Understanding Construction Surety Bonds
What is a Surety Bond?
A surety bond isn't insurance. It's a guarantee where the surety ensures the contractor (the "principal") will fulfill the "obligation" stated in the bond. For instance, in a bid bond, the principal promises to honor their bid. In a performance bond, they commit to finishing the project. In a payment bond, they agree to pay subcontractors and suppliers properly. Bonds often state that if the principal fully meets the obligation, the bond becomes void; otherwise, it remains active.
If the principal fails to meet the bond's obligation, both the principal and surety are liable. Their liability is "joint and several," meaning either or both can be sued, and the full liability can be collected from either. The bond's "penal sum" or "penalty amount" is its issued amount, which typically caps the liability, barring rare exceptions.
The "obligee" is the person or company to whom the principal and surety owe their obligation. For bid, performance, and payment bonds, it's usually the owner. For subcontractor bonds, it could be the owner, general contractor, or both. Those who can sue on a bond, often called "beneficiaries," are typically defined in the bond's language or in state and federal laws requiring bonds for public projects.
Common Construction Bonds
License Bonds
Contractor license bonds financially guarantee to a state that contractors will operate legally and ethically. If a contractor's customer suffers financial harm due to a state law violation, the bond may pay out.
Bid Bonds
Construction bonds are often required when performance or payment bonds are needed. These guarantees typically come as bid bonds but can also be postal money orders, certified checks, cashier's checks, or irrevocable letters of credit. The amount usually equals a percentage of the bid price. If a winning contractor fails to complete required paperwork, the agency may end the contract and use the bid bond to cover the price difference with the next lowest bid. Unsuccessful bidders get their guarantees back after bid opening, while the winner receives theirs after finishing all required documents and bonds.
Performance bonds
Performance bonds usually cover 100% of the contract amount, increasing with each change order. Sureties can request updates from the contracting officer about work progress, payments, and completion percentages in writing.
Conclusion
Don't worry if construction surety bond terms seem confusing at first. Keep this guide handy for reference. These bonds are necessary for most large U.S. construction projects and are becoming more common internationally. Our next article will explore how to obtain surety bonds, contractor options for surety companies, and typical agreements between contractors and sureties when issuing construction bonds.