Surety Bond Construction
A Primer in Understanding Surety Bonds
Although the concept of the surety bond has been around for many millennia, the modern surety bond has its modern roots in the 1800s and 1900s. The Heard Act of 1844, the Miller Act of 1935, and various smaller state acts have all contributed to the contemporary methods of managing risk associated with performance of contracts from Redding to Death Valley.
Because it’s difficult to know which construction companies are reliable, surety bonds for construction projects are the way to ensure that the project owner has recourse in case of non-performance of the contractor. Hiring a company for a project and then having it fall through mid-way with no safety net can be a huge and financially destructive event.
How does a project owner get a surety bond?
First of all, keep in mind that there are three parties involved: the contractor, the project owner, and the surety company (which is much like an insurance company). Contract surety bonds come in three varieties: the payment bond, the performance bond, and the bid bond. Each one has its own place in the process, and can be obtained from an insurance agency that handles business insurance.
The payment bond ensures that contractors will pay for the materials and workers they will need to complete the project. This protects the project owner from liens against the contractor that could interfere with use, refinancing, or sale of the property.
The performance bond is financial protection for the project owner in case the contractor fails to carry out the terms of the contract or has significant delays. This bond is important to owners who will depend on tenants and property availability deadlines.
The bid bond, which is usually the first step, ensures the owner that the contractor will provide services according to the bid agreed upon, and that the other two bonds are forthcoming. Often the bid bond is required first because it will help weed out those contractors who can’t offer the other two bonds. In the end, all three bonds are necessary in all large projects.
Some sources say the project owner will want to pay the premium on the bond, for the reason that he or she can be sure the bonds are actually completed and provided. The higher the “penal sum,” or the monetary amount of the bond, the higher the premium will be. However, it’s in the owner’s best interest to have the bond set high enough to cover all expenses in case of the contractor’s default. Other sources state the contractor is responsible for purchasing the bond if the contract with the owner states that a bond will be provided in Red Bluff.
How much do surety bonds cost?
Although they vary based on the parameters of the project, most of the surety bonds cost from one-half of one percent to two or even three percent of the construction bid value. It’s not unusual to see bonds in six digits, but when you’re talking about projects that run into millions of dollars, this is a small price to pay for a guarantee that the construction will be completed on time.
The premium largely covers the insurance company’s costs in prequalifying contractors. This is an involved evaluation of the contractor’s dependability. This process assures, among other things, that the contractor has enough appropriate experience, workers, equipment, and finances (including credit) to get the job done to the owner’s specifications. Contractors’ references are thoroughly checked, their reputations scrutinized, their credit histories carefully inspected, and their ability to pay for materials and workers judged.
What happens when a contractor defaults?
lthough it’s not the intention of a contractor to default on a project, it still happens. When it does, the project owner is required to formally claim that the contractor has not performed the functions set forth in the contract. The terms of the contract will determine what happens next. For example, if the contract provides for a replacement contractor to take over the job, the surety company will hire that contractor to complete the project.
Even the project owner who has worked with a particular construction company before and found it to be reliable should have a surety bond. That construction company may experience problems with their subcontractors (with whom the construction company should also have a surety bond) or could have another project fall through that puts them into a serious financial bind. Because an owner can’t control distant events that could cause his project to suffer, this chain of surety bonds is important.
Construction surety bonds are a detailed and complicated subject. This short introduction is only the beginning of what a contractor, subcontractor, or project owner needs to know before pursuing a large project or surety bond. Make sure you read and understand all contract material and what it means before you embark on your project.