This is part 2 in a series of blog posts where we will continue to explore surety bonds and bank letters of credit – what each is, their differences, and the advantages and drawbacks with each.
How is each obtained?
- The contractor obtains the bond through a surety bond agency or a surety bond producer such as Goldleaf Surety Services.
- The contractor obtains the LOC through a banking or lending institution.
What is your borrowing capacity with each?
- Performance and payment bonds are usually issued on an unsecured basis and are usually provided on the construction company’s financial strength, experience, and corporate and personal indemnity. The issuance of bonds does not diminish the contractor’s borrowing capacity and may be viewed as a credit enhancement.
- Specific liquid assets are pledged to secure bank LOC’s. Bank LOC’s diminish the contractor’s line of credit and appear on the contractor’s financial statement as a contingent liability. The contractor’s cash flow in funding initial stages of construction and retention amounts throughout a contract term can be adversely affected.
What is the duration of each instrument.
- Surety bonds remain in place for the duration of the contract plus a maintenance period, subject to the terms and conditions of the bond, the contract documents, and the underlying statutes.
- A bank LOC is usually date specific, generally for one year. LOC’s may contain “evergreen” clauses for automatic renewal with related fees.
In the next blog post in this series, I will discuss the cost, coverage, and claims process for each.