Demystifying Surety in the North American Underground Construction Market – Part 1
By Craig Covil, PE, CEng, FASCE, FICE, DBIA, NAC (member of The Moles and The Beavers)
In the North American construction industry, surety bonds provide financial security and assurance that contractors will fulfill their contractual obligations. They function as a type of risk control mechanism, ensuring project owners that their contractors will complete work, pay labor, subcontractors, and adhere to contract terms. These bonds are crucial for public and many private construction projects, offering protection to owners, lenders, subcontractors, and suppliers. The underground construction market, be it tunneling or mining, or alike, is by definition riskier than traditional conventional above-ground construction, as it is dealing with and relying on the unknowns and variabilitiesnatural materials such as rock, soils and water rather than traditional man-made materials.
Surety bonds shift the risk of contractor default from the project owner to the surety company (as long as the owner/obligee fulfils its own obligations under the construction contract). The three common types include (i) bid bonds (providing monetary protection to the owner if the bidding contractor fails to enter the awarded contract), (ii) performance bonds (guaranteeing project performance andcompletion), and (iii) payment bonds (protecting against non-payment of labor, subcontractors/suppliers). This two-part article focuses on performance bonds.
Background
A significant cost, surety bonds are very often required for larger projects and demonstrate the contractor’s (or CJV’s) financial stability and reliability to potential clients. Surety companies (sometimes as a panel of sureties) vet contractors before issuing bonds, assessing their experience (knowledge of client, project, risks, type of construction and delivery method), workforce (union, non-union, specialized or not, and resource availability, leadership and management) and financial capacity (availability of funds, assets, and access to credit, as well as the knowledge, skills, and behaviors necessary to make sound financial decisions).
Surety bonds are a standard requirement in the construction industry, especially for public projects and increasingly for private ones. The Miller Act (Federal Act dating from 1935, as well as the various State legislated “Little Miller Acts” – various dates) are intended to protect the taxpayers and certain subcontractors and suppliers on federal construction projects. Specifically, its payment bond protections don’t extend to all tiers of subcontractors and suppliers, and it can be difficult for some parties to navigate the notice and claim requirements. Additionally, while the act requires bonding, the reality is that sureties still hold significant control over the government construction market, and individual sureties are rarely accepted.
Canada has no single federal equivalent to the U.S. Miller Act. Instead, the requirement for surety bonds on public construction projects is governed by a combination of provincial laws, federal prompt payment legislation, and project-specific requirements.
The Role of Sureties
Surety companies evaluate contractors based on the “three C’s” to ensure they can meet their obligations: (i) Character: A contractor’s reputation and record of fulfilling obligations are assessed through their credit history and business acumen. (ii) Capacity: evaluation that the contractor has the necessary experience, equipment, and staff to complete the project successfully, reviewing their back-log of work and rate of burn. (iii) Capital: The contractor must demonstrate financial stability and have sufficient resources to complete the project and cover unforeseen issues.
The Miller Act (and Canadian federal equivalent) applies to contracts receiving federal funding that exceed a construction value of $150,000 for construction, alteration, or repair of any public building or public work of the United States. The U.S. penal amount is typically 100% of the original construction contract price, plus any increases, “…unless the contracting officer deems a lesser amount sufficient to protect the government”. In Canada it is typically 50% of the contract value.
Be aware; there is limited coverage: The Miller Act primarily protects first and second-tier subcontractors and suppliers who contract directly with the prime contractor or a first-tier subcontractor. This means that suppliers to suppliers (e.g., TBM supplier, dewatering and/or grouting subcontractor etc.), further down the chain, are not covered and cannot file a claim under the act. This can leave some parties unprotected. The act requires specific notice and claims procedures, which can be challenging for some parties to navigate, especially if they are unfamiliar with the legal requirements. For example, there are deadlines for providing notice (e.g., 90 days from last furnishing labor or materials). Failure to comply with these requirements can result in the loss of the right to make a claim.
The Act requires a one-year statute of limitations for filing a lawsuit to enforce claims under a performance bond on federal construction projects. This one-year period typically begins to run from one of the following dates, whichever occurs first:
- When the contractor defaults on the contract.
