Wednesday, March 25, 2015

Performance Bonds

The Miller Act, enacted in 1935, provides that all federal construction contracts performed in the US must require contractors to furnish performance bonds in an amount satisfactory to the contracting officer. In 1994, the Federal Acquisition Streamlining Act (FASA) set a threshold for performance bonds at $100 thousand. Prior to that, all construction contracts required performance guarantees. The statutory requirements of the Miller Act, and FASA are implemented by FAR Part 28, Bonds and Insurance.

Surety bonds are guarantees in which the surety guarantees that the contractor will perform the obligation stated in the bond. Usually the obligation requires the contractor to complete the project on time and within cost. If the contractor fails to perform the obligation stated in the bond, both the contractor and the surety are liable on the bond. The amount in which a bond is issued is referred to as the penal amount. In the case of construction for the Federal Government, the penal amount is generally one hundred percent of the contract amount. The penal amount is usually increased whenever there are change orders.

The most common means of satisfying federal bonding requirements is purchase a bond issued by a corporate surety. Not just any surety will satisfy the requirement. The Department of Treasury maintains a listing of "approved" corporate sureties. That listing can be found here and it is updated whenever a new surety is added to the list.

The Treasury Department audits the financial strength of corporate sureties and establishes bonding limits. On Federal construction projects, the contracting officer is required to make certain that the surety has not exceeded its bonding limit. On very large construction projects, performance bonds are usually issued by several approved surety companies as co-sureties.

There are other ways of satisfying bonding requirements, in theory. Contractors could pledge enough of their own assets to support the penal amount. As a practical matter however, contracting officers prefer to deal with approved corporate sureties. For contractors that might not otherwise qualify for bonds issued by corporate sureties, this might be the only way to compete for a contract.

Performance bonds, of course, cost money. Bonding costs however are allowable contract costs when required by the contract or in accordance with sound business practices. The rates and premiums must be reasonable under the circumstances (see FAR 31.205-4).

The cost of bonding will vary based on many "underwriting" factors including past experience. Companies with less than stellar records will pay comparatively higher rates than good companies. That might put them at a competitive bidding disadvantage.

No comments:

Post a Comment