International Surety Bonds vs. Letters of Credit
If you plan to expand your business overseas, or your company is an international company that does business in the U.S., then your trading partners may require guarantees before they will contract to work with you. An international surety bond or letter of credit (LOC) can serve to guarantee that the work you are contracted to do will be accomplished. While LOCs and surety bonds have some similarities, there are some considerations that may make international surety bonds a more attractive alternative to LOCs.
While a LOC can tie up a company’s credit capacity, a surety bond usually does not. Opting for a surety bond may help preserve the company’s valuable access to capital. International surety bonds can also be a cost-effective alternative to LOCs, which include interest charges tied to interest rates in global markets. In a rising rate environment, this cost can be an especially important factor to consider. Plus, an international surety bond can be uniquely tailored to meet the specific needs and regulations of a certain country.
What Is an International Surety Bond?
An international surety bond is a guarantee that a company will fulfill an obligation, typically a contractual or regulatory one, in a country other than where the company is domiciled. While an international surety bond works similarly to a U.S. surety bond, there are important differences related to each country’s specific regulations and market practices relative to surety bonds.
Often, international contracts can include more than one type of surety bond, which makes working with an experienced international surety bond provider with a broad capability to issue multiple types of bonds especially valuable. Travelers has experience providing international commercial and contract surety bonds that meet your needs in 65 countries outside the U.S.
How Do International Surety Bonds Work?
While their titles may differ overseas, there are still three parties involved in an international surety bond. In the U.S., the three parties to a surety bond are the principal, the obligee and the surety. For international bonds, they may be referred to as the guarantee applicant, the guarantor and the guarantee beneficiary, or similar titles. The roles of each vary:
- The guarantee applicant purchases the surety bond to guarantee quality and completion of contracted work.
- The guarantee beneficiary is the project owner who requires the applicant to purchase the bond.
- The guarantor is the surety company that issues the bond and financially guarantees the applicant’s ability to complete the contracted work.
With an international surety bond, if the guarantee applicant does not complete the work as contracted, the guarantee beneficiary can make a claim for payment per the bond and contract, typically up to but not exceeding the bond amount. The guarantee applicant would then be obligated to pay back the claimed amount to the surety.
Many international surety bonds are conditional, unlike LOCs which are unconditional and can be claimed for any reason or for no reason at all. Even if a company believes they have satisfied the guaranteed obligations, there could still be a dispute. In this case, a guarantee beneficiary would have more leverage over the guarantee applicant and could expose the guarantee applicant to unfair claims.
Furthermore, for many companies, it may make more sense to utilize their credit capacity on obligations that cannot be satisfied with a bond rather than to guarantee contractual obligations.
Types of International Surety Bonds
There are several types of international surety bonds that Travelers offers global companies. Often, a company may need more than one kind of bond, depending on its business activities.
- Maintenance bonds: A maintenance bond guarantees that a contractor will remedy workmanship or material defects for a specified period.
- Warranty bonds: Similar to a maintenance bond, a warranty bond guarantees that a contractor will fix defective equipment or material should an issue arise during the time specified in the contract.
- Advance payment bonds: When a project owner advances funds to a contractor before the project is completed, the advance payment bond guarantees the contractor will pay the project owner back for any unamortized funds if the project is not completed.
- Performance bonds: A performance bond protects the project owner in the event the contractor defaults on its obligations for delivery, function or quality under the bonded contract.
- Supply bonds: If a supplier fails to deliver materials on time, up to the required agreed-upon quality standards, or in agreed-upon quantity as outlined in the contract, a supply bond pays the contract owner for the cost of the missing and/or below standard materials.
- Judicial bonds: A judicial or litigation bond ensures a litigant pays the costs related to a legal action.
- Customs bonds: A customs bond guarantees that taxes, duties and fees are paid on all imports.
How to Apply for an International Surety Bond
Different countries have varying requirements for surety bonds. It is important to understand what type of bond your customer or project owner requires and in what amount in order to get a surety bond. You can then contact your independent agent to help you apply for a surety bond. That process will typically include:
- Evaluation and qualification – You will be required to provide financial documents that demonstrate your creditworthiness and that you have the resources to fulfill the terms of the surety bond. You will also be asked to provide details about the project that will be covered by the bond.
- Underwriting – During the underwriting process, Travelers assesses the application. The evaluation typically looks at three factors:
- Character – A strong credit record and other history of upholding obligations
- Capacity – Appropriate skill, experience, equipment and other factors necessary to perform contracts
- Capital – Strong financial position to manage the new project in addition to handling other obligations and potential problems
Travelers Brings Expertise in International Surety Bonds
Travelers has more than 100 years of surety bond experience. Our offices in North America, Latin America and Europe and our international surety services network give us the capability to structure international surety bonds in Canada, Latin America, Africa, Asia, Australia and Europe.
Our international underwriting teams have the knowledge and experience to help you navigate the complexity of international bonding. Our teams are well connected in the local markets and informed of the latest developments in surety markets around the world.
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