Understanding the Cost of Bonding?
In an industry where projects can be won or lost by the smallest of margins it makes it increasingly important to understand your cost associated with bonding a project. Calculating the cost of a Performance and Labour & Material Payment Bond is not as simple as multiplying the contract price by the rate you’re Broker or Surety Company provides you. Your Surety Company outlines these additional costs and your rates in your Terms & Conditions Agreement.
In order to budget your bonding cost at the tendering stage there are certain factors you need to be aware of that affect the premium. A few examples are GST/HST, Non-Standard Bond Forms, Waiving of Final Bonds, and additional Maintenance Requirements.
Once the project is awarded and the bond has been invoiced it isn’t necessarily the final cost. The initial premium is only a deposit and it is adjustable. Therefore you need to make sure you’re aware of these cost and budget accordingly.
Understanding what costs apply is important because the last thing you want is to be surprised with an invoice at the completion of a project and impact the profitability of the project.
Let’s start with the seemingly never clear question “is tax included in the contract price when calculating the premium?”.
It seems like every Contractor questions why Surety Companies would calculate the bond premium on the contract price inclusive of GST/HST. Sureties for the most part say they are responsible to pay the GST/HST on claims and cannot recover it through tax credits. Therefore they feel they are entitled to be compensated for this exposure. Depending on how the surety chooses to resolve the claim determines if the surety is required to pay taxes. In some cases they are responsible and others they may not be. The purpose of this article is not to debate the issue but to make you aware of potential additional cost. The final decision of whether GST/HST is included in the contract price when calculating the premium is up to your Surety. For the most part the answer is “yes” surety companies do include GST/HST in their premium calculation.
Non-Standard Bond Forms
The most commonly used bond forms are the CCDC 221 – 2002 Performance Bond and CCDC 222 – 2002 Labour and Material Payment Bond. The CCDC wording is established through the collaboration of several sectors of the construction and surety industries. The forms have been tested in court and legal precedents have been established as to the meaning of the clauses and intent of the guarantee provided by the bonds. Some government bodies and even private owners still choose to use their own bond forms. As a result surety companies usually impose a surcharge for the use of these forms because of the added exposure.
Waiving of Final Bonds
Some owners require tender documents (ex: Pre-Qual Letter, Bid Bond or a Consent of Surety/ Agreement to Bond) only to waive the Performance and Labour & Material Bond once the project is awarded.
Surety companies go to great length to underwrite their contractors and determine their ability to perform the work they tender. The cost to qualify the contractor is incurred prior to the tendering process and premium is only charged on issuance of final bonds. As a result Surety Companies are forced to charge a fee usually a fixed % of the premium that would have been charged had the final bonds been issued. This can put the Contractor in a difficult position and potentially stuck paying this fee and not being able to recoup it from the owner. One solution is to include a clause in the contract that if final bonds are waived a fee will be charged.
Standard CCDC 221 – 2002 Performance Bond typically includes a 12 month maintenance period after substantial completion. The cost of the 12 month maintenance period is included in your rate. Some contracts specify additional maintenance (24 months or even in some cases more). Surety Companies will charge additional premium for maintenance requirements beyond 12 months. This surcharge should be outlined in your rate schedule which forms part of your Terms & Condition Agreement with your Surety.
Cost Overrun/ Underrun & Anniversary Premiums
Bond premium can be either an annual rate or a sliding scale. To keep things simple let’s base this piece on annual rates. Sliding scales are for large or long term contracts. Surety companies upon issuance of the Performance and Labour & Material Payment Bond will charge a premium based on the contract price and a construction period of less than 12 months. This is considered a deposit premium that is adjustable in the event the contract price increases or decreases. If the project is not complete within 12 months an anniversary premium is assed on the portion of the contract that remains incomplete. Surety Company’s exposure is directly related to the cost of the project therefore when calculating the premium it is based on the final contract price. Most projects have change orders that result in an increase or decrease in the contract value. When pricing these changes the additional or return premium of the bond should be taken into account.
These are just a few examples of additional cost that can be incurred on a bonded project that you must be familiar with to avoid any surprise invoices. In order to fully understand your Bonding Facility you should review your Terms and Conditions Agreement with your Broker or Surety.