Why Developers Can't Afford to Overlook Surety Bonds

Reducing risk exposure isn’t always top of the priority list for developers. Brokers are used to facing pushback from clients who fail to grasp the potential challenges they could face when embarking on a project. Contractors may prefer to bury their heads in the sand but could face financial and reputational ruin if they fail to protect themselves adequately.

Surety bonds provide effective protection against the financial repercussions of a construction business failing to meet its contractual obligations. As such, they are an essential part of risk mitigation for those operating within the construction industry.

For developers, this guide will answer all their questions about surety bonds – helping them to understand the scale of the risks they’re taking on and how surety bonds can help to reassure their clients and strengthen their reputation.

How do Surety Bonds Work?

Surety bonds are agreements between three interested parties: the developer (the ‘principal’), the project owner (the ‘obligee’) and the surety bond provider (the ‘surety’). The principal takes out the surety bond which, essentially, acts as a guarantor that they will fulfil their obligations detailed in the contract that they hold with the obligee. If they default on the contract, the obligee can make a claim against the surety bond and the surety will cover financial losses incurred as a result of the default.

Why are Surety bonds Important?

Surety bonds offer developers and their clients protection against contracts being unfulfilled and projects being delayed or unfinished. Imagine your client takes on a large, high-profile contract but decides against taking out surety bonds. Halfway through the project, financial mismanagement and unforeseen delays caused the firm to default, leaving the project owner with an incomplete structure, unpaid subcontractors, and mounting legal battles.

The project owner is left scrambling to find another contractor, often at a much higher cost. Subcontractors and suppliers, who were relying on payment, may resort to lawsuits and the developer – now facing legal claims and reputational damage – risks bankruptcy and future business losses. In the worst-case scenario, the entire project could be abandoned, leaving behind a half-built liability instead of a thriving development.

This isn’t a pretty picture, but it’s one that’s entirely avoidable with the right level of surety bond cover.

Why take out surety bonds on a construction project?

To mitigate risk: Fundamentally, they protect construction companies and project owners from the costs involved with any failure to meet contractual obligations.

To fulfil legal or contractual requirements: Some contracts, especially larger public contracts, require surety bonds to be taken out. Others may not mandate surety bonds, but project owners are likely to find contractors that seek out surety cover, as standard, more appealing than those that resist.

To boost credibility and reputation: Surety bonds offer safeguarding against projects running over and against failure to complete. They increase levels of accountability on behalf of the contractor, suggesting they take a responsible approach to their work.

Which risks can surety bonds help to mitigate?

Financial risks
Centrally, surety bonds protect the financial interests of those awarding contracts to construction firms. They ensure that these project owners can claim back the costs incurred in the event that the contractor defaults on their contract. These costs could include taking on new contractors to finish the job, paying suppliers or covering legal fees.

Operational risks
Surety bonds also protect project owners against the operational disruption caused when a contractor fails to meet their contractual obligations. This could help to reduce delays in completing projects or prevent projects from being abandoned altogether.

Reputational risks
As well as the more tangible benefits of taking our surety bonds, their ability to prevent disruption and get projects back on track protects the reputation of both the contractor and the project owner.

What should you consider when taking out surety bonds?

The application process
A surety provider will look at several factors when offering surety bonds to contractors. They’ll take into account aspects like financial position and creditworthiness, as well as the level of obligation included in the contract. The cost of the bond will depend on the outcome of these assessments.

Any exclusions that apply
Most surety bonds will include certain exclusions. It’s vital that contractors understand the limitations applied to the bonds they are taking out and how this impacts the scope of their cover.

How regulation might impact the contract
Changes to construction, development and building regulations can impact the scale and validity of surety bonds that have been taken out. Changes in regulations have the potential to add extra requirements to contracts part-way through a project or even leave bonds unenforceable.

Costs
The cost of bonds or premiums depends on the assessments surety providers undertake when contractors make their initial applications. Contracts with a smaller scope or developers deemed more financially secure, without historic credit or contractual problems, are likely to pay less for their surety bonds.

The surety provider’s financial stability
Just as providers check the contractor’s financial position, those taking out surety bonds should also look into the surety provider’s stability. Working with a reputable broker with access to the best providers helps to reduce this risk.

Cancellation risks
There are some risks, such as non-payment of premiums or financial changes that impact the validity of the contract between the project owner and the developer, which could lead to the cancellation of surety bonds. These risks should be identified and monitored throughout a project.

Getting the bond value right
The value and scope of the bond taken out should be appropriate for the project it’s covering. There are major risks involved with taking out inadequate levels of cover.

Market conditions
Wider market conditions should be taken into account as they can have an impact on the availability and cost of surety bonds.

Getting the right surety bond deal

A knowledgeable broker makes sure that contractors secure the right level of coverage from financially stable providers, minimising risks while optimising conditions and costs. They help identify potential pitfalls, monitor regulatory changes, and negotiate the best terms, ensuring that construction firms can confidently take on new projects without unnecessary exposure to financial loss.