Getting contract bonds on Public Private Partnerships may be a challenge. Find out more about these projects and how to obtain contract bonds for them.
A Public Private Partnership (also called PPP or P3) is a contractual agreement between one or more government entities and one or more private stakeholders to provide a public project and/or service.
From a construction perspective, a P3 often involves a long term contract, where a Private construction company builds a Public project using Private dollars. The Contractor pays for the project and collects a profit through the fees generated from the operations of the completed project.
P3s have been around for decades and are used by many countries around the world. In the United States, however, P3s are relatively new to most states and municipalities.
There are many different types of P3 projects. They generally fall into two categories:
These are existing structures that are being converted. Some examples may include the renovation of a treatment plant or treatment plant.
P3s create challenges for contractors and surety bond companies. These include the following:
One of the biggest challenges for contractors wanting to provide performance bonds and payment bonds on P3s projects is that they tend to be long term contracts. In many cases these contracts can last 20 years or more.
Surety bond companies typically shy away from long term commitments as conditions change over time, even for the best contractors.
Obtaining contract bonds on P3s will likely require that the maintenance guarantee is limited to a period of 5 years or less.
Financing P3 can be extremely complicated. There are endless ways and combinations that Public and private money may combine. Consider an example:
A toll road is being built. The contractor is responsible for construction costs and paid through future toll revenue on the road. This contractor will have to obtain financing for construction costs or fund the costs through their own cash and operations.
This presents an extremely risking proposition for the contractor and their surety bond company. Unlike most construction projects, the contractor must finish the entire project before collecting revenue.
Secondly, the toll revenues may not meet Projections. Drivers may find alternative routes, carpool, or find other ways to avoid the tolls. In fact, revenue Projections on P3S are routinely over optimistic.
Subcontractors need to be very aware of the financing risks associated with P3s. Subcontractors may be unaware that they are sharing in the General Contractor’s risk. Because the General may not be getting Progress payments, they run a very high risk of not being able to pay subcontractors and suppliers.
Subcontractors and Material Suppliers on P3 projects should make sure the General Contractor has a Payment Bond on the project. They should also not let the General get behind on payments. An even better practice would be to have the General Contractor and lender set aside and escrow project monies.
There are a number of ways to improve a contractor’s chances of getting their bond company to support contract bonds on a Public Private Partnership.
As mentioned earlier, surety bond companies do not like long term commitments. Contractors should work to separate the construction phase of the project from the operations phase. The performance bond, payment bond, and Maintenance Bond can cover the construction contract and then the operational contract takes over once construction is complete.
This sounds simple but contract bond underwriters view these projects as very risky. Make sure you know the risks and pitfalls and have a plan to overcome them. This should include in-depth knowledge of how the P3 works, a commitment for financing, Projections and stress testing for project revenues, and a plan for if things do not go as expected.
Because P3 projects are risky, contract bond companies will want contractors to have more than enough cash, working capital and net worth than required for most contract bonds. They will likely not support these bonds for contractors that are “stretch cases” or overextended.
Many smaller surety companies are unfamiliar and uncomfortable with P3 projects at this point. Contractors looking at P3 projects likely need to be working with a top 5 surety company who has familiarity and expertise to support P3 projects.
P3 can be extremely risky and many fail. However, the U.S. is likely to see the number of P3s increase in the coming years and contractors and their bond companies need to be prepared to consider these projects. Axcess Surety is an expert in providing all types of bonds. Contact us anytime or visit our Surety Bond FAQ page.