What Is a Construction Surety Bond?
We’re frequently asked about the difference between insurance and a surety bond. Although a surety company is typically part of an insurance company, the surety bond is not a typical insurance policy. On privately funded projects, bonds create a smooth transition from construction financing to permanent financing and provide support to the contractor as well as ensure project completion. On public projects, surety bonds support prequalification of contractors, payment protection for subcontractors and contract completion protection for the public.
A surety bond is a three-party contract comprised of the Surety, the Principal (contractor) and the Obligee (owner). The Principal promises to perform in accordance to its contract obligations. Surety bonds used in Construction are called Contract Surety Bonds.
There are 3 types of Contract Surety Bonds:
1. Bid Bond - provides financial protection to an obligee if a bidder is awarded a contract pursuant to bid documents, but fails to sign the contract and provide required performance and payment bonds. The bid bond process also helps to screen out unqualified bidders and is necessary to the process of competitive bidding.
2. Performance Bond - protects the owner from financial loss in the event the contractor fails to perform the contract in accordance with its terms and conditions. If the Obligee declares the Principal in default and terminates the contract, it can call on the Surety to meet the Surety’s obligations under the bond.
3. Payment Bond - assures the contractor will pay certain workers, subcontractors and material suppliers.
Who requires Bonds:
1. Public Sector - Statutory Requirement
- Federal Government (protects taxpayer dollars; assures that lowest bidder is capable of completing the project)
- State and Local Governments (necessary payment protection for subcontractors and suppliers)
2. Private Sector - Discretionary Owner Requirement
- Private Owners (Surety assures qualified contractor; provides expertise, experience and assistance; in event of contractor failure surety handles and completes the project)
- Lending Institutions (Surety assures project will be built according to terms and conditions of the contract; lender can be dual obligee with direct rights under the bond)
- General Contractors (may require bonds from their subcontractors)
A surety bond is there to ensure project completion within the terms of the contract. If a contractor experiences cash flow problems, the Surety may assist the contractor. If the contractor abandons the job, the Surety may replace the contractor.
Most surety companies are subs or divisions of insurance companies and both surety bonds and insurance policies are regulated by state insurance departments. However, insurance policies are designed to compensate against unforeseen adverse events. Surety bonds are designed to guarantee the contractor’s contractual obligations.The Surety prequalifies the contractor based on financial strength and construction expertise. The bond is underwritten with little expectation of loss.
So the next time you are enjoying a concert or a sporting event, take a look around in the building where the event is taking place. It all started with a contractor bid and a Construction Surety bond that guaranteed the work.