These bonds play a critical role in maintaining transparency and reliability throughout construction work. These bonds act as financial guarantees provided by a third-party surety company to ensure that a contractor will meet their obligations to the project owner. There are three main types of bonds typically used in construction projects:
- Bid Bonds
- Performance Bonds
- Payment (Labor and Material) Bonds
Importance of Construction Bonds
In the construction field, costs can rise unexpectedly due to material price fluctuations, labor shortages, or delays. What is a contract bond? It is a tool that helps shift the risk of such uncertainties from the project owner to the surety. This gives project owners peace of mind that the job will be completed and that workers and suppliers will get paid.
Legal Requirements
On federal projects in the U.S., the law mandates the use of performance and payment bonds for contracts exceeding a certain value. Many states and local agencies have adopted similar requirements for public construction, making bonds a standard part of the process.
1. Bid Bonds
These are submitted with a contractor’s bid to show they are serious about the offer and financially capable of completing the work. If the contractor refuses to sign the contract after winning the bid, the bond covers the difference in cost to hire the next qualified bidder. These bonds usually don’t require extra premiums and typically cover a small percentage of the bid amount.
2. Performance Bonds
They act as a financial guarantee that the contractor will meet the terms agreed upon in the project contract. In the event of a contractor’s default or inability to complete the work, the surety intervenes by finishing the project or compensating the project owner up to the bond’s specified limit. These bonds usually match the full value of the contract and may include specific terms regarding contract changes and deadlines.
There are different types of performance bonds depending on the type of project. While some public projects use short-form bonds, private jobs often involve more detailed agreements.
3. Payment Bonds
Also known as labor and material bonds, these protect subcontractors, laborers, and suppliers by guaranteeing they will be paid for their work and materials. Failure to receive payment allows them to pursue a claim against the bond. This reduces the chance of legal claims or liens against the property. They are typically compulsory for projects financed by the government or public entities.
The Claims Process
To make a claim, a supplier or a subcontractor must follow strict timelines and procedures. For example, certain notices must be given within a set number of days, and legal actions must be taken within one year of the claim.
Additional Points
Contract changes usually don’t require notifying the surety unless otherwise specified. Legal rules governing public projects often override any conflicting contract terms. Project owners can still pursue other damages, like late penalties, separately from bond claims. It’s vital for contractors and sureties to read all contract terms carefully to avoid unexpected liabilities.
