Western Australia
Mon 15 January 2018

Tendering for US Govt works? You need to understand Surety Bonds

Construction contracts completed under United States law, including works for the US Navy in the Northern Territory, are subject to additional tendering and contractual requirements compared to contracts under Australian law. Scott Simmons from the Surety team at Lockton outlines these requirements and the implications for contractors looking to tender on any work for the US Navy in Australia.

Background

Announced in 2011, the US Force Posture Initiatives are an extension of Australia’s relationship with the United States.  They include a rotation of US Marines through Australia’s Northern Territory during the dry season.  These initiatives were also designed to generate investment in infrastructure across northern Australia, with costs to be jointly shared between Australia and the United States.

Design and construction activity will occur over a number of years as part of the 25-year agreement and the first projects were put to tender in November and December 2017.

The contracts will be completed under US law, meaning the tendering requirements will be different from a typical Australian government contract.  One of these tendering changes is an adjustment to the contractual security requirements.  It is crucial for contractors to understand these new Surety requirements and the implications for their business.

What is a Surety Bond?

A Surety Bond is a financial instrument (“Bond”) issued by an insurance company (“Surety”) in order to satisfy a contractual obligation.  It is a form of contract security.

Under the General Conditions of Contract under Australian law (AS2124, AS4000, AS11000) contractual security is often required to support the contractual obligations of the Contractor, typically with a value of 5% of 10% of the contract amount.  This security can take the form of cash retention, Bank Guarantee, or Surety Bond.

US Surety Bonding Requirements

(US Bonding requirements are outlined in depth in Federal Acquisition Regulation 52.228, formerly known as “Miller Act”)

Under US law, contractual security is required for any government work when the contract is greater than US$150,000 in value.  This contractual security can be issued in the form of a Surety Bond, a money order, check, irrevocable Letter of Credit, or Bonds and notes from the United States.  If issued as a Surety Bond, it must be issued by a corporate Surety whose name appears on the list contained in the Treasury Department Circular 570 (commonly referred to as being “T-listed”).  Contractors are required to issue three instruments, as opposed to the typical one or two totalling 5% or 10% under Australian law.

US Surety Requirements table

Sureties account for their exposure in a different manner to Australian Bank Guarantees or Surety bonds.  Whilst the dollar amount on the face of the instrument will not change, the Surety will amortise the bond amount as the contract progresses.  In order to do so, the Sureties will require progress payment certificates to be provided to them on an ongoing basis.  As the contract progresses, progress payments are made and payments are made to Sub-Contractors, and so the risk to the Surety decreases.

The pricing mechanism will differ from a typical Australian Bank Guarantee or Surety bond.  Sureties will treat the performance and payment Bonds as a single instrument when charging and accounting for their exposure.  Essentially the Surety will only charge for the performance Bond and the bid Bond.  Premium is charged up front for the full duration of the bond at a set rate.

Claims Functionality

Bonds issued in this manner are not on demand, irrevocable instruments in the same manner as Bank Guarantees, irrevocable letters of credit or typical Australian Surety Bonds.

In the event of a claim upon any of the Bonds, the onus is on the claimant (whether Principal or Sub-Contractor/Supplier) to prove that contractual obligations were not honoured by the Contractor and the call is a valid one.

The Surety has the right to investigate the claim and has up to 90 days to resolve the claim.

A key difference to Australian Surety Bonds is that the Surety has step-in rights, meaning they can take over the project in the event of a claim either acting as the Contractor or taking over the flow of receivables and payables, appointing another Contractor to complete the works.

Significant case law exists in the United States regarding claims and this, coupled with the language of the Bond, is what will be relied upon in the event of a disputed claim.

Implications for Contractors

Whilst implications for individual businesses will differ depending on their existing financing relationship in place, some general points to consider include:

  • Ability of existing financier/s to support the Bonding requirements; if security is usually supplied by a bank, they would need to supply up to 220% of contract value in irrevocable Letters of Credit.  If usually supplied by a Surety, they need to be US Treasury listed.
  • Potential cost; Surety Bonds issued under US law will have a lower rate charged than Letters of Credit or Bank Guarantees.  This is because a US Bond is a conditional instrument and is not on demand, meaning that there is a reduced capital allocation requirement (and therefore capital cost), and Sureties will not have the significant liquidity risk associated with on demand instruments.
  • Impact to balance sheet; a Surety facility has numerous benefits over a bank guarantee facility.  There is typically no collateral or ‘hard security’ taken meaning no cash is restricted.  Further, it opens up your banking lines to be utilised for other purposes, affording the opportunity to grow the business.
  • Potential indemnity requirements; Sureties will require a more comprehensive Deed of Indemnity and Guarantee compared to a typical Australian indemnity.  This is because Sureties need the ability to step-in and take over the project or the project’s receivables.  It is crucial that this is articulated correctly to any existing financiers in order to ensure their support is granted.
  • Competitive advantage; not all Contractors will be able to meet the Bonding requirements of the US Navy, meaning tendering costs will be prohibitive.  Contractors able to utilise Surety Bonds for contracts involving the US Navy will have an advantage when tendering for these contracts. Total spend for these contracts in the region is expected to be in the billions.

Given the market available in Australia for this type of Bonding is limited, Lockton recommends using an experienced broker to support your discussions with your financiers and potential Sureties.

For more information contact:

Scott Simmons
Senior Associate, Surety and Trade Credit
Tel: 02 9236 0612
Mob: 0418 965 778
Email: Scott.Simmons@au.lockton.com 

Richard Shillington
National Manager – Construction
Tel: 08 9217 0808 (Direct) / 08 9217 0800 (Main)
Mobile: 0402 260 300
E-mail: Richard.Shillington@au.lockton.com