The Expert Podcast

There’s a number of new industries that are not only evolving but becoming more prominent that didn’t even exist before. Many of these can benefit dramatically from surety bonds. And let’s take a look at how surety bonds can be an opportunity for both bond producers, insurance companies, clients, and even business development. One example is renewable energy. This is an industry where they’re building new power plants to replace coal, gas, fossil fuel plants. They could be solar, they could be wind, they could be other types of non-standard energy production.

Problem is, these all need to be constructed and these are large projects. So when you go into producing these facilities, there are many contractors. There’s builders, architects, designers, construction companies. And each of them need to guarantee that they are going to be able to fulfill their part of the bargain. One way to do it is to have financing, to have letters of credit, to have capital, working capital. Another way to do it is with a surety bond. And a surety bond is very, very good from the standpoint of a developer because it’s not debt. It is a contingent liability, meaning that it’s only going to be a liability for the contracting company if they mess up.

If they do everything right, it doesn’t affect them. They have to pay a bond fee, but that’s small potatoes compared to having a million dollars in the bank or a $2 million line of credit. And sometimes your client’s going to require that you have that capital. Putting together these plants is not only about guaranteeing the creation of the facility but also that the facilities kind of produce the power it’s supposed to. They’re very complex financial structures, and this sector is not used to using bonds. They’re not used to using anything other than cash and capital reserves. So a lot of the surety companies are going through the process of getting surety bonds accepted by utilities.

And these utilities are the ones that consume the power from these generating plants. If you are a generating plant or a construction company, having a surety bond to back up your promises—say “look, we’re going to deliver this much power to you”—is a lot better than having cash in the bank or reserves. The power company, the utility, they would be the obligee that would benefit from this surety bond. So they’re the ones who are the gatekeeper. They’re the ones who say whether they accept it or not. And the plant is the one who is the principal.

Getting the obligee to accept a bond is a combination of efforts from the principal and of the surety. One of the hiccups has been, there are some utilities that had difficulty collecting on bond obligations. You know, bonding companies would kind of reject claims sometimes, so they’re a little cautious on taking claims for production promises. In reality, a surety bond should be more of a rock-solid financial guarantee because the surety already designates the obligee as the beneficiary.

A line of credit may or may not—you know—and it’s not a direct payment. You can’t just go to the bank and say give me the money. There has to be some escrow process to go through. Commercial surety bonds also help the balance sheet of the producer of the power plant or the construction company because they don’t have to put debt on their balance sheet. They don’t have to take cash out of their bank account. They can pay a one-time fee of a surety and now their balance sheet remains the same.

Their liabilities do not go up because that surety bond is only a liability if there’s a problem. It’s contingent upon there being some kind of problem, which is not presumed. Sometimes these utility and power plant producer deals have some down-the-road obligations—for example, decommissioning a plant, taking apart a solar system, repairing lines. And a surety bond is a good way to guarantee that that’s going to happen.

Having that surety in place at the beginning makes sure that even if the company becomes insolvent or maybe not as well capitalized down the road, that the obligee, the beneficiary, knows that this is going to be done. And if the contractual requirements of the principal are not met, then the bonding agency, the surety, will step in and find somebody else that will.

So whether you are a large Fortune 500 company that’s doing complex financial deals with obligations and representations that would affect your balance sheet, or you’re a small contractor that needs to play with the big boys in construction and wants to have the same amount of horsepower behind you—financial horsepower—a surety bond can solve both problems. It can keep you as a large firm, a large company, from having to impact your balance sheet with debt or with reduced working capital.

It can also help you as a smaller company have the same backup as a large company. For example, look—if you’re bidding against a mega developer or mega power plant and they have a $10 million surety bond from XYZ bonding company, if you have the same surety bond, basically you’re on equal footing with them. It’s not like they’re dealing with a smaller company. In fact, there may be advantages of them dealing with you as a smaller firm, but the financial backing is what puts you at a disadvantage. With a surety bond from a large surety company, now you’re equal financially to that large company.

So look at a surety bond as a way to level the playing field if you’re a small producer, or to make your balance sheet remain healthy if you’re a large company that has the capital reserves. Let us know what you think in the comments or if you have any questions.