A P3 Makeover for the Standard Surety Bond – Reprinted from ENR 11/20/2013

By Richard Korman in San Diego

 Responding to the demands of potential lenders and concessionaires, sureties may play an important role in expanding public-private partnerships in the U.S. by providing a new type of completion and payment bond, according to speakers at the International Risk Management Institute’s construction conference in San Diego held Nov. 17-21.
The new bonds would allow P3 project lenders or developers to make a claim for cash while the majority of the guarantee would be fulfilled in the traditional manner, with the surety investigating the claim and controlling the method of completion.
P3 concessionaires and lenders say they are uninterested in what some see as illiquid traditional bond guarantees that may take weeks or months to fulfill.
The new product is needed to move ahead the very slowly developing P3 project market in the U.S., said J. William Ernstrom, vice president of major strategic projects for The Walsh Group, Chicago, a major infrastructure contractor.
“If we can ever get the surety industry to respond with the right product, this will take off,” Ernstrom said in a seminar on project risk.
AON, the insurance and surety broker, reports that several leading surety companies have developed performance security alternatives to the traditional performance and payment bonds, and that the planned new bonds also provide a much larger performance limit and important payment protection for labor and material providers.
One company, Zurich American Insurance, had announced a new hybrid bond product in late 2011 that has an “on-demand” feature through which the owner can look to the surety bond and receive payment upon the declaration of a contractor default for delay. The new bond also incorporates specific time limits for the resolution of disputes between the surety and the obligee, the company states.

Meeting New P3 Risk Issues

So far there are no known projects that have used the new type of bond, which it is hoped will help solve some of the risk-transfer challenges that stand in the way of P3 approaches on U.S. infrastructure projects.

Bonds with a liquid component “will help contractors like us that are living in this marketplace,” said Ernstrom.

Spurred by the 2012 federal transportation authorization, sureties have been working with the U.S. government to expedite P3s.

The authorization requires the U.S. Dept. of Transportation to come up with ways to expedite P3s and to develop standard P3 transaction model contracts and make them available to state and local governments.

Walsh is gradually accumulating experience with the U.S. P3 market and its risk issues. A year ago, the company won a P3 contract for one of two new cable-stay bridges across the Ohio River; it also won a separate design-build contract for the other that does not use the P3 approach.

Under P3s, the lender and concessionaire pass liability and risk down to the design-builder in ways that are unfamiliar to construction companies that have not worked on such projects.

For example, P3 lenders and concessionaires transfer risk for rights-of-way and permits to the design-builder. In addition, concessionaires may ask the design-build team to provide a financial close bond or letters-of-credit.

And even differing site and soil conditions—risk traditionally borne by the owner—may end up with the design-builder.

Age of Collaboration

Ernstrom’s presentation was predicated on the belief that project delivery and risk had entered a new age of collaboration, integration and innovation. Supersize projects are becoming customary, he said, with contractors often chosen based on best value.

On its Ohio River Bridge project, Walsh and its partner are required to provide performance and payment bonds and letters of credit.

P3s also require adjustment by risk-averse design companies, said experts at the IRMI conference. Many designers are only accustomed to taking risks that limit damages to a low multiple of their design fees.

Large engineers are more willing to take 100% of the liability for any third-party claims related to the design work, and bigger design firms are taking on unlimited liability, according to several speakers.

How many other designers will go down this road isn’t clear, but if P3s eventually become a major marketplace factor, firm may have little choice if they hope to compete or grow.

 

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