Surety Bonds

Generally ½ - 1% of contract price for contractors with established bonding credit. The premium includes a 100% performance bond, 100% payment bond, plus a one-year maintenance period.
The bond premium is included in the contractor's bid price.

Bank Letters of Credit

Cost is generally 1% of the contract amount covered by letter of credit - e.g. if LOC covers 10% of contract, Cost = 1% x (10% x Contract Amount).
The cost of the letter of credit is included in the contractor's bid price.

Bonds

The surety company has obligations to both the owner and the contractor. If the contractor and owner disagree on contract performance issues and the owner declares the contractor in default, the surety must investigate the claim.
The surety has several alternatives to respond should the contractor be in default:

Finance the original contractor or provide support necessary to allow the contractor to finish the project;
Arrange for a new contractor to complete the contract;
Assume the role of the contractor and subcontract out the remaining work to be completed; or
Pay the penal sum of the bond.

With payment bonds, the surety pays the rightful claims of certain subcontractors, laborers, and suppliers.

Letters of Credit

The bank will pay on a letter of credit upon demand of the holder. The holder or beneficiary must make a demand prior to the expiration date. No funds are available after the expiration date, even for liabilities incurred prior to expiration. There is no obligation to complete the project.
There is no completion clause in a letter of credit. The task of administering completion of the contract is left to the owner.
The owner must determine the validity of claims by subcontractors, laborers, and materials suppliers. If there is not enough money from the letter of credit to pay all of the claims, then the owner has to decide which claims will be paid and which will be rejected.

Surety Bonds

Surety companies are writing more contract surety bonds overseas as they gain recognition as a more comprehensive coverage to guarantee completion of construction projects within the term of a contract.

Bank Letters of Credit

Currently, more commonly accepted overseas. Some foreign project owners may not accept a surety bond.

Surety Bonds

100% performance bond of the contract amount.
100% payment bond protects certain subcontractors, laborers, and materials suppliers and protects owner against liens.
At least 10% coverage for maintenance of defects the first year after completion.
Before paying, the surety investigates claims for payment, verifying their validity.

Bank Letters of Credit

The letter of credit may be obtained for any percentage of the contract, but 5% to 10% is typical.
No protection/guarantee that subcontractors, laborers, and materials suppliers will be paid in event of contractor default. They may file liens on the project.
The owner must determine which claims are valid.

Declaration of Default

When a contractor defaults on a bonded project, the first step in the whole surety claims process is the Declaration of Default. This is a legally bound statement from the owner declaring the contractor in default. A formal declaration of default must happen before the claims process can proceed. Delay in the claims process can be avoided if clear explanation of what constitutes default is clearly expressed when the contract is written and executed.

Once a formal default has been declared, the surety claims department will begin an investigation. This entails a complete review of the contract, progress reports, and all relevant documentation associated with the project. The claims investigation process takes a fair amount of time to gather an accurate picture of where the contract stands.

The surety analyzes all the facts of the case, reviews all the options, implements action plans, and makes decisions. The surety will review all its alternatives and choose the best course of action. A prime objective is to keep the project moving since delays merely increase costs.

Herein lies a key proponent of bonding: when default does occur there is a process to rectify the situation. The owner has an experienced surety company to rely on. Without a bond, the owner has to arrange for project completion.

When default has been formally declared, the bond's function of construction assurance and project completion begins.

To complete the project, the surety may:

Re-bid job for completion;
Arrange for replacement contractor; or
Retain original contractor and provide trained personnel, offer financial assistance to contractor, provide payment for subs and suppliers

Whatever option is chosen, the goal is the same: project completion, construction assurance, and financial security.

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