Surety Bonds

Bonds are insurance products that secure the financial risk of one party against the default of another party to the same agreement. Most commonly this is associated with contractor default.

What is a surety bond?

A bond or surety is a promise by the guarantor (the surety/bond company) to pay one party (the beneficiary) a certain amount if a second party (the principal) fails to meet certain obligations according to the EPC contract.

The the surety bond protects the beneficiary against losses resulting from the principal’s failure to meet the obligation. In other words: the bond provides a guarantee that the bonded company will perform its obligations in good faith.

Failure to do so may trigger a requirement that the surety company, who provided the bond, steps up in its place. In that case, the surety company is obligated to find another contractor to complete the contract or compensate the beneficiary for the financial loss incurred.

Surety Bond vs. Insurance

What is the Difference?

Surety bonds are an important risk mitigation tool designed to protect the obligee that has entered into a contract with a second party. It’s essential to know that insurance and surety bonds are two different types of tools. The terms “surety bond,” “surety bond insurance,” and “surety insurance” are often used interchangeably, causing some confusion and misunderstanding for consumers. It’s important to note that surety bonds are not insurance

Advance payment bond

Due to the hard costs of the project associated with the generating equipment is quite high and manufacturers often require substantial deposits for the manufacturing and delivery. Or perhaps the project site is very difficult to access and requires significant infrastructure in place before any generating installations can begin.

In either case, the EPC contractor may seek upfront money to defray these costs, in advance of any work put in place. The lender/financing institution would require some sort of guarantee that they will be reimbursed if the contractor fails to achieve certain milestones.

This guarantee may be in the form of a letter of credit, or a bond. The typical bond amount is about 10% of the contract value but could be higher. Underwriting is almost exclusively based on the financial strength of the applicant.

Performance bond

A typical performance bond would ensure that the Solar project was built according to all terms and conditions of the EPC contract, within the contractual time. Often these bonds are required by contract. Depending on the jurisdiction, the bond amount would be average from 10-100% of the contract value. In the United States, it is usually 100%, 50% in Canada & Mexico and 10-20% in South America, the EU, and others.

The percentage guarantee depends on the language of the bond. Higher percentage bonds typically are “remedy” in nature. In the event of a default, the obligation of the surety is to remedy the problem. Note there must be a legitimate default, declared by the beneficiary, and presumes the beneficiary is not in default of its obligations to the contractor. Resolution by the surety may include providing financing to the contractor or replacing the contractor with a completing entity, or (extremely rarely) writing a check to the beneficiary and allowing them to complete.

Lower percentage bonds may have these same characteristics, but are more likely to be “demand” in nature and much more like letters of credit in wording. They do not require a formal default, nor is there much of a chance to refute the demand. It is typically “pay now, argue later”.

In cases of conflict between the language of the bond and the language of the underlying contract, the latter usually prevails. Questions that relate to output guarantees, defective workmanship warrantees, definitions of default and damages, etc. all factor into the equation.

Cost of the bonds differs markedly because of the risk differential.  Underwriting is based on several factors:

– Language of the contract
– The financial status of the applicant
– Previous experience of the applicant on similar type/size projects
– Labor vs material risk. Subcontractor risk evaluation.
– Positive confirmation of project funding
– Legal/political jurisdiction of project site

Labor & material payment bond

These bonds guarantee that the EPC contractor/ principal named on the bond will use the contract revenues to pay material vendors, subcontractors, labor and all other costs directly incurred in the prosecution of the bonded contract.

Payment bonds typically go hand in hand with performance bonds. Since these are usually co-written with performance bonds, no additional underwriting is required.

Should a payment bond alone be required, underwriting would depend on adequacy and confirmation of project funding, and the financial capacity of the client.

Maintenance bond

A maintenance bond or warranty bond, guarantees that the work will be free of defective material and/or defective installation work for a stated period according to the EPC contract. Maintenance bonds become effective after the project has an acceptance certificate.

The starting date of a maintenance bond also effectively serves as closeout of the performance bond. Maintenance bonds are often required by contract, along with requirements for performance bonds.

The underwriting of maintenance bonds revolves principally around two factors:

– Duration of the guarantee

– Exposure to process or output during the warranty period

Warranty period up to three years is most common. Three-five years maintenance bonds are difficult to obtain. Beyond 5 years is almost impossible.

Decommissioning bond

The essence of decommissioning bonds is to guarantee that the installation will be dismantled and removed at the end of it's useful life. These type of bonds are required by the property owner and/or local governmental authority and the project developer/owner is required to provide them.

Decommissioning bonds can be very challenging to underwrite due to the length of the obligation. Solar Power Plants are designed for operation 25 years into the future.

Therefore to write a bond for that length of time is virtually impossible without significant collateral.

Bonds to meet these requirements are either annually renewable or run for an acceptable specified period of time (3 or 4 years) with renewal options. The only other choice for the developer is a letter of credit.

Decommissioning bonds are pure financial guarantees and underwritten solely on the strength of the clients' balance sheet.

Interconnection bond

Most of the Solar Power Plants are connected to the local power grid to distribute electricity. The utility company, private or state-owned, would enter into an interconnection agreement with the developer which sets forth the obligations of the developer to install all infrastructure needed to accomplish electricity distribution.

Usually, this includes the design, construction, and maintenance of a substation and transformers to convert the energy for transmission onto the grid.

These installations may be in place for many years. If the utility takes possession of the facility after start-up, they own it and have to maintain it.

However, if the developer holds that obligation, very often the utility will be looking for some financial guarantee to ensure they will perform maintenance and corrective work over the term of the interconnection contract.

Interconnection bonds are almost the same like the decommissioning bonds, but with the added risk that failure on the part of the developer to maintain the interconnection may be interpreted to be a side guarantee to the power purchase agreement as well.

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