Contract surety bonds and loan guarantees
Loan guarantees on contracts with surety bonds require subordination or allocation agreements to protect the government's and lender's interests.
Overview
FAR 32.304-7 addresses the relationship between contract surety bonds and government-guaranteed loans in defense contracting. It establishes that surety bonds are generally incompatible with government-guaranteed loans unless the surety's interests are subordinated to those of the loan. The regulation requires agencies to ensure that, when a contractor's defense contracts are significantly covered by surety bonds or the bond amount is substantial relative to the contractor's net worth, a subordination agreement must be in place before authorizing a loan guarantee. Additionally, for contracts with substantial subcontracts covered by surety bonds, agencies must ensure a reasonable allocation agreement exists between sureties and the financing institution, allowing the lender to benefit from payments attributable to expenditures under bonded subcontracts prior to default notice.
Key Rules
- Incompatibility of Surety Bonds and Guaranteed Loans
- Surety bonds are not compatible with government-guaranteed loans unless the surety's interests are subordinated to the loan.
- Subordination Requirement
- Agencies must not authorize loan guarantees on bonded contracts unless the surety agrees to subordinate its rights to the financing institution.
- Allocation Agreement for Subcontracts
- For substantial subcontracts with surety bonds, a reasonable allocation agreement must be established to protect the lender's interests for expenditures made before default.
Responsibilities
- Contracting Officers: Must ensure subordination and allocation agreements are in place before approving loan guarantees on bonded contracts or subcontracts.
- Contractors: Must facilitate agreements between sureties and financing institutions as required.
- Agencies: Must oversee and enforce compliance with these requirements before authorizing loan guarantees.
Practical Implications
- This section exists to prevent conflicts between surety rights and government-guaranteed loan interests, ensuring the government's financial exposure is protected.
- Contractors and agencies must coordinate closely with sureties and lenders to ensure all agreements are in place, avoiding delays or denials of loan guarantees.
- Common pitfalls include failing to secure proper subordination or allocation agreements, which can jeopardize loan guarantee approvals.