General Bond Education
Construction contract surety bonds protect project owners from the expense of contractor failure. Such bonds are unique three-party agreements more closely related to the credit-extending banking industry than the insurance one that regulates it. In contract bonds:
(1) A bond company, (surety), assures a
(2) project owner, (obligee), that the
(3) contractor, (principal), will follow a contract agreement.
Typically the project owner, (obligee), is a public entity such as a city or county. However, when a general contractor requires a subcontractor to bond a job, the general contractor is the obligee and the subcontractor is the principal).
Unlike insurance where there is a transfer of risk, after examining and verifying a contractor’s qualifications, a bond company’s decision to issue a bond serves to provide significant confidence that a contract will, indeed, be completed. A bond’s issuance serves to demonstrate the bond company’s seal of approval of a contractor’s ability to perform and avoids an owner from losing money on those that are more likely to fail. Nearly all public entities require bonds for public works projects, subject to varying minimal sizes. As society continues to evolve towards placing responsibility where it belongs, more and more private owners see the small price of a bond as worthwhile to get their projects completed within budget and on time.
Before issuing a bond and unlike insurance, a bond company will require a contractor and its ownership to be primarily responsible for jobs by signing an indemnity agreement. This agreement is what enforces the signing parties to be first and foremostly responsible for the liability they accept in construction contracts/agreements, as opposed to insurance when it is transferred to an insurance company. The indemnity agreement protects a bond company from a contractor’s failure to fulfill its contractual obligations. Bond companies usually obtain a “General Indemnity Agreement” to avoid having to obtain a new agreement for every bond they issue.
After issuing a bond on a specific project, bond companies will then stand behind the contractual commitments undertaken by a contractor on that project. Although the contractor continues to remain primarily responsible to fulfill the obligations contained in it, a bond company is now secondarily obligated to perform in the event of a contractor’s default. Bond premiums are service fees for the surety’s investigation, opinion, and financial backing. Bond premiums are lower than insurance premiums because the risk has not been transferred as in insurance policies. Bond companies investigate, decide whether or not they wish to support a contractor’s obligations despite uninsurable obstacles, and even then remain only secondarily responsible.
Contract bonds are project specific and not general to all of a contractor’s workload. A bid bond guarantees a contractor’s bid for a project is serious and includes a penalty for failing to proceed if awarded a project. A performance bond provides the comfort that the contractor will perform the contracted work and shields an owner from losing money if the contractor fails to honor a contract. A payment bond makes sure subcontractors and suppliers are paid.
Some bond companies have a direct charge for each bid bond they issue. Other bond companies charge annual fees for providing bid bonds; meanwhile, other bond companies have no charge for providing bid bonds. Performance & payment bonds, (referred to as “final” bonds), cost anywhere from one-half of one percent to three percent and premiums are based on the contract amount. The rate can be derived from numerous factors including the size, type, and duration of the project, the contractor’s qualifications, and the issuing company. Sometimes performance bonds incorporate payment bonds and maintenance bonds, and frequently but not always, there is no additional premium charged. If the contract amount changes, the premium will be adjusted for the change in the contract price.
A bond company first investigates the credit, financial qualifications, experience, and more in deciding whether or not to bond a contractor. Larger contractors, including those more active in the public contracting sector, need bonds regularly and establish themselves on an “account” basis with a bond company. The bond company then turns to focus on any specific projects a contractor needs a bond for.
Bond companies desire contractors who act responsibly and make their decisions using as much historical documentation as they can review. The Bond Connection recommends contractors provide as much information as possible to obtain bonds, reduce their costs, and/or maximize the size of bonds that can be made available to them.