- When the contractor ceases working on the project.
- When the surety refuses or fails to perform its obligations under the bond.
Any legal action to enforce the performance bond must be initiated within this one-year period from the occurrence of the earliest triggering event among these three options.
While the Miller Act aims to ensure performance (and payment) through surety bonds, commercial sureties still hold significant control. This is because the Act allows for individual sureties, but in practice, agencies rarely accept them. For larger projects, prime contractors will look to a panel of sureties. This can create a situation where the sureties ‘en masse’ effectively control the market, potentially impacting the availability and terms of bonds. A recent case suggests that sureties could face liability under the False Claims Act if the bonded contractor violates it. While the sureties in that case escaped liability due to lack of knowledge of the claim, it highlights the potential for broader liability and the need for sureties to be aware of the risks involved in bonding federal projects. There are hundreds of surety companies, but only a couple of dozen who are large enough to be active in the tunneling market.
While statute of limitations is crucial, some courts have treated it as a claim-processing rule rather than a strict jurisdictional requirement, which might allow for some flexibility. Timely action is critical: It’s important to remember that failing to file suit within this one-year period can be fatal to the claim. While the Miller Act sets a standard for federal projects, individual states have their own “Little Miller Acts” that govern performance and payment bonds on state-funded projects. These state laws can have different statutes of limitations, notice requirements, and other provisions that may vary from the federal Miller Act requirements.
It is strongly recommended that parties involved in Miller Act performance bond matters consult with their in-house risk manager(s), brokers and legal professionals to ensure compliance with the specific requirements and deadlines applicable to their situation.
Some leading surety providers in the US underground and tunneling construction industry (there are others too):
- Zurich: Known for their deep experience and capacity in handling surety bonds for major construction and public works projects, including those for large ENR 400 firms. Zurich has a long history in the U.S. surety market.
- Travelers: A major player in the surety market, offering high bonding capacity and strong financial resources to support large public works and construction projects. They also serve smaller contractors with a specialized program. They have regularly been publicizing their case study research results – a good read for many.
- The Hartford: Offers a wide selection of construction surety bonds and can provide high bonding capacity.
- Liberty Mutual: A leader in the U.S. and global surety markets with strong financial resources and a range of construction bond options for various business sizes and industries.
- Chubb: A long-standing leader in construction surety, with high bonding capacity and a significant presence among top contractors.
- Berkshire Hathaway: a well-respected leader in the US.
In the North American underground and tunneling construction industry, surety brokers play a critical role in facilitating and navigating the complex world of surety bonds for contractors involved in these specialized projects. Brokers such as Aon, NFP, American Global, Willis, Lockton etc., are all good brokerages to talk with and get advice from. The key functions of a good brokerage are: (i) they act as intermediaries, understanding the specific needs of underground and tunneling contractors and matching them with surety companies best suited to provide the required bonds. (ii) they guide contractors through the bonding process. Obtaining surety bonds involves a rigorous underwriting process where sureties assess the contractor’s financial strength, management, project history, and capabilities. Brokers assist by preparing detailed bond applications, ensuring all necessary financial statements, project plans, and documentation are complete and accurate. (iii) Negotiating bond terms and conditions, aiming to secure favorable terms and conditions for the bonds. This may include negotiating bond amounts, indemnity requirements, and other critical aspects of the surety agreement. (iv) Providing risk management and mitigation insights. Brokers collaborate with contractors to identify and address potential risks associated with underground and tunneling projects, which can significantly impact bond-ability. They may offer guidance on improving financial health, strengthening project management practices, and mitigating specific risks inherent in underground construction. Owners and Owners Reps have not recognized that, for example, TBMs are simply seen as a tool in the contractors’ means and methods’ approach, and hence not part of the permanent works for the Owner, and as such are not typically covered under the Builders’ All Risk Insurance. TBMs can be the most significant driver of performance in a tunnel project. (v) Facilitating and maintaining a long-term relationship with contractors, providing advice on strengthening their financial position and improving their overall bond-ability over time, as well as advising on future procurement plans/strategies. (vi) Surety brokers are expected to be knowledgeable about industry trends, regulatory changes, and evolving market conditions that might impact bond availability and pricing for underground construction projects.
