The owner of a building under construction must know that thecontractor doing the work will be able to finish the work on timeand within budget.

Although no one can predict such things with certainty, contractbonds issued to the contractor by a corporate surety help to easethe mind of the building owner.

When issuing a bond, the bonding company is counting on thecontractor to be able to finish the job. Bond underwriters look atthe “three Cs” for any contractor — character, capacity, andcredit. A successful contractor must have all three.

• Character: The contractor must be honest andpossess a high degree of integrity.
• Capacity: The contractor must have theexperience and knowledge to complete the job.
• Capital: The contractor must have access toappropriate amounts of capital in order to fully fund theproject.

Here is a look at the five most common bonds used to secureconstruction projects.

1. Bid or Proposal Bonds: A contractor submitsa bid bond along with the bid on a particular job. The bondguarantees that, if awarded the job, the contractor will sign thecontract. It also guarantees that the contractor will furnish allnecessary performance and payment bonds.

If the contractor defaults, the surety must pay the differencebetween this contractor’s bid and the next higher one. The surety’sliability is limited to the bond penalty (analogous to a limit ofliability on an insurance policy). The bond sets a six-month timelimit for suits against the surety.

An alternative to the bid bond is the bid letter. Sometimesrequired on public (government) projects, this is a letter signedby the surety. In the letter, the surety agrees to execute thebidder’s obligation in an amount equal to the amount upon which theproject award was based. Because no penalty is specified, there isno limit on what the surety may end up paying.

2. Performance Bonds: A performance bondguarantees that a project will be completed according to contractspecifications and lien-free, if the principal pays thecontractor.

The owner, therefore, must advance enough money to complete theproject. The owner must also contest any liens on the project anddetermine the amount of loss before turning to the surety.

3. Payment Bonds: A payment bond is for thebenefit of those supplying labor and materials to a constructionproject. It agrees to indemnify the owner for any loss sustainedbecause the principal does not pay the suppliers.

The provisions of a payment bond are usually included in theperformance bond. If a payment bond is written separately from aperformance bond, there is no charge for the payment bond.

4. Maintenance Bonds: Often a contractor mustagree to fix any defects in the workmanship for a period of timeafter the project is complete. A maintenance bond guarantees to theproject owner that the contractor will meet this maintenanceobligation.

5. Completion Bonds: When a contractor receivesa loan to complete a construction project, the lender oftenrequires a completion bond. Such a bond guarantees to the lenderthat the project will be completed without any liens against theproperty.

Although the same surety may provide the contractor’sperformance bond and the completion bond, such a procedureis usually not recommended.

Editor’s note: This information is excerpted from theFC&S Online article “ContractBonds.”