A surety bond is not an insurance policy. A surety bond is a guarantee, in which the surety guarantees that the contractor, called the “principal” on the bond, will perform the “obligation” stated in the bond. For example, the “obligation” stated in a bid bond is that the principal will honor its bid; the “obligation” in a performance bond is that the principal will complete the project; and the “obligation” in a payment bond is that the principal will properly pay subcontractors and suppliers. Bonds frequently state, as a “condition,” that if the principal fully performs the stated obligation, then the bond is void; otherwise the bond remains in full force and effect.
If the principal fails to perform the obligation stated in the bond, both the principal and the surety are liable on the bond, and their liability is “joint and several.” That is, either the principal or surety or both may be sued on the bond, and the entire liability may be collected from either the principal or the surety. The amount in which a bond is issued is the “penal sum,” or the “penalty amount,” of the bond. Except in a very limited set of circumstances, the penal sum or penalty amount is the upward limit of liability on the bond.
The person or firm to whom the principal and surety owe their obligation is called the “obligee.” On bid bonds, performance bonds, and payment bonds, the obligee is usually the owner. Where a subcontractor furnishes a bond, however, the obligee may be the owner or the general contractor or both. The people or firms who are entitled to sue on a bond, sometimes called “beneficiaries” of the bond, are usually defined in the language of the bond or in those state and federal statutes that require bonds on public projects.
Contractor license bonds provide a financial guarantee to a state to ensure contractors operate in a legal and ethical manner. If a contractors customer is financially harmed as a result of a state law violation, then a bond payout may occur.
A bid guarantee is usually required whenever a performance bond and/or a payment bond is mandated. Bid guarantees usually are in the form of bid bonds, but they may also be submitted as a postal money order, certified check, cashier’s check or an irrevocable letter of credit. A bid guarantee will be requested in an amount equal to a percent of the bid price. The standard solicitation provision requiring bid guarantees says that if the contractor awarded the contract fails or refuses to execute all contractually required documents, the agency may terminate the contract for default. In such a case, the agency will make a demand on the bid bond or bid guarantee to offset the difference in price between that bid and the next lowest bid. Bid bonds and bid guarantees are returned to unsuccessful bidders after bids are opened; bid guarantees are returned to the successful bidder after all contractually required documents and bonds are executed.
The penal amount of the performance bond is generally one hundred percent of the contract amount, and the penal sum is generally increased for each change order. The surety is entitled to receive information from the contracting officer concerning the progress of the work, payments, and estimated percentages of completion whenever it so requests in writing.
If the terminology of construction surety bonds is confusing at first, you may want to keep this guide as a reference. Surety bonds are required for most large construction projects in the United States and now more frequently they are required in other countries. Our next article will review the process of obtaining surety bonds, the choices contractors have among surety companies, and the agreements typically entered into between contractors and sureties when construction surety bonds are issued. Disclaimer: This page is not meant to provide conclusive legal definitions of construction surety bonds. It is only to serve as a reference by which you may conduct further research into the legalities of construction surety bonds. The contents of this web site are subject to change / revision without notice.
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