Surety brokers serve as valuable advisors and facilitators for both contractors and owners in the underground and tunneling construction sector. They help navigate the complexities of surety bonds, secure the necessary financial guarantees, and ultimately increase the competitiveness and ability to undertake these specialized and often high-risk projects. Many brokers provide free of charge services to review surety clauses in market RFPs and provide both owners and contractors with feedback prior to the contract terms and conditions being finalized – a service that the more knowledgeable contractors make good use of in today’s heated procurement market.
The Cost of Sureties
Bond premiums are calculated as a percentage of the bond amount as related to the Construction Value, ranging from about 0.5-10% (but more typically 1 to 3%) with costs varying based on the contractor’s financial health and bond type. Building a strong relationship with a surety company can benefit a contractor by securing future bonding opportunities and fostering trust based upon successful construction delivery. The cost is influenced by the type of construction, contract terms, and durations, delivery method and “maturity level” of the Owner team: A new owner, or an owner undertaking their first Design-Build or P3 delivery, or having a long litigious history with contractors will impact the pricing.
Credit ratings play a crucial role in the U.S. construction industry, influencing a company’s ability to secure financing, manage cash flow, win bids, and build strong relationships with clients and suppliers. When a company doesn’t have a credit rating (which is quite common) then owners will rely on the project surety process.
In the U.S. construction industry, specifically concerning tunnel projects, surety bonds are a critical component for risk mitigation and ensuring project success. Here’s an overview of how surety bonds function and the concept of “surety calls”:
- Fundamentals: A surety bond is a contract involving three parties: the contractor (principal), the project owner which also may include certain other beneficiaries (the obligee), and the surety (often an insurance company). The surety provides a guarantee that the contractor will fulfill their contractual obligations.
- Purpose in Tunnel Projects: Due to the inherent risks in tunnel construction, plus the added complexities, such as long-lead items including TBMs or mining equipment orders, differing site conditions, construction delays, cost overruns, and potential contractor default, surety bonds offer financial protection for project owners and other stakeholders. Note however that the bond does not necessarily protect the owner from cost overruns (or resulting delays) if the source of the overruns is outside the scope of the contract.
- “Surety Call”: This occurs when the project owner formally notifies the surety that the contractor has defaulted on their contractual obligations. This triggers the surety’s responsibility to investigate and address the situation. The surety has several options to ensure the project is completed, such as paying the bond penalty to the Owner/Obligee, completing the project using the defaulted contractor, finding a new contractor, or allowing the owner to complete the work with the surety covering some of the costs.
- Subcontractor Default: Surety calls can also result from subcontractor/supplier defaults. General Contractors (GCs) often use Subcontractor Default Insurance (SDI) or require subcontractor bonds to manage this risk. In some Construction Joint Ventures (CJVs), the CJV might have one party as a “Line-Item JV partner” and in these cases that partner would provide separate bonding, typically 100% of their “Item” component of the construction contract value. This is an appropriate risk management approach when the contract includes distinctly different scopes (e.g., tunnel construction and rail track/catenary installation for example).
- Challenges and Safeguards: While providing protection, surety bond claims can happen due to various factors like poor financial or project management, underbidding, or economic issues. Sureties carefully assess contractors to minimize these risks. Strong financial practices, effective project management, and clear communication can also help prevent surety bond claims.
