Bonding basics: Sureties can reduce risk and ensure payments to subcontractors and suppliers, says SAC representative

pierre cadieux
Pierre Cadieux

Ontario Construction News staff writer

Sureties can significantly reduce risks in completing projects and ensure payment to subcontractors and suppliers, keeping projects on track, says a representative of the Surety Association of Canada (SAC). These factors mean that they have an important place in the construction documentation process.

Pierre Cadieux, a government and stakeholder specialist and SAC’s regional director for Quebec, outlined some of the reasons and procedures of sureties, and sought to dispel some myths, at a presentation to the Ottawa Chapter of Construction Specifications Canada (CSC) last Thursday.

The new Ontario Construction Act includes a provision to require 50 per cent performance and 50 per cent labour and material bonds from contractors performing work under public contracts signed after July 1, 2018 and valued at $500,000 or more.

Cadieux said one myth about sureties is that a “50 per cent labour and material bond provides only 50 per cent protection” when, in fact the bond provides 100 per cent protection up to the bond’s value.  This means, on a $1 million construction project, that properly documented claims will be paid until $500,000 in labour and materials claims are received – meaning that it is highly unlikely anyone would not be compensated in full if things go wrong.

He clarified that surety coverage is not insurance. Insurance is a two party contract between the organization seeking insurance and the insurer. In the case of sureties, there are three parties, the principal, surety and obligee – and the surety has recourse through indemnification provisions against the principal in the event of default.

This fact, of course, means that the surety granting process effectively sets prequalification standards for contractors seeking surety coverage (and thus access to public projects in Ontario under Bill 148), but Cadieux says the bonding process should not unreasonably restrict even smaller contractors from achieving coverage, provided they are seeking surety within their level of experience and competence.

“Bonding companies need to write bonds” and there is plenty of competition in the industry, Cadieux said. “Some sureties will only bond small contractors; others have small contractor divisions.”

“Small firms will secure bonding for jobs within their realm of experience.  Bonds are only a barrier to unqualified contractors.”

Cadieux said surety companies look for three things in assessing whether to issue bonds: Capital, capacity and character.

Sureties effectively result in a restraint on contractors over-extending themselves, or taking risks that could put their businesses in jeopardy. And, because trades and suppliers have confidence they will be paid and public agencies are confident that their project will be completed, contractors and sub-trades can bid more competitively because a significant risk factor is taken out of the picture.

Without bonding, the work could go to unqualified contractors, or what Cadieux described as the lowest “irresponsible” bidder. And when that happens, things can go very wrong, with unpaid subs and suppliers, liens, and project disruption.

As well, despite the surety industry’s best practices, there are times when there are massive claims, especially since the construction industry has the second highest rate of failure for new companies, and the highest rate in terms of unpaid obligations.

“Since 2008, the surety industry has paid over $2 billion in claims,” he said. However, 2018 was the worst year nationally and in Ontario, with a net ratio loss of 105.6 per cent, “that is the difference between $628.5 million in premiums and $660.3 million in claims.”

That year, a major Ontario general contractor’s surety default appeared “likely to go down as the largest loss in Canadian surety history,” surety broker Petrela Winters & Associates (PWA) said in its newsletter.

The broker says the default coupled with “several (other) high profile contractor defaults,” led to direct losses of slightly more than $400 million (on $565 million of direct written premiums) as of September, 2018, representing a loss ratio of 71 per cent. “This compared to a loss ratio of just over 11 per cent for the same period in 2017,” the broker reported.

The contractor behind this major default was Bondfield Construction and related companies, and the surety was Zurich Insurance Company.

However, Cadieux says the big recent losses shouldn’t create much stress or increase costs for contractors, in part because the surety companies cover themselves through reinsurance policies. As well, while they must ensure the projects are completed and trades and suppliers are paid, they have recourse under the indemnification provisions of their contracts – and they also can recover additional losses through the payments they receive when the projects are completed.

Cadieux says he recommends contractors plan ahead for their surety requirements. “For contractors without a surety, it takes time to establish a facility” and the best way to deal with the challenge is to connect with a qualified surety broker, who can work to match the contractor with the correct provider.

He said there are other “unseen” services of surety bonds, including:

  • facilitating the resolution of construction performance issues that could lead to default;
  • providing management and business assistance to assist contractors with administrative issues;
  • providing financial assistance to financially distressed contractors; and
  • providing technical/engineering expertise if required.

Overall, Cadieux says research indicates that the surety process reduces economic risk, especially for insolvency. “Non-bonded firms are 10 times more likely than bonded companies to suffer insolvency,” he said, citing a 2017 SAC-commissioned independent study.

Because bonds are relatively inexpensive, they have major economic protection value. “If insolvency rates rise, bonds protect 25 times more economic activity than the premiums cost.”  Overall, he said sureties have a multiplier effect, protecting more than “$3.5 million of Gross Domestic Product for each $1 million of premiums paid.”


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