Surety Bonds

Bonds are insurance products that cover one party's financial risk against the default of another party to the same agreement. Frequently 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 specified amount. But if a second party (the principal) fails to meet certain obligations according to the EPC contract.
The surety bond protects the beneficiary from losses incurred as a result of the principal's inability to meet the obligation. For example, the bond ensures that the bonded company will fulfill its obligations in good faith. Failure to do so may result in a requirement that the surety company that provided the bond, steps up in its place. In that instance, the surety company then must locate another contractor to complete the contract or refund the beneficiary for the financial loss sustained.
Surety working
Surety working

Surety Bond vs. Insurance

The difference: Surety bonds are key risks mitigation measures. They are designed to protect the obligee that has entered into a contract with a second party. It should be noted 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, which can lead to consumer confusion and misunderstanding. It is important to note that surety bonds are not insurance.
Due to the project's hard costs related to the generating equipment are relatively expensive, manufacturers frequently need large deposits for fabrication and delivery. Or perhaps the project site is difficult to access and requires significant infrastructure in place before any generating installations can begin.
In either scenario, the EPC contractor may require upfront funds to defray these costs before initiating any work. The lender/financing institution would require some assurance that they will be reimbursed if the contractor fails to meet specified goals.
This guarantee may be in the form of a letter, credit or a bond. The usual bond amount is around 10% of the contract value but could be higher. Underwriting is almost solely based on the financial strength of the applicant.
A typical performance bond would ensure that the Solar project was completed in accordance with the terms and conditions of the EPC contract and within the time frame specified. These bonds are frequently required by contract. The bond amount would range between 10 and 100% of the contract value, depending on the jurisdiction. It is normally 100% in the United States, 50% in Canada and Mexico, and 10-20% in South America, the EU, and other places.
The percentage guarantee is determined by the bond's language. Bonds with higher percentages are often “remedy” in nature. In an event of a default, the obligation of the surety is to remedy the problem. There must be a legitimate default, declared by the beneficiary, and presumes the beneficiary is not in default of its obligations to the contractor. The surety may provide funding to the contractor, replace the contractor with a completing entity, or (very rarely) write payment to the beneficiary and allow them to complete.
Lower percentage bonds may have the same features. Except they have a higher chance 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.
When the language of the bond and the language of the underlying contract disagree, the latter usually prevails. Questions about output guarantees, defective workmanship warranties, definitions of default and damages, and so on all play a role.
Most importantly, the 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 the project site.
These bonds ensure that the EPC contractor/principal identified on the bond will use contract revenues to pay material vendors, subcontractors, labor, and all other expenses directly incurred in the performance of the bonded contract.
For instance, payment bonds are frequently used in combination with performance bonds. No additional underwriting is necessary because these are usually co-written with performance bonds.
Should a payment bond alone be required, underwriting would be based on adequacy and confirmation of project funding. Taking in mind the financial capacity of the client.
A maintenance bond is also known as a warranty bond. It ensures that the work will be free of defective material and/or defective installation work for the duration specified in the EPC contract. Maintenance bonds become effective after the project has an acceptance certificate.
The start date of a maintenance bond also serves as the closeout date of the performance bond. Maintenance bonds are often required by contract, along with requirements for performance bonds.
The underwriting of maintenance bonds is primarily based on two factors. Firstly the duration of the guarantee and secondly the exposure to process or output throughout the warranty period.
Warranty period up to 3 years is most common. Three-five years of maintenance bonds are difficult to obtain. Beyond 5 years is almost impossible.
The purpose of decommissioning bonds is to assure that the installation will be dismantled and removed at the end of its useful life. These types of bonds are required by the property owner and/or local governmental authority and the project developer/owner is required to provide them.
Due to the promised period, underwriting decommissioned bonds can be very difficult. The Solar power plant is designed to operate for 25 years into the future. But without significant collateral, it is nearly impossible to write a bond for that length of time.
Bonds issued to meet these standards are either annually renewable or run for an acceptable fixed period time (3 or 4 years) with the option of renewal. The only other option for the developer is a letter of credit.
These type of bonds are simply financial guarantees and underwritten solely on the strength of the clients’ balance sheet.
To distribute electricity, the majority of Solar Power Plants are linked to the local power grid. 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.
Typically, this involves designing, constructing, and maintaining a substation and transformers to convert energy for transmission onto the grid. These installations could be in place for several years. If the utility takes custody of the facility after start-up, they own it and are responsible for its upkeep.
However, if the developer holds that obligation, the utility company usually demands financial guarantees to ensure they will perform maintenance and corrective work over the term of the interconnection contract.
Interconnection bonds are similar to decommissioning bonds, but with the added risk that the developer's failure to maintain the interconnection may be seen as a side guarantee to the power purchase agreement as well.
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