by Keith Nicholson, CPA, CIC
16. October 2008 10:53
It goes without saying that before entering into a contract, especially a construction contract, any prudent businessperson should make sure that the contractor is not only qualified to do the work but also able to meet all the financial obligations required by the job. After all, if the contractor cannot pay for the labor, equipment, and materials required for the job, the work will not get done. The problem is that obtaining vital information about a construction firm's finances is no easy task.
That's where surety companies can provide an invaluable service. By definition, a surety is one who has contracted to be responsible for another, especially one who assumes responsibilities or debts in the event of default; the term is also used to describe the promise to provide such security. In the construction industry, a surety company will prequalify a contractor, based on both the contractor's expertise and financial stability, before assuming the risk of contractor failure by performing an in-depth review of the contractor's financial position and business operations.
So what does a surety look for prior to issuing a bond to a contractor? The surety company must ascertain that the contractor has the following:
- a good reputation in the industry, backed by solid references;
- the ability to meet current and future contractual obligations;
- the equipment necessary to do the work (or the ability to obtain it);
- experience that matches the requirements of the contract;
- the financial strength to support the desired construction project;
- an excellent credit history; and
- an established banking relationship with an available line of credit.
In addition to the information listed above, the surety company will also seek to establish that the contractor's business is well managed; a surety wants to know if the contractor deals with clients fairly, keeps its promises, and satisfies its obligations in a timely manner. In fact, because prequalifying a contractor is such a comprehensive process, surety bonds are usually underwritten with very little expectation of loss.
Contractors seeking to ensure that they remain competitive in the industry and win their fair share of bids, both big and small, should consult an insurance specialist, who can help them meet the requirements for bonding prequalification.
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