Construction Bond News August 2006

IBCS August 2006 News Letter                  Revision                         DC office (202) 425 – 2865

New Law Provides More Support for Use of Individual Sureties   

International Bonding & Construction Services, Inc., ("IBCS") as an authorized Risk Manager for the Scarborough Bond and Guarantee Program, and in conjunction with state and local governments , has been instrumental in supporting the State of Maryland Legislature’s enactment of House Bill 169 and the companion Senate Bill 390 authorizing the use of individual sureties for all state and local municipality construction contracts. The purpose of HB 169 is to support the growing need for individual surety bonds in the State. The Bill was signed into law by Governor Ehrlich on May 2, 2006, and as outlined in the Baltimore Business Journal, Del. Dan Morhaim, D-Baltimore County , was the chief sponsor of the bill.  When commenting on the importance of the Bill, Del. Morhaim said "the state looked at ways to make its contract process more competitive and we have [through the enactment of this Bill].”

Supporters of the Bill say underwriting has tightened among corporate sureties as some have left the business, five this year alone, making it harder for small, mid-size and even some of the nations largest contractors to receive surety bond coverage or to increase capacity. A number of contractors testified to the difficulty in obtaining bonds, including the need to joint venture with larger contractors just to get a “small piece of a project” for which they are qualified to perform as a prime contractor.

Industry associations opposing the bill said insurers have plenty of resources to issue surety bonds to “qualified” businesses and they argued that the Bill was not needed.  Ironically, several of those who opposed the Bill had ties to the Surety Association of America ("SAA") and tried to lead the delegates in the House to believe that if one of their members was not willing to write a bond for a contractor, then no one should.  The opposition’s arguments were heard loud and clear by the full Senate and House, as several members of the Senate Committee told the opposition that "your association has been telling this body for over four years it can help with this problem and for four years we have gotten nothing but lip service.  If we have anything to do about it, this bill will pass.”

Additionally, Edward Gallagher, general counsel for the SAA’s argued that Corporate Sureties provide more safeguards than individual sureties. To support his argument, Gallagher testified that corporate surety involvement in the Maryland guaranty fund program combined with the fact that corporate sureties are licensed and authorized to write bonds in the State provide both Owners and subcontractors with safeguards not present when working with an Individual Surety.

Gallagher’s arguments are unfounded and misleading. The New Law now makes Individual Sureties Authorized by the State. Additionally, individual sureties protect against default by providing, dollar for dollar, assets backing each bond in an FDIC insured bank to be held in trust to support each issued bond. Such testimony is misleading, in fact, neither corporate nor individual sureties routinely contribute to the Maryland Guarantee Fund program, as the Program is funded through the State.

Both the Maryland Senate and House Unanimously Voted to Pass this Bill Authorizing the Use of Individual Sureties.
           
            Maryland Senate vote: (for-against) 47-0;
            Maryland House vote: (for-against) 138-0.

COMPARISON OF CORPORATE AND INDIVIDUAL SURETIES

Basically, there are two types of sureties: corporate sureties and individual sureties. The similarities and differences between the two are discussed below:

Corporate Sureties

In the United States, the United States Fidelity and Casualty Company of New York became the first corporate surety company to issue bonds; it was established in 1880.  Since then, corporate sureties have become the dominant players in the bonding industry, issuing the majority of guarantees including bid bonds, performance bonds, payment bonds, final guarantee bonds, and license and permit bonds.

Corporate sureties are incorporated entities (often subsidiaries of insurance companies) that are licensed to write surety bonds in one or more of the states. To write a surety bond in the United States , a company must be licensed by the insurance department/commission of the state(s) where it seeks to do business. Corporate sureties must abide by strict guidelines established by the state regulatory agencies.

According to the SAA, corporate sureties generate approximately $3.5 billion in written premiums annually from surety bonds.

Most of the bonding for Federal construction projects is provided by corporate sureties. The Department of the Treasury maintains a formal list of federally approved corporate sureties.

Individual Sureties

Individual sureties have participated in bonding construction projects for centuries.  In fact, individual sureties were the original source of surety bonding.  Suretyship came into being when either an individual or group pooled private resources to provide a private or public owner with a surety guaranty in return for a fee.  The assets of these private parties served as collateral to the project owners guaranteeing that the project would be completed.

Individual sureties are not incorporated and generally are started by groups or individuals who own or control a large amount of cash or other assets that they are willing to pledge in order to support bonds.  They are not licensed or regulated by state agencies and are not listed on the Department of Treasury’s list of approved corporate sureties. 

Though over time and with easier and greater access to capital, corporate sureties rose to dominance in the industry, despite being minority players, individual sureties still play a very valuable role.  Individual sureties today serve a large market of solid contractors who, for one reason or another, do not qualify for and are often refused bonding by a corporate surety. (e.g. because of the contractor’s size, length of time in the business, and/or minority status).  Additionally, even though individual sureties require contractor applicants to pass a thorough prequalification process, they have greater flexibility when approving a contractor and issuing a bond.  Like their corporate counterparts, individual sureties not only give consideration to financial ratios as guidelines, but also have the opportunity to give more weight to factors such as capability, experience, management strength, financial stability, type of work and work location.  It is also significant that individual sureties are not bound by the rigidity of financial ratios, as are corporate sureties.  As a result, individual sureties often give small, new or minority contractors the bonds they need to get their first major contract so that they may establish a presence in the construction industry.

Not all owners or government contracting agencies are familiar with individual sureties. The Federal Acquisition Regulation ("FAR") specifically permits Federal contracting officers to accept the bonds of individual sureties. See FAR 28.201(a)(1), et seq.  In the past, bonds issued by individual sureties have been accepted by Federal agencies for projects far in excess of $100,000.

The Benefits of Individual Surety Bonds over Corporate Surety Bonds

Despite the common perception to the contrary, an individual surety bond can actually provide greater protection to the owner than a corporate surety bond. This is because a corporate surety is not required to segregate the assets backing a bond.  Instead, they may use the same assets to back several bonds, the aggregate value of which can exceed that of the assets. Simultaneous claims against multiple bonds of a corporate surety can, and have, resulted in a corporate surety being unable to meet its obligations and subsequently being forced to go out of business.  In contrast, the assets in the trust underlying the Scarborough Bond and Guarantee Program “individual surety bonds” are equal to the penal sum of the bonds, segregated and may not be used to back any other bond or financial obligations until an Owner releases the bond.

Should you have any questions concerning the use of the Scarborough program, please feel free to contact IBCS’s office at (202) 425-2865.