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Surety bonds can benefit contractors in the evolving North American P3 project market

October 19, 2016

As the North American approach to P3 Project security continues to evolve, it is important to revisit the many benefits that surety bonds can provide to contractors pursuing and executing P3 projects.

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This article first appeared in Engineering News-Record’s Insurance Today II.

The growing use of public-private partnership (P3) projects to deliver public infrastructure in Canada and the United States has produced an evolving North American approach to P3 project security. Initial North American P3 projects were modeled after foreign market approaches that incorporated low-percentage and on-demand performance security typical of construction procurement in Europe, Asia and Australia. At the same time, project finance rating methodologies focused on liquid and unconditional security came into use in Canada and the United States. This P3 approach was not aligned with North American contractor balance sheet structures, bank line sizing or ready access to large-capacity surety facilities established to meet the high-percentage performance and payment bond requirements of most public construction work in Canada and the United States.

In response, many domestic contractors were forced to negotiate increased letter of credit facilities by providing banks with enhanced security packages or leveraging government export agency support. North American contractors also partnered with surety companies to develop bond product innovations that maintained the broad coverage of high-percentage surety bonds, while meeting the time-certainty needs of P3 projects. As the North American approach to P3 project security continues to evolve, it is important to revisit the many benefits that surety bonds can provide to contractors pursuing and executing P3 projects.

Reduced pursuit costs
Developing P3 project proposals can take years of effort and cost contractors millions of dollars. Pursuit costs can quickly escalate when the procuring agency has not developed standardized processes or documentation. Many surety companies have been active in the North American P3 market for more than a decade and are well-equipped to help contractors minimize pursuit costs by sharing best practices and lessons learned on past project pursuits in different geographies with different procurement agencies. Early involvement by the surety can help develop document language, provide precedent P3 transaction information and avoid common challenges.

Contract advisory and legal resources
Risk allocation amongst multiple project stakeholders and the complex interdependence of contractual relationships remain key challenges on all P3 projects. Contractors invest significant time and resources to negotiate the risks and project obligations passed down from the concessionaire. Sureties with P3 experience can supplement these efforts by assisting contractors with contract review services and access to legal resources. Many surety companies can also provide market standard guidance and insights around key contract language accepted by stakeholders on past projects, form and amount of comparable performance security packages or prior negotiations with project lenders, financial advisors and rating agencies.

Tailored bond language for P3 project stakeholders
The surety industry continues to develop P3 bond language that further enhances the broad coverage of high-percentage performance and payment bonds by explicitly securing payment of liquidated damages, quantifying surety response timelines, establishing expedited claims processes and incorporating funding agent and public owner step-in rights. Leading sureties have experience and demonstrated results tailoring bond language to meet the time certainty needs of P3 project concessionaires, lenders and rating agencies.

No burdening of bank lines with letters of credit
Most contractors qualified to pursue North American P3 projects enjoy large-capacity surety facilities available to support full contract value performance and payment bonds securing multiple projects. Unlike typical letter of credit facilities, North American surety capacity is largely extended on an unsecured basis. Use of high-percentage surety bonds to secure North American P3 projects can provide contractors with a sustainable performance security option that reduces the expense of increasing bank line limits (and lender security packages) beyond a contractor’s actual borrowing requirements.

Surety remedies beyond funding a demand
The role of letter of credit-issuing banks in a P3 project begins and ends with honoring a demand for payment and seeking immediate reimbursement from the contractor. High-percentage surety bonds eliminate demand risk for contractors, as the surety is required to investigate default claims in accordance with the P3 bond’s claims process and response timelines. Surety companies are also motivated and equipped to help contractors avoid default on individual contracts and across a program of bonded projects.

This article is provided for informational purposes only. Please consult with qualified legal counsel to address your particular circumstances and needs. Zurich is not providing legal advice and assumes no liability concerning the information set forth above.