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- A surety bond is a three-party contract whereby the bonding company (Surety) guarantees the obligee (Owner) that the principal (Contractor) will perform their work according to contract. Surety bonds used in construction are Contract Surety Bonds.
- There are three primary types of contract surety bonds:
- The bid bond provides financial assurance that the bid submitted by the contractor has been submitted in good faith and the contractor intends to enter the contract at the price bid and provide the required performance and payment bonds.
- The performance bond protects the owner from financial loss should the contractor fail to complete the project in accordance as bid.
- A payment bond guarantees that the contractor will pay their workers, subcontractors, and suppliers.
- Surety bonding is very similar to a banking line of credit. The Bonding Company's underwriting process is very similar to the process utilized by a bank for a line of credit. The Bonding Company's roll is to back the contractor's bid to complete the project. The owner then has the guarantee of the Bonding Company that his project will be finished even if the contractor he hired is unable to complete the project. The surety bond premium is a fee for underwriting or prequalifying the contractor.
- Bond Underwriting: A bonding underwriter will look for the following characteristics before agreeing to issue a contract bond:
- good references;
- experience with the type and size project the bond is issued to guarantee;
- financial stability
- an excellent credit history; and
- an established bank relationship and line of credit.
- When there is a default, the surety's has several options. These options may include the right to re-bid the job for completion, bring in a replacement contractor, provide assistance to the existing contractor, or pay the penal sum of the bond.
- The cost of a performance bond is a one-time premium, which typically ranges from 0.5-2% of the contract amount, depending on the size and type of the project and the contractor's bonding capacity. There is often no charge for the bid bond, and the payment bond may be issued at no additional charge when issued in conjunction with a performance bond.
- To bond a project, the owner specifies the bonding requirements in the contract documents. Obtaining bonds and delivering them to the owner is the responsibility of the contractor who will consult with a surety bond producer.
- Contract surety bonds:
- assure project completion;
- assure a qualified contractor on the project;
- guarantee that the laborers, suppliers, and subcontractors will be paid;
- relieve the private owner from the risk of financial loss arising from liens filed by unpaid laborers, suppliers, and subcontractors;
- smooth the transition from construction to permanent financing by eliminating liens on private projects;
- help the contractor grow by increasing construction project opportunities and offering assistance and advice;
- provide intermediaries - the surety company and surety bond producer - to whom the owner can air complaints and grievances;
- lower the cost of construction in some cases by facilitating the use of competitive bids; and
- screen out unqualified contractors and irresponsible competition.
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