Conflicting federal court rulings muddy surety bond issues
Federal courts in Kansas and South Carolina have issued contradictory rulings on whether a surety company settling a bond claim must engage in arbitration if that form of dispute resolution is contained in a subcontract incorporated by reference in the bond, according to Construction Law Review.
The same case of a general contractor's claim against the surety company for two of its subcontractors saw the U.S. District Court for the District of South Carolina rule that the bonding company must go through arbitration proceedings because subcontracts incorporated by reference in the bonds required it. The District Court in Kansas, however, ruled that because the bonding company did not specifically agree to arbitration, that clause is not binding on the surety.
Surety bonds guarantee a contractor or subcontractor will do a quality job according to the construction schedule and that they will pay all of their financial obligations related to the project in question. If a bonded company defaults, the surety company steps in to pay the outstanding bills or, if necessary, to find a replacement contractor.
Because the surety company — a specialty insurance firm — has to make good on the bonds it issues, a contractor who wants to be bonded must undertake a rigorous review process in order to do so. Unlike insurance coverage, the bonded company has to pay back the bonding company for any losses.
Bob Raney, senior vice president of construction surety at Travelers, told Construction Dive last year that a contractor or subcontractor that wants to qualify for bonding would do well to consider the "three Cs": character, capacity and capital.
The "character" element analyzes how successful a contractor has been on past projects and if the company has ever defaulted on a job commitment. "Capacity" refers to resources the contractor has on hand, such as skill, equipment and employees, and if those elements are enough to help the contractor perform successfully. Cash flow, credit history and cash on hand all contribute to "capital."
A financial audit is sometimes used to verify this information. After a thorough review, the surety decides whether to issue a bond guaranteeing the contractor's work and financial capabilities.
While some private sector owners want contractors to provide a bond, the requirement is more common in the public sector.
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