A Surety Bond is a promise by a Surety (the term for the company that issues the bond which is usually an insurance company) to pay one party (the Beneficiary) a certain amount if a second party (the Contractor) fails to meet some obligation, such as fulfilling the terms of a contract. The surety bond protects the Beneficiary against losses resulting from the Contractor's failure to meet its obligations.
In most instances the Beneficiary is either the Principal, project owner, or main contractor in a project, and makes it a requirement in the contract with the Contractor that the Contractor provide either a Surety Bond or bank guarantee. Thus it is the Contractor who is the Applicant for the Surety Bond.
When awarding contracts, Project owners (and/or lead contractors) consider critical risks, especially the contractor’s ability to competently undertake the project through the timely and proper performance of the contractor’s obligations. To help manage this risk and ensure certainty when considering bids and awarding contracts, there is an almost universal requirement for contractors to provide a third party financial guarantee so that the Beneficiary can call upon the guarantee / surety bond to rectify or compensate them in the event the contractor does not perform their contracted duties satisfactorily. This guarantee is generally provided by a bank (ie a bank guarantee) or a Surety (by way of a surety bond).
A surety performance bond provides strong evidence that the contracting business has a genuine expectation to complete the project as specified. But more importantly, the surety performance bond provides assurance that the other party will not suffer financial losses should the contracted business fail to complete the project on time and to specifications.
The key advantage of utilising a Surety Bond over a bank guarantee is that it frees up your cash /security assets, that are usually pledged to the bank (and frozen) when a Bank guarantee is issued. A surety bond on the other hand usually only requires a Deed of Indemnity to be executed, 'freeing' up the resources tied up in a conventional Bank Guarantee, that can be utilised in a more effective and efficient manner to grow the business instead.
A Deed of Indemnity and Guarantee would be required, and other security may be called for depending on the financial profile and trade experience of the company (Applicant).
There is an application fee payable upfront according to the size of the Bond required, regardless of the outcome of the Bond Application. There may also be legal fees payable, associated with the setup and execution of the Deed of Indemnity and Guarantee. These fees are generally around $2,000. Higher legal fees may apply depending on the complexity of the Bond requirements and guarantors involved.
All premiums, any associated costs and government duties (if applicable) must be paid upfront before the executed Bond document can be handed over.
Depending on the type of bond required and its purposes, generally the maximum period is up to three years.
Realistically it may take four to six weeks to get a Bond approved and issued. This is heavily dependent on the quality and relevance of the information supplied by the Applicant at both the application and submission stage. Hence it is imperative that a timely application be made to avoid unnecessary delays.
A Deed of Indemnity and Guarantee is a legally enforceable document that gives the underwriter the right to recover the amount of the bond from you (et al) (“the Guarantors”) if you default under the contract, after a Bond is called on and paid for by the Underwriter (Surety).
After the bond is issued, you (Bond holder) will need to adhere to the following obligations required by the Underwriter:
• Ongoing management reports and accounts are required to be provided by you on a Quarterly basis
• Your nominated project administrator will be contacted by our account manager regularly for updates on contract progress
The Bond holder must also notify BGA immediately in writing and/or adhere to the following requirements:-
a) Any major change in shareholding, directors, principals or managers of any company which has provided an indemnity or guarantee; and/or
b) Any major changes to the financial position of any entity or person(s) who have signed a Deed of Indemnity and Guarantee.
c) Submit copies of the audited annual statutory accounts for the Applicant and its controlled entities within 150 days of the Contractor's financial year end, to the Underwriter;
d) To immediately advise us of the acquisition of any subsidiaries or other structural changes including the involvement in any joint venture projects
e) To immediately advise us of any subsidiaries that may have commenced business or are likely to commence business
f) To always maintain adequate business and business-related insurances at all times. Documentary proof shall be provided to the Underwriter annually and/or upon request.
g) To immediately advise us of any other bond or bank guarantee facilities to be entered into by the Contractor or its subsidiaries
h) Immediate advise of any proposed security to be taken over the assets of the Applicant, or any other party to the Guarantee and Indemnity document. That is, no additional security over an asset, or number of assets is to be offered by the Contractor or any subsidiary or associated parties, without the prior written consent of the Underwriter (consent shall not to be unreasonably withheld)
i) To immediately advise of any additional guarantees that the guarantors to the Bond may be required to provide to other financial institutions (excluding preexisting arrangements prior to the issue date of this Bond) or entities during the term of this Bond. Note no additional guarantees are to be provided by the Guarantors of this Bond without the prior written consent of the Underwriter (consent shall not to be unreasonably withheld)
j) No non-trading assets owned by any of the Guarantors or major non trading assets owned by the various entities are to be disposed of without first notifying the Underwriter and seeking consent.
k) The Contractor shall provide a copy of their internal management accounts (including Profit and Loss Accounts, Balance Sheets, Cash Flow projections, and Work in Progress reports) as an entity and / or consolidated as a group, within 90 days of the close of each quarter.
l) The Contractor undertakes to notify BGA immediately of any breaches of financial covenants and to inform BGA promptly of any amendments which may subsequently apply to any existing financial covenants and undertakings agreed with any other finance provider.
m) An undertaking from the Contractor that they will maintain a minimum Equity ratio of not less than 15%. (note - Equity ratio means the ratio of Tangible Net worth over Total Tangible assets expressed as a percentage. Tangible Net worth means Total Tangible Assets less Total Liabilities. Total Tangible Assets means, at any time, the aggregate book value of all Assets of the group, calculated on a consolidated basis in accordance to Australian accounting IFRS standards. Total Liabilities means, at any time, the aggregate amount of all Liabilities of the group, calculated on a consolidated basis in accordance to Australian accounting IFRS standards
n) An undertaking from each Guarantor that is party to the Deed of Indemnity and Guarantee that each Guarantor undertakes to the Underwriter that it will not, without the prior written consent of the Underwriter (consent shall not to be unreasonably withheld) provide loans, guarantees, other financial support and/or make investments exceeding $500,000 to any related entity or individual not a party to the Deed of Indemnity and Guarantee.
o) An undertaking by the Applicant to the Underwriter that it will not, without the prior written consent of the Underwriter (consent shall not to be unreasonably withheld), make any dividend payment or distribution (including but not limited to Management fees and non trade related disbursements) that would be greater than 50% of the net profit after tax in the financial statements in any one financial year.
p) An undertaking by the Contractor to the Underwriter that it will not take up additional Surety Guarantees (Bonds), Bank Guarantees and/or Bank financing, from the issue date of this Bond, without the prior written consent of the Underwriter (consent shall not to be unreasonably withheld).