Contract Bond Basics
An Overview of Contract Bond Basics
The contract bond in general assures the fulfillment of actions or products specified in a contract. The contract bond can be found for construction projects, supplies, repairs, and guarantees of payment. For construction projects, the surety bond is for bids, performance, and payment. The bond helps assure a project owner of a completion date for a specified project by making provisions for contractor defaults.
Although no contractor would purposely default on a job—it’s in a construction company’s best interest to finish their projects on time—sometimes a construction firm can’t control the events that affect projects, like subcontractor failures or problems with other projects the company is involved in. When these things happen to a contractor, often the surety company steps in and helps solve the problem so the project can get done right and within the time limit.
The Bonds and Parties
There are three parties involved in these bonds, the project owner the City of San Francisco (oblige), construction contract firm (principal), and the surety company, which is often an insurance company that handles business insurance. There are also three different types of contract bonds, and each has a specific role in the surety process:
- The Bid Bond. This bond is usually the first one obtained. It guarantees the project owner that the contractor will perform the bid they agreed on, and provides for the development of two other necessary bonds: payment bond and performance bond. Contractors that can’t supply or qualify for the other two bonds won’t submit the bid bond.
- The Payment Bond. This ensures the contractor will pay for subcontractors, crews, and supplies necessary for the job’s completion, and also protects the project owner from liens initiated by those entities against the contractor.
- The Performance Bond. This bond is protection for the owner, again, in case the contractor has delays or can’t fulfill the contract for whatever reason. This is important in time-sensitive construction projects, like apartment buildings, university campus buildings, etc.
How Construction Contract Bonds Work
First, the contractor submits an application that also contains a questionnaire and general indemnity agreement. The application supplies enough information on the company and its members to investigate its solidity. Everything from key personnel to company credit is checked.
The general indemnity agreement provides for alternate repayment on funds in case of contractor failure. In other words, if a contractor has failed to pay suppliers and the surety must do so in order to keep the project on track, the contractor is supposed to repay the surety—if the contractor fails, the indemnity agreement allows the surety to seek the payment from anyone who has agreed to do so. Often the signers on an indemnity agreement range from a parent company to relatives of the construction firm’s owners.
The main points in an indemnity agreement are the collateral deposit, which is a fund provided by the contractor much like an escrow; the assignment of contracts, which states that if a contractor needs to be replaced the subcontractors are still employed for this project; and the right to take over work, which provides for the surety company to either loan the current contractor the funds to complete the project or replace that firm with another.
What the Bond Does
A contractor can’t always prevent problems on a project. Sometimes events that happen thousands of miles away affect a construction firm’s ability to complete a project, like a supplier that has experienced a natural disaster, or a subcontracting firm that has gone under.
If problems begin to arise with a project, often the surety will pick up on them early. Taking a proactive position is a benefit to all, and can save time and last minute scrambling around. If a contractor needs money, it can be supplied rather than when he is in serious trouble; if the construction firm loses a subcontractor, a surety can participate in finding one, which underscores the need for the contractor to have surety bonds with subcontractors as principals.
When problems do begin, it’s the job of the surety bond to limit the damage and fix the problem with a workout agreement. This helps the original contractor stay on the job in order to avoid a default claim. As soon as the surety company is aware of the problems, a meeting will be called between the parties to work out solutions. The workout agreement is usually flexible enough to allow the best possible methods of recovery while still providing firm guidelines for project completion.
Sometimes a contractor’s position can’t be saved and a default will occur. When that happens, the surety will initiate a takeover agreement instead of a workout agreement, and take steps to hire out the project. Often the contract bond will outline particular remedies, but it’s still in the best interest of the construction to consider all alternatives.