Surety bonds have been a standard requirement for construction projects within the United States for decades. It has been proven to be an important part of construction project procurement and operations—providing a host of benefits not just for the project owner but for the contractor as well.
There’s been an increase in demand for surety bonds in recent years, especially when it comes to P3 projects. This demand is born out of a need.
And over time, this need will continue to grow because according to Star America Infrastructure Fund Founder & Managing Partner, William A. Marino, the U.S. “is poised to become the largest P3 market in the world for infrastructure projects.”
Before we delve into the importance of surety bonds to P3 projects, let’s first define what P3 is and what P3 projects are.
What is P3 and what are P3 projects?
P3 is an abbreviated term for public-private partnerships. It is also sometimes referred to as PPP and Triple Ps.
According to the United States Department of Transportation (USDOT), P3s are “contractual agreements formed between a public agency and a private sector entity that allow for greater private sector participation in the delivery and financing of transportation projects.”
P3s is not a new revenue source. It’s an agreement that will provide a source of financing for the public entity to procure work.
These agreements are not unique to the construction industry. In fact, it’s being utilized in other industries as well, like finance and engineering. However, the majority of P3s are infrastructure projects.
Through this financial arrangement, the public agency (government agency) will contract with the private sector to finance, construct, operate, and manage an infrastructure project.
One of the most important parts of P3 is risk transference. The extent of which will depend on the type of project.
The public agency will transfer the risks to the private entity that is more capable and experienced in handling such risks.
Because of such, out of the 6 critical components that have been identified by the National Council for Public-Private Partnerships, proper partner selection is the most important one in terms of ensuring the success of P3s.
The other components are political leadership, public sector involvement, comprehensive plan, dedicated income stream, stakeholder, and communication.
Once bonded, the surety will share the risk with the private entity. Together, they will share the responsibility for the construction project.
Surety Bond for P3s
Despite being issued on a regular basis for P3 projects, many are still unaware of the importance of surety bonds. Surety bonds provide a list of benefits for the government agency and the contractor. Here are a few of those benefits.
Benefits of Surety Bonds for Government Agency (Obligee)
- Project Completion Guarantee
The primary purpose of surety bonds is to ensure the government agency that the contractor will satisfactorily perform all the duties that are listed on the contract. Surety bonds increase the likelihood that the project will be completed.
- Recovery of Financial Loss
Surety bonds protect the Obligee from losses resulting from the Principal’s default. In addition, any contractor default will be reimbursable through these bonds. Under the agreement, both the surety and the contractor will be indebted to the government agency when a default occurs.
- Additional In-Depth Assessment
As mentioned earlier, proper partner selection is pertinent in P3 projects. Aside from the government’s own assessment of the contractor, sureties will conduct their own thorough applicant assessment in order to determine the risks that are involved. An underwriter will check if the contractor is financially capable of completing the project, has a good history of completing projects, and has a good credit score to name a few. Chief among these when it comes to bond premium is the contractor’s credit score. The creditworthiness of an applicant is important because surety bonds are credit transactions.
- Obtain more projects
This is so because surety bonds drive the relationship of private entities with public agencies. They know that having a bond will help the project improve its chances of survival.
- Decreases rate of default
P3 projects have their own unique contractual needs that involve a higher degree of risk. Sureties can find equitable solutions for the contractor to avoid default or save the project in case of a default. They can guide the contractors from the onset through a thorough assessment and assumption of the appropriate risk levels. This information will help the private entity determine the level of risk that they need to manage, thereby resolving issues even before they start.
The importance of a surety bond—and more importantly, a surety—in P3 projects go beyond the boundaries of bonds being financial guarantees.
Experienced sureties can help private entities resolve issues before and during the term of the P3 project. Aside from that, sureties will stand as an advocate for the contractor and a strong financial partner.