What is a Construction Surety Bond?

What is a Construction Surety Bond?

In the construction industry, a construction surety bond is a credit instrument that binds the contractual obligations between the parties. Surety bonds assure financial security by providing owners confidence that their contractors will perform according to the terms settled in the agreement.

Article Highlights 

— A construction surety bond is a credit instrument that guarantees the obligations (by contract) between the owner, contractor, and surety company

— NOT an insurance policy

— How to obtain a surety bond

— There are three types of surety bonds: Bid bond, performance bond, payment bond

Roles in Construction Surety Bond

Surety Company

— Is typically part of an insurance company

— Runs extensive background and financial checks on the contractor before approving a bond

— Assists the contractor if the principle experiences cash flow issues, but if the contractor abandons the project, the surety may replace the contractor

— Provides a line of credit to the payment of any claim on an agreement. 

Project Owner (Obligee)

— The project owner or investor is usually a government agency that lists a project that they want to be done. 

— The obligee requires all contractors on the job to put up a bond to reduce the likelihood of a financial loss against future work performance.

Contractor (Principle)

— The owner selects the contractor with the best-performing bid in accordance with investor guidelines. 

— Contractors state that they can complete the job according to the contractual policy. 

— Provides financial and quality assurance to the owner that they have the financials to manage the project, and the project will be built at the highest quality specified.

How to Obtain a Construction Surety Bond for Projects

Before a bond can be issued by a surety bond company, the big determinant is your credit-worthiness. Surety bond agents will look for different items before acquiring a surety bond, but some items to consider are:

— Documentation of the history of your company, organizational charts, and contractor/employee resumes

— A corporate or strategic plan that details current and future company plans, goals, and objectives (1-3 years). 

— Financial statements and documentation from the past three years from a certified accountant or with proof of financial information. 

— Credit Relationships and Credit References

Though considerations differ from surety company to surety company, its a brief list of what is necessary for a construction surety bond.

Types of Bonds

There are three types of bonds that the Surety Bond provides. 

Bid Bonds

Bid Bonds are required on federal projects whenever performance bonds and/or payment bond is authorized. In this bond, each contending contractor has to submit their bid along with a bid to protect the owner in an event the contractor backs out. The bid bond process helps filter out unqualified bidders to ensure the competitive bid process. The bid bond leads to the performance bid, which is necessary to start working on a project. 

Performance Bonds

A performance bond is transformed from a bid bond. It is the process when a contractor accepts a bid and begins to work on a project. A performance bond protects the owner from financial loss if the work of the contractor is defective, or subpar in quality, and didn’t follow the terms and conditions in the agreement.

Payment Bonds

The payment bond is also known as a labor and material payment bond. It guarantees that the winning contractor has the financial means to pay their workers, suppliers, and subcontractors. With this payment bond, the owner benefits because it provides a replacement to the mechanic’s liens as fixes for non-payment.

Privately Funded Projects vs. Publically Funded Projects

On privately funded jobs, the surety bond creates an easy transition from construction financing to permanent financing. Also, surety bonds provide support and ensure project completion to the contractor. 

On public funded projects, surety bonds provide payment protection for subcontractors and contract completion protection for public jobs.

Key Takeaways:

Contractors and subcontractors are targets for legal actions; construction surety bonds protect the contracted party if the contract was not completed or fulfilled on time. For example, if you (the contractor) decided to back out of your contract, or you did not finish it in time with the specified terms, your client won’t be left with the consequences. The surety bond will cover the costs and will finance the new contractor to finish the work that you failed to complete.