Contractor bonds, or surety bonds, are agreements where a surety company assures the owner of a company or project that a contractor will complete an arranged construction contract. These are an excellent solution for making sure that there is not only assurance, but financial security in place when it comes to the work in question and the pay owed to workers, suppliers and subcontractors involved in the job. Here are the things you need to know about contractor bonds.
Types of Contract Bonds
There are three general types of contract bonds. Each has its own use and purpose in a contract job.
- Bid Bonds ensure that the bid is being entered into in good faith and offers assurance that the performance and payment bonds will be delivered.
- Performance Bonds provide insurance against financial loss if the contractor does not perform up to the agreed upon standards.
- Payment Bonds detail the labor force, subcontractors and suppliers that will be paid throughout the course of the job.
Surety and Insurance
In most cases, the surety company that engages the contract bond is a division or subsidiary of an insurance company. These agreements, like insurance policies, are a form of risk management that is under the authority of the state’s insurance department.
The main difference is that insurance exists to protect against things that may happen, where the surety company creates agreements regarding things that are supposed to happen. These protect project owners from loss, should contractors fail to deliver.
Surety bonds have been required by the United States government since 1893 for all public works contracts. The same kind of legislation has been enacted at the state and local level for almost every state.
A surety company conducts a thorough check on the contractor so that they can offer assurance that the contractor can see the project through from start to finish. Some of the things the contractor checks include are:
- Reputation and references;
- Capability to meet all job requirements;
- Experience and expertise;
- Possession of equipment or the ability to get the equipment needed;
- Financial viability to see the project through; and
- Credit history, rating and relationship with a bank.
If the Contractor Defaults
Defaults happen, no matter how carefully a contractor is investigated. If this occurs, the project owner will declare the default and the surety company will investigate the situation before settling the claim. The contractor is required to obtain any bonds that are specified in the agreement, and the surety company will use these bonds to review their options to satisfy the claim. Among the possibilities are:
- The job could be re-bid;
- The contractor may be replaced;
- Financial assistance may be offered to the existing contractor; and/or
- The bond’s penal sum could be paid off.
In the end, contractor bonds protect against many risks through rigorous background evaluation and an ironclad agreement regarding the completion of responsibilities by the contractor. They are an important element of risk management in any major construction project. Do you have any experience with these sorts of agreements? Leave a comment and let us know!