With globalization, more and more companies are looking to expand their businesses to other countries and/or continents. However, when undertaking such a move, contractors need to consider certain criteria.1
International surety bonds are part of the requirements to be met, as the owners/beneficiaries may require guarantees before they contract with an international contractor.
What Is an International Surety Bond?
An international surety bond guarantees that an international contractor will fulfill an obligation, either contractual or regulatory. If the contractor does not complete the work as contracted, the obligee can make a claim, usually up to—but not exceeding—the bond amount. The contractor would then be obligated to pay back the claimed amount to the surety.
Differences between Markets
Although all surety bonds fulfill the same purpose, these may vary depending on the specific regulations of the country as well as the market practices related to surety bonds. In this sense, it is important to understand what type of surety bond the project owner requires and in what amount.
For example, a company may need more than one type of bond, depending on its business segment. The following are some of the most common.
Bid bond. This type of bond guarantees that if the contract is awarded, the contractor will sign the contract at the price bid.
Performance bonds. It is one of the most common types of surety bonds. It guarantees that the contractor will fulfill the obligations under the contract according to the contract terms and conditions.
Advance payment bonds. This kind of surety bond protects an owner when providing an advance payment. It guarantees that the contractor won't just abscond with the money and will use the funds for the purpose for which they were advanced. They are very common in Latin American countries.
Payment bonds. These guarantee the payment directly to the subcontractor and suppliers of the contractor on the bond. In some countries, these may be called wage bonds.
Maintenance bonds. A maintenance bond guarantees the owner that the contractor will remedy workmanship, design, or material defects for a specified period.
Warranty bonds. Warranty bonds, like the maintenance bond, guarantee that the contractor will fix defective equipment or materials during the time specified in the contract.
Custom bonds. These guarantee the payment of taxes, fees, and duties on all imports.
Judicial bonds. Guarantees that a party to a legal action will do whatever it is supposed to do once the judge rules.
Another great distinction can be the bond penalty amounts. In Latin America, surety bonds usually are "low penalty," meaning that they only represent a percentage of the contract amount—unlike in the United States, where surety bonds are required to be 100 percent of the amount of the contract(s).
What Contractors Need To Know
Once the type of bond, amount, and penalty has been specified, it is important that the contractor takes into consideration the criteria that the local surety company could request to evaluate when analyzing the contractor.
Financial analysis. Provide financial statements that reflect the financial strength to comply with the obligations to guarantee. The contractor must demonstrate that they have plenty of working capital to fund the project and sufficient net worth to address any problems that may arise. This also includes having a strong credit record and backlog history. The principal or contractor needs to have a strong financial position to manage a new project, in addition to their current backlog, to handle other obligations. Having a good reputation also comes into play here, as they want to ensure the contractor has integrity and is trustworthy.
Technical capacity. Provide a past and current backlog to show appropriate skills and experience. Show the ability to do the work and perform the contracts by providing the history, resources, equipment, and manpower of the company. Joint ventures with local contractors allow the transfer of knowledge from the local market.
Contract analysis. Provide a risk analysis of the contract that is going to be executed. The surety will review the contract and all its implications. What is the obligation to be guaranteed?
Counter guarantees. If the contractor is just beginning operations in a new country, the financial statements of that subsidiary might not have the necessary strength the local surety is looking for. That being said, they will likely rely on the strength of the parent company. The contractor must show its most solid financial profile, and if that means including the parent company, this must be taken into consideration. In those cases, the surety may ask for parental indemnity.
Counter guarantees will also change depending on each country and its standard practice. Some will work with indemnity agreements, others with promissory notes, and others with both. It will depend on the local market practices.
Contractors cannot expect to succeed in another country unless they are familiar with that country's market, laws, customs, and language. It is important to know if the market is on demand or not and if it is a low penalty or not. What are the reputation and best way of working with each beneficiary? What could happen with the change of a political party in the government? Be sure to understand the political and economic risks of each country.
Before beginning to look for work on contracts in other countries, contractors must research and understand important issues such as all labor laws and legislation, as well as having sufficient and skilled manpower. It is important to have all the geological studies, licenses, and environmental permits that are part of the contractor's responsibility. If it is a construction contract, logistics must be considered, such as the importation of machinery and obtaining raw materials.
Another important point that should be considered is project margins, which will differ greatly from country to country, as well as the danger of encountering cost overruns, especially in an economy marked by rising inflation. Several contracts in Latin America already take this variable into account and make periodic adjustments to the amount of the contract.
Understanding the issues and putting these suggestions into practice is an important first step. Be sure to choose a surety and broker that are familiar with the country in which the work will be performed. Doing so will make the process of doing business safer, smoother, and easier when you have a team that can provide the information and local knowledge you need about each surety market, requirements, wording, and general practices.
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1 Thanks to María Jose Soriano, vice president—surety for international operations at American Global, for authoring this article.