Understanding Construction Bonds I Be on the Safe Side
Contract suretyship, in the form of construction bonds (bid, performance and payment bonds), provides specific benefits to contractors, subcontractors, as well as for the project owner and suppliers. Construction Bonds are legally binding agreements among three entities, including:
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Principal – This is the individual or business (contractor) that purchases the bond to guarantee future work performance.
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Obligee – This is the entity that requires the bond; Government agencies, school districts, municipalities etc.
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Surety – This is the insurance company that writes and backs the bond. The surety steps in if the principal fails to fulfill the contractual obligation.
Bid Bonds
A bid bond is required by a project owner (such as public agencies, municipalities, private companies) as a guarantee that the bidder will enter into the contract if awarded the job.
The purpose of a bid bond:
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Eliminates unqualified contractors or irresponsible contractors from competitive bidding.
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Saves the owner the expense of another bid if the successful bidder does not accept the awarded contract, up to the amount of the bid bond.
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Assures the owner of the completion of the project at the lowest possible cost.
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A bid bond provides that the surety will compensate the owner if the bidder is awarded the contract but fails to accept and sign it or perhaps fails to provide the requisite performance and payment bonds. A contractor’s ability to provide a bid bond reflects their positive qualification through a bonding company’s detailed underwriting process. While most ‘public works’ projects require a bid bond, a growing number of General Contractors are starting to require that their subcontractors have bid bonds.
The surety is obligated to pay the owner the difference between their contractor’s bid and the next lowest responsible bidder. The surety’s liability is limited to the face amount or penal sum of the bond, which is generally 5 to 10% of the total contract bid.
Performance Bonds
The purpose of a performance bond is to protect the owner from financial losses arising from the contractors default in performing the contract. Government statutes require performance bonds for all federal, state and municipal projects. The performance bond is a joint-and-several promise by the surety and the bond principal/contractor to the obligee that the principal will fully and faithfully perform all its obligations in the contract.
Labor and Material Payment Bonds
The essential commitment of the payment bond is that the principal shall pay all labor and material supplied for the project. Prompt and full payment to subcontractors, suppliers, and material suppliers who work on a construction project is of fundamental importance. Subcontractors are the primary beneficiary of a payment bond. A payment bond is generally required to be executed in the amount equal to 100% of the contract price.
Maintenance Bonds
In most cases, the performance bond automatically covers the contractual maintenance or warranty obligations for defective materials and faulty workmanship for one year from job completion. Nevertheless, separate maintenance bonds may still be required. The maintenance bond provides protection for defective or faulty materials discovered after the project has been completed and accepted and usually for at least one year.