Tunnel Risk Management
During the 1990s there were unfortunately a series of spectacular tunnel collapses (Nicholl Highway, Singapore; Hull Wastewater Tunnel UK; Heathrow Express Tunnel UK; Hollywood Boulevard subway collapse, LA; Lacey V. Murrow Memorial Bridge sinking Seattle USA; and others) which focused the public and tunnel owners’ attention on the inherent risks in tunnel design and construction. As a result, risk management became more formally integral in the delivery of most underground projects. The British Tunnelling Society (BTS) promoted risk management in tunneling through its Joint Code of Practice (2003), co-developed with the Association of British Insurers (ABI), to encourage best practices in identifying, mitigating, and allocating risks. The code, a requirement for insurance on many major tunnel projects, helps minimize accidents by emphasizing live risk registers, risk meetings, robust communication, and a culture of continuous learning to achieve successful tunnel projects. The British Tunneling Society (BTS) supported by the global insurance underwriters (most of which are based in London) then working with the International Tunnel Association (ITA) picked up the BTS document and further jointly developed, promoted and published an international guideline. This guideline started to become adopted worldwide, but neither consistently, fully nor fast. The current version is the 3rd edition; dated Feb 2023. This guideline is a well-written simple document that outlines the findings and hence the checklist that the insurance underwriting market typically uses when assessing the provision of insurance on tunnel projects. Insurance and surety are different, – but related: This guideline is a good reference in approaching the tunnel/underground contractors “3Cs”. This 3rd edition of the ITA guideline includes review and input from North American tunneling fraternity experts, and more and more is being utilized in tunnel project delivery as a standard threshold reference or specification.
Challenges
Surety is not the same as insurance. While surety bonds are crucial for financial protection and ensuring contractor performance in the tunnel construction industry, challenges exist within the surety market. Tunnel projects are inherently complex and involve significant technical, geological, and environmental uncertainties. This makes it challenging for surety companies to accurately assess and underwrite the associated risks. Obtaining surety bonds for tunnel projects can be a time-consuming and stringent process, requiring contractors to provide extensive financial information, documentation, and a detailed understanding of their risk mitigation approaches. The rigorous underwriting process can add ongoing costs, such as accountant fees for CPA-prepared financial statements, potentially posing a financial burden on contractors, especially smaller or newer firms. An overheated tunneling market stresses all resources including contractors’ bond capacities. Unfavorable market conditions or concerns about the stability of the tunnel construction sector can make surety companies reluctant to provide bonds, or they may impose stricter conditions and higher premiums.
There are contractor-specific challenges. Surety bonds are ultimately a credit instrument, and sureties focus heavily on the contractor’s financial strength, including factors like liquidity, working capital, and debt ratios. Demonstrating a track record of successful tunnel project completions, on time and within budget, is critical for obtaining bonds. Inadequate financial practices, such as underbidding, poor cash flow management, or failure to track costs accurately, can lead to financial distress and bond failures. Taking on too many tunnel projects simultaneously or venturing into unfamiliar geographies can strain a contractor’s resources, increasing the risk of default and negatively impacting bond capacity. Failures in subcontractor performance or problems with material delivery can trigger delays, cost overruns, and lead to bond claims.
There are tunnel /mining project-specific challenges. Long completion times increase the risk of unforeseen circumstances and potential cost escalations or delays. Insufficient or unstable financing can lead to payment delays and even project abandonment, which surety companies want to avoid. Certain onerous contract clauses that unfairly shift or “dump” risks back to the contractor (e.g., contingent payment clauses, imbalanced risk allocations, owner disclaimers of subsurface data, short cure periods, tariffs, uncontrollable material escalations) can make it more difficult to secure bonds. If a contractor defaults, limited surety resources or difficulties in finding a suitable replacement contractor can prolong project completion. Limitations on the types of losses covered by the bond can lead to disputes between the project owner and the surety, further delaying resolution.
While surety bonds are designed to protect against risks in tunnel construction, the inherent risks,complexity and specialized nature of these projects, combined with contractor-specific factors and market conditions, can create hurdles in obtaining and effectively utilizing these provisions.
About the Author
Craig Covil is a senior advisor in the construction industry, advising on project delivery, P3s, Design-Build and other alternative delivery, engineering, design management, technical advisory as well as interface and risk management for mega projects and programs of private and public sectors of infrastructure and buildings. Craig is an SME and senior advisor to NFP, part of the Aon Group, currently advising on a number of projects including the Gateway Program, the largest current US infrastructure/tunneling program at $16B.
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