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Surety Bonds Versus
Bank Letters of Credit

Definitions
Surety Bonds A three-party agreement among the surety, the obligee (the project owner), and the principal (the contractor). A performance bond protects the owner from non-performance and financial exposures should the contractor default. A payment bond, aka labor and material bond, protects certain subcontractors, laborers, and material suppliers against nonpayment by the contractor.	Bank Letters of Credit A bank letter of credit (LOC) is a cash guarantee to the owner, who can call on the LOC on demand. The LOC converts to a payment to the owner and an interest-bearing loan for the contractor. The performance of the contract has no bearing on the bank’s obligation to pay on the letter of credit.
Prequalification
Surety Bonds A surety company and producer assess the contractor’s business operations, financial resources, experience, organization, existing workload and its profitability, and management capability to verify the contractor is capable of performing the contract. The purpose is to avoid default.	Bank Letters of Credit The banker examines the quality and liquidity of the collateral in case there is a demand on the letter of credit. If the banker is satisfied that the contractor can reimburse the bank if demand is made upon the LOC, there is no further prequalification.
Borrowing Capacity
Surety Bonds 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.	Bank Letters of Credit Specific liquid assets are pledged to secure bank LOCs. Bank LOCs 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.
Duration
Surety Bonds Surety bonds remain in force for the duration of the contract plus a maintenance period, subject to the terms and conditions of the bond, the contract documents, and underlying statutes.	Bank Letters of Credit An LOC is usually date specific, generally for one year. LOCs may contain “evergreen” clauses for automatic renewal, with related fees.
How To Obtain
Surety Bonds The contractor obtains the bond through a surety bond producer. A list of surety bond producers is available through the National Association of Surety Bond Producers (NASBP) at www.nasbp.org.	Bank Letters of Credit The contractor obtains the LOC through a banking or lending institution.
Cost
Surety Bonds Generally 0.5% to 2% of contract price. Bond is project specific, covers duration of contract. Included in contractor’s bid price.	Bank Letters of Credit Cost is generally 1% of the contract amount covered by LOC - e.g. if LOC covers 10% of contract, Cost = 1% x (10% x Contract Amount) x years of contract. Included in contractor’s bid price.
Coverage
Surety Bonds Performance bond - 100% of the contract amount for project completion. Payment bond - 100% of contract amount protects certain subcontractors, laborers, and materials suppliers and protects owner against liens. At least 10% coverage for maintenance of defects the first year after completion.	Bank Letters of Credit The LOC may be obtained for any percentage of the contract, but 5% to 10% is typical. No protection/guarantee that subcontractors, laborers, and materials suppliers will be paid in the event of contractor default. They may file liens on the project.
Claims
Surety Bonds If the owner declares the contractor in default, the surety investigates. If the contractor defaults, the surety’s options are to: Finance the original contractor or provide support; Takeover responsibility for completion (up to penal sum of bond); Tender a new contractor; or Pay the penal sum of the bond. With payment bonds, the surety pays the rightful claims of certain subcontractors, laborers, and suppliers up to the penal sum of the bond.	Bank Letters of Credit The bank will pay on an LOC upon demand of the holder if made prior to the expiration date. There is no completion clause in an LOC. The task of administering completion of the contract is left to the owner. The owner must determine the validity of claims by subcontractors, laborers, and materials suppliers. If there is not enough money from the LOC to pay all of the claims, then the owner has to decide which claims will be paid and which will be rejected.

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For more information about surety bonding, please contact the: Surety Information Office 1828 L St. NW, Suite 720 Washington, DC 20036-5104 (202) 686-7463 | Fax (202) 686-3656 www.sio.org | sio@sio.org The Surety Information Office (SIO) is the information source on contract surety bonds in public and private construction. SIO offers complimentary brochures and CDs and can provide speakers, write articles, and answer questions on contract surety bonds. SIO is supported by The Surety & Fidelity Association of America (SFAA) and the National Association of Surety Bond Producers (NASBP). All materials may be accessed at www.sio.org.

The Surety & Fidelity Association of America 1101 Connecticut Avenue, NW, Suite 800 Washington, DC 20036 (202) 463-0600 | Fax (202) 463-0606 www.surety.org | information@surety.org The Surety & Fidelity Association of America (SFAA) is a District of Columbia non-profit corporation whose members are engaged in the business of suretyship worldwide. Member companies collectively write the majority of surety and fidelity bonds in the United States. SFAA is licensed as a rating or advisory organization in all states, as well as in the District of Columbia and Puerto Rico, and it has been designated by state insurance departments as a statistical agent for the reporting of fidelity and surety experience. SFAA represents its member companies in matters of common interest before various federal, state, and local government agencies.

National Association of Surety Bond Producers 1828 L St. NW, Suite 720 Washington, DC 20036-5104 (202) 686-3700 | Fax (202) 686-3656 www.nasbp.org | info@nasbp.org The National Association of Surety Bond Producers (NASBP) is the international organization of professional surety bond producers and brokers. NASBP represents more than 5,000 personnel who specialize in surety bonding; provide performance and payment bonds for the construction industry; and issue other types of surety bonds, such as license and permit bonds, for guaranteeing performance. NASBP’s mission is to strengthen professionalism, expertise, and innovation in surety and to advocate its use worldwide.