? Do they cost more than a standard payment and performance bond?
EDR bonds are not used in addition to performance and payment bonds. They are stand-alone performance and payment bonds. The cost of the EDR bond is no different from more traditional payment and performance bonds. Its cost depends on the type of project, including the project size, duration and the risks being assumed by the contractor.
Can EDR bonds be used on P3 projects? How do they work and what are the Benefits?
Yes, public-private partnership (P3) projects are a great example of when an EDR bond might be beneficial. Imagine a case where a dispute arises between the contractor and the owner on a large P3 project. The dispute centers on why the contractor is behind schedule for completion. The contractor says that permitting delays outside of its control are the cause. The owner says that’s not the case. On top of that, the contractor’s parent company has developed significant financial difficulties and subcontractors and suppliers are not being paid, so they’ve stopped working. The owner’s security is a five percent or 10 percent letter of credit, which the owner has almost entirely exhausted to get the subcontractors to return to work.
If the schedule is delayed further or the contractor is not able to complete the work, it could greatly affect the owner’s finances and reputation. Plus, even if the owner prevails on the issue of responsibility for the delay, there is no certainty that the contractor will be able to pay the damages assessed against it.
If an EDR bond were in place, it could offer:
- significantly more coverage (up to 100 percent of the contract value for both performance of the contract and payment of all subcontractors and suppliers) for the owner than a five percent or 10 percent letter of credit;
- financial protection for the publicly funded or tax-financed portion, as well as the ultimate user of the assets being constructed under a PPP project;
- full payment protection for subcontractors/suppliers working on the project;
- a 15-day claim investigation by the surety to determine if the owner’s declaration of default is valid;
- a 45-day adjudication proceeding if the surety disputes the default declaration. This would result in an independent third-party decision that is binding;
- security for the owner that the project schedule would continue with minimal delays (either the contractor or its surety would ensure the project continues and the schedule is maintained as best as possible); and
- full coverage for liquidated damages and warranty issues.
Is prequalification any different with an EDR bond?
Prequalification is no different from the traditional bond prequalification process. The biggest factor is always the scope of the work and the contractor’s ability to perform that work, regardless of the type of bond. However, one additional consideration is that the contractor must have dedicated internal legal personnel capable of helping the surety respond in the time frames outlined in the bond.
How do EDR bonds affect the contractor’s financials?
EDR bonds are no different from any other performance or payment bonds. They are considered a contingent liability and are not reflected on a contractor’s balance sheet. Also, unlike a letter of credit, an EDR bond does not impact the contractor’s borrowing capacity or tie up its existing cash assets.
Are EDRs commonly used in other countries?
No, they are not commonly used in other countries, though there has been an adjudication-style performance guarantee used on projects in Great Britain. EDR bonds were designed to address the unique risks of the construction market in the United States and Canada.