Most agents and brokers are aware that performance and payment bonds address the risks involved when a contractor or design-builder defaults when building a construction project.
But not all bonds are created equal.
Here, Stan Halliday, chief underwriting officer for Travelers Bond & Specialty Insurance, Construction Services and National Accounts, shares insights about expedited dispute resolution (EDR) bonds.
PC360: What exactly is an EDR?
Stan Halliday: In my experience, the specific language in the surety bond can significantly impact both the time period in which a surety must respond and the alternatives available to the surety when an owner declares a default.
The Expedited Dispute Resolution (EDR) performance bond combines the coverage options of a traditional AIA 312 performance bond with a streamlined claim investigation and adjudication process that helps resolve disputes quickly and keeps the project’s construction schedule on track. The EDR bond form expressly covers liquidated damages and warranty provisions and can be further tailored to align with the underlying contract terms.
Travelers offers these bonds to benefit the owner of a construction project and the contractor, too. Essentially, an EDR bond enables a quicker and more well-defined resolution from the surety than traditional performance bonds and is treated as a credible form of performance security by lenders and ratings agencies.
An EDR bond is not well-suited to every construction project. (Photo: iStock)
PC360: When should EDRs be used?
Halliday: While an EDR bond has some significant benefits, it is not suited for every construction project. It was created to address the needs of larger Design-Build and Engineer-Procure-Construct projects, particularly those with a time-critical component.
An EDR bond may be a good fit when:
- An owner is asking for a Letter of Credit (LOC).
- The project timing is sensitive and critical.
- The liquidated damages are potentially high.
- The borrowing and financing costs to the owner are particularly high.
- The project is financed with private bond debt.
Examples of projects where EDR bonds could be beneficial include power plants, oil and gas pipeline reconstruction, manufacturing facilities, data centers, high-tech projects, private institutions and public-private partnerships. EDR bonds aren’t the best fit for traditional design-bid-build projects where the design risk falls under a separate contract than the construction contract.
Most performance LOCs fall within 3 to 10 percent of the construction value. (Photo: iStock)
PC360: When is a Letter of Credit (LOC) necessary?
Halliday: A performance LOC is a written financial undertaking from a bank that guarantees the contractor’s performance to a construction owner. If the contractor is unable to perform on the contract, the owner may make a demand on the bank, and the bank will be required to pay the requested amount up to the full value of the LOC. Most performance LOCs fall within 3 to 10 percent of the construction value.
Related: Taking care of trucking companies
PC360: How does an EDR compare to an LOC?
Halliday: Here are the main advantages to a construction owner of securing an EDR bond over an LOC:
- Ongoing prequalification services;
- Incorporation of the underlying construction contract documents;
- Payment of valid claims from subcontractors and suppliers; and
- Dedicated claims professionals to assist with project completion and payment of all valid claims, keeping the project lien free.
An EDR bond also offers some advantages to the contractor. These include:
- It does not utilize a contractor’s borrowing capacity and existing liquidity, and
- It provides an independent third-party evaluation of the dispute, ensuring both parties are treated fairly.
In some instances, an EDR may provide significantly more coverage in the event of a construction contract dispute. (Photo: iStock)
PC360: Can you provide an example of where an EDR bond likely would be beneficial?
Halliday: Imagine a case where a dispute arises between the contractor and the owner on a large Design-Build project. The dispute centers on why the contractor is behind on the original schedule for completion. The contractor says that permitting delays outside of its control are the cause. The owner says that’s not the case. Further complicating matters is the fact that the contractor’s parent company has developed significant financial difficulties and subcontractors and suppliers are not being paid, so they’ve stopped working. The owner’s security is a 5 percent or 10 percent LOC, which the owner has almost entirely exhausted to get the subcontractors to return to work.
Related: Brokers and their fiduciary duties
The owner may have significant financial and reputational exposure should the schedule be delayed further or if the contractor is not able to complete the work. Plus, should the owner prevail on the responsibility for the delay, it’s not certain that the contractor can pay the damages.
Were the EDR bond in place, it would offer:
- Significantly more coverage (up to 100 percent of the contract value for both performance of the contract and payment of all subcontractors and suppliers) for the owner than a 5 percent or 10 percent LOC. The taxpayers and subcontractors/suppliers would be protected.
- A 15-day claim investigation by the surety to determine if the owner’s declaration of default is valid.
- A 45-day arbitration proceeding if the surety disputes the default declaration. This would result in an independent third-party decision that is binding on all parties.
- Security for the owner that the project schedule would continue with minimal delays. Either the contractor or its surety would make sure the project continues and the schedule is maintained as best as possible.
- Full coverage for liquidated damages and warranty issues under the performance bond.