As a contractor grows and develops, more of its projects will require performance and payment bonds, particularly if it operates in the public construction market. Because a contractor’s capital and financial position is a consideration in determining whether it qualifies for bonding (and how much), small contractors especially face challenges in accessing surety credit.
The surety industry and government agencies offer programs to facilitate access. For example, The Surety & Fidelity Association of America’s (
SFAA) Model Contractor Development Program (
MCDP) is a collaboration between the surety industry and local partners (usually state or local government entities) that consists of educational workshops that provide information on improving a construction company’s operations.
Another tool for facilitating access to surety credit is the Small Business Administration’s (
SBA) Surety Bond Guarantee (
SBG) program. The SBG evolved from a pilot project developed in 1971 to provide small and minority contractors with increased contracting opportunities. Under the SBG, the SBA guarantees bonds written by private corporate sureties for small contractors. It serves as an incentive for sureties to issue bonds to contractors that otherwise could not obtain a bond in the traditional commercial marketplace. If a surety incurs a loss under a bond, the SBA will reimburse the surety for a certain percentage of that loss. As the SBG was originally created, the SBA provides guarantees up to 90 percent of a surety’s loss, should a contractor default on a contract. Before issuing a bond, the surety must obtain the SBA’s approval for each bond guarantee issued.
The original structure of the SBG became known as the Prior Approval Program. Many sureties chose not to participate because of the administrative burden, and the lack of participation eventually limited the number of contractors able to obtain bonds through the program. In 1988, the SBA Reauthorization and Amendment Act amended the statutory provisions of the SBG by adding a Preferred Surety Bond Guarantee (
PSB) program. Under the PSB, a surety “would be freed from SBA prior approval of each decision relating to the issuance and administration of a guaranteed bond. SBA would approve only the firm’s standards and procedures for bond underwriting and administration, including claims.” Under the PSB, a surety may provide bonds within the limits set forth in the guarantee agreement without seeking the SBA’s prior approval. The guarantee is 70 percent.
Sureties expected broader participation in the program because of the streamlined procedures. Unfortunately, many of the expected benefits of the PSB have not been realized because of policies, procedures and regulations that hinder the flexibility of the surety’s decision-making process and threaten the availability of the SBA’s guarantee to the surety.
Several regulations that apply to the Prior Approval Program and involve SBA’s particularized review of each bond also apply to the PSB. 13 CFR 115.15, which applies to both programs, states the terms and conditions of the contract and bond must be “reasonable.” This regulatory requirement implies SBA’s involvement on each bond—hardly freeing up the surety from SBA involvement in each underwriting decision.
Moreover, the authorizing statute permits the SBA to deny liability if “the surety has substantially violated the regulations promulgated by the administration.” If the SBA determines the conditions of the bond were not reasonable, can the SBA deny liability even if it previously agreed to provide guarantees? Such uncertainty can be a disincentive for sureties.
The Prior Approval Program does not provide such certainty either. For example, a regulation states that the SBA shall deny liability if the surety increases the bond amount during the project by more than 25 percent without obtaining SBA approval. Such a denial does not seem equitable if the loss for which the surety is seeking reimbursement is within the original bond amount.
Proposed Program Enhancements
In light of the current economic climate, assistance to small businesses is urgently needed. SFAA and the National Association of Surety Bond Producers (
NASBP) recently developed a proposal to implement several enhancements to the SBG program to entice more sureties and contractors to participate. Some enhancements would be implemented statutorily, and others are expected to be implemented through regulations. SFAA and NASBP have been discussing the proposal with congressional and SBA staff.
The primary proposal combines the Prior Approval Program and the PSB into one bond guarantee program, creating a unified model under which the SBA would enter into guarantee agreements with sureties. The terms and conditions of each agreement would be based on the SBA’s assessment of the surety’s underwriting and claims procedures and capabilities. The surety would decide whether to provide a bond or pay a claim, and the SBA would agree to provide guarantees in accordance with the agreement.
The enhancement would call on the original intent of the PSB to free the surety from bond-by-bond oversight, providing more flexibility to serve the small contractor market. This proposal also would make permanent the temporary change designated in the American Recovery and Reinvestment Act (ARRA) giving the SBA greater discretion to pay a claim despite a technical violation of a regulation.
Other proposed enhancements include:
- Requiring the administrator to reduce or waive the guarantee fees paid by contractors and sureties in the SBG for 18 months, with authority to extend the time period for such actions. The current fees contractors must pay to the SBA may put them at a competitive disadvantage in the bidding process. The existing fee structure makes the program economically unattractive for many sureties and could affect its continued viability.
- Guaranteeing sureties up to 95 percent of all SBA bonds for a period of 18 months. This should help make more bonds available.
- Making permanent the temporary changes enacted in the ARRA to increase the size of the contract that can be guaranteed. The SBG typically can provide guarantees on construction contracts up to $2 million. ARRA temporarily increased this threshold to $5 million.
- Establishing better internal coordination and communication between the SBG and other SBA small business programs, such as those relating to loan guarantees and business assistance. A contractor’s need for financing may be as critical as its need for surety credit.
- Establishing a grant assistance program to assist small contractors in procuring and paying for the professional services (e.g., accounting, legal) they need to bring their operation and financial reporting up to standards to qualify for bonding. This proposal is set forth in current legislation (H.R. 3771).
- Implementing better interagency coordination between loan and bonding programs in the SBA, Department of Transportation and similar programs in the Department of Veterans Affairs. House legislation (H.R. 4253) enacted Feb. 14, 2008, provides a model for coordination. The Military Reservist and Veteran Small Business Reauthorization and Opportunity Act of 2007 requires the president to establish an interagency task force to coordinate the efforts of all federal agencies involved in increasing capital and business development opportunities for small business owners and service-disabled veterans. The law directs the interagency task force to coordinate administrative and regulatory activities, as well as develop proposals to increase capital access and capacity of these small business concerns through loans, surety bonding and franchising.
These enhancements would make the SBG program more cost effective, flexible and streamlined for all participants—ultimately enabling surety companies to reach more small businesses and strengthening the competitive free enterprise system by assisting qualified small and disadvantaged contractors in obtaining bid, performance, payment and ancillary bonds.