32.304-7 Contract surety bonds and loan guarantees
Source: FAR 32.304-7 on acquisition.gov
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.
(a) Contract surety bonds are incompatible with the Government’s interests under guaranteed loans, unless the interests of the surety are subordinated to the guaranteed loan.
(b) If a substantial share of the contractor’s defense contracts are covered by surety bonds, or the amount of the bond is substantial in relation to the contractor’s net worth, the agency shall not authorize the guarantee of a loan on a bonded contract unless the surety enters into an agreement with the financing institution to subordinate the surety’s rights and claims in favor of the guaranteed loan.
(c) The agency approval of a guarantee for a loan involving relatively substantial subcontracts covered by surety bonds shall also depend on the establishment of a reasonable allocation agreement between the sureties and the financing institution. The agreement should give the financing institution the benefit, with regard to payments to be made on the contract, of the portion of its loans fairly attributable to expenditures made under the bonded subcontracts before notice of default.