Supply Bonds are needed to guarantee certain contracts. They are becoming more common. Learn more about what these surety bonds guarantee, what they cost and who needs them.
A supply bond is a type of surety bond that guarantees the delivery of material, equipment, or finished projects at a specified time and price. Supply bonds are useful because they help protect against price fluctuations and delivery problems.
Supply Bonds are considered a type of commercial surety bond by most bond companies. However, supply can be classified as contract surety bonds because they may accompany other types of contract bonds such as bid bonds, payment bonds and maintenance bonds. However, when a contract calls for material or equipment to be supplied and installed, a performance bond is the appropriate way to guarantee the contract obligations.
A manufacturer or distributor (The Principal) purchases a supply bond from a bond company (The Surety). In return for paying the bond premium, the Surety provides a guarantee to a third party (The Obligee) that the manufacturer or distributor will supply the goods at the specified time and price. Should the manufacturer or distributor not deliver the goods under the contract, a claim could be made against the Supply Bond and the Surety Bond Company.
For larger Supply Bonds, the bond company will still want to obtain financial statements on the company. They will also want information on the supplier’s history and experience fulfilling similar contracts. They may also request personal financial statements on the companies owners in some scenarios. However, small simple Supply Bonds can be obtained with an online application and credit check.
Supply Bonds can be considered either low risk or high risk depending on a few factors. These include uniqueness, Supply Chain and Locality.
Product Uniqueness plays an important role in providing Supply Bonds. For example, standard PVC pipe for plumbing would not be considered a unique product. Many distributors stock this type of pipe. If a principal were unable to deliver the product under the contract, a surety bond company could easily find an alternative at a reasonable price under normal circumstances. This type of Supply Bond would be considered low risk.
Alternatively, consider a large water pump used for moving water through a dam. The product is likely to be very specialized and unique. The Surety Bond company would have a difficult time finding a replacement if the Principal defaults. This supply bond would be considered high risk.
Supply Chain issues are another factor that surety bond underwriters consider when writing supply bonds. The COVID-19 Pandemic increased awareness of these risks. Even when a product is not unique, it may be risky if there are delays in the supply chain. For example, roofing material is not considered unique, yet getting these materials was a challenge during the pandemic when many manufacturing facilities shut down.
Demand also plays a role in providing Supply Bonds. When products are in very high demand, they may be difficult to obtain and increases the likelihood that a Principal will be unable to complete the contract. A recent example was Person Protective Equipment during the pandemic. Although facemasks are not unique and were being made by manufacturers, they were in such high demand that many contracts were being unfulfilled or late.
Locality is another risk factor in underwriting supply bonds. A bond underwriter will want to know if the product is made in the U.S. or in another country. Also, where are the raw materials and components coming from? Governments regularly restrict trade with other countries. Additionally, local regulations, labor or politics may make getting materials difficult. Bond underwriters want to make sure that there will be no issues obtaining the necessary products.
The cost of supply bonds depends on the financial strength of the supplier and the risk of the product being supplied. However, these bonds are considered less risky than contract surety bonds and the price is less for most suppliers. Most suppliers will pay between 0.5% – 1% of the contract amount. These costs may be more if the supply bond needs to be combined with a payment bond or maintenance bond.
Supply Bonds are generally easy to obtain. However, material and labor shortages could increase the challenges for obtaining these bonds in the future.
