To ensure the completion of a designated development, a lot of political jurisdictions have ordered the owner or developer of a real property requiring them to post their financial security as a prerequisite to granting a construction permit.
There are different ways to prove your financial situation:
- Cash Deposits – This includes posting up your own cash with the obligee. This option works best if you have a significant amount of cash available.
- Irrevocable Letters of Credit – In the simplest words, your banking institution underwrites and provides the obligee or the project owner their own guarantee on your behalf. They do a financial analysis of your company, the job coming up that you require the LOC for, the risks involved with the job and the expected outcome of the project before they issue this document.
- Surety Bonds – These bonds work similar to insurance but are completely different when it comes to a claim payout. The principal (YOU) provides a bond to the obligee (person hiring you) to guarantee them that a specific construction or builder job will be completed successfully. A surety bond can cost between 1-10% of the full bond amount, but you can still get different rates from different providers.
If you are a developer or a builder, the safest and most cost-effective way to guarantee project completion is through surety bonds issued by licensed sureties. Surety bonds should be acquired through an experienced bond agent that specializes in subdivision or improvement bonds. All jurisdictions in the US and the UK generally accept surety bonds, however there are some states or jurisdictions that has some exclusions and minor exceptions.
In most cases, the problem with cash is that you can be tied up for a long a time, same goes for letters of credit. Surety bonds or multiple surety bonds may be a far better alternative. The following are some of the benefits of surety bonds:
- Its competitiveness with fees compared to letters of credit. In many cases, the cost of surety bonds is lesser unlike with the others.
- There’s no collateral requirement in order to obtain a surety bond.
- Most of the bank loans will include letters of credit for an additional fee. This reduces the amount that amounts that you can be borrowed. In some cases, with smaller banks, it affects the loan to single borrower limitation.
- Assets may be tied up for long after the work is substantially completed before the letters of credit is released that is if there are cash or real estate collateralizing letters of credit.
- It may be difficult to obtain a letter of credit if the developer does not have a bank account. It is a big advantage for the developer to have a surety line of credit or relationship with a surety in such cases.
- There’s a reasonable time span that can go as long as 45 days to respond to a claim or demand against its bond. The surety will investigate and give the principal time to have the demand reversed or to assess the default.
The bottom line is, a surety bond is the simplest way to offer financial guarantee to ensure the principal (whoever needs the bond), the obligee (the one requiring the bond), and the surety (the company guaranteeing the principal can fulfill the requirements) will meet their obligations.
The purpose of this bond is very specific. If the company doesn’t complete the job or did not meet the expected level of standard when it comes to the work deliveries and with the quality of the construction project, the bond may be used to recovering loses when the project owner experiences one.
The party who required the surety bond can use it as a financial guarantee to secure themselves from loses in case that the party making the promise doesn’t deliver or finish a job agreed on the contract terms.
Do you know other ways on how to guarantee service improvements or completion? Share it with us in the comments!