Summary: The owner of a building (the obligee) under construction must know that the contractor(s) (the principal) doing the work will be able to finish the work on time and within budget. While no one can predict such things with certainty, contract bonds issued to the contractor by a corporate surety (the surety) help to ease the mind of the building owner. The five such contract bonds are the topic of this treatment.
Underwriting Contract Bonds
When issuing a bond, the bonding company is counting on the contractor to be able to finish the job. Bond underwriters look at the “three C's” for any contractor — character, capacity, and credit. A successful contractor must have all three.
1. Character: the contractor must be honest and possess a high degree of integrity.
2. Capacity: the contractor must have the experience and knowledge to complete the job.
3. Capital: the contractor must have access to appropriate amounts of capital in order to fully fund the project.
Bid or Proposal Bonds
SAMPLE BID BOND — Construction or Supply
THE CONDITIONS OF THIS OBLIGATION ARE SUCH that, if any awards made within sixty days from the date of this instrument, by said Obligee, to the above Principal under a public invitation for [description of project] shall be accepted by said Principal and said Principal shall enter into a contract for the completion of said work, and give Bond with the [name of the surety company] as surety, or with other surety or sureties to be approved by the Obligee for the faithful performance thereof, then this obligation shall be null and void; otherwise to remain in full force and effect.
PROVIDED: First—That the liability of the Surety shall in no event exceed the penalty of this bond.
Second—That any suits at law or proceedings in equity brought or to be brought against said Surety to recover any claim hereunder, must be instituted within six months from the date of this instrument.
Analysis
A contractor submits a bid bond along with his or her bid on a particular job. The bond guarantees that, if awarded the job, the contractor will sign the contract. It also guarantees that the contractor will furnish all necessary performance and payment bonds. If the contractor defaults, the surety must pay the difference between this contractor's bid and the next higher one. The surety's liability is limited to the bond penalty (analogous to a limit of liability on an insurance policy). The bond sets a six month time limit for suits against the surety.
An alternative to the bid bond is the “bid letter.” Sometimes required on public (government) projects, this is a letter signed by the surety. In the letter, the surety agrees to execute the bidder's obligation in an amount equal to the amount upon which the project award was based. Because no penalty is specified, there is no limit on what the surety may end up paying.
Performance Bonds
PERFORMANCE BOND for General Contractors
NOW, THEREFORE, THE CONDITION OF THIS OBLIGATION is such, that, if Contractor shall promptly and faithfully perform said contract, then this obligation shall be null and void; otherwise it shall remain in full force and effect.
The Surety hereby waives notice of any alteration or extension of time made by the Owner.
Whenever Contractor shall be, and declared by Owner to be in default under the Contract, the Owner having performed owner's obligations thereunder, the Surety may promptly remedy the default, or shall promptly:
1) Complete the Contract in accordance with its terms and conditions, or
2) Obtain a bid or bids for submission to Owner for completing the Contract in accordance with its terms and conditions, and upon determination by Owner and Surety of the lowest responsible bidder, arrange for a contract between such bidder and Owner, and make available as work progresses (even though there should be a default or a succession of defaults under the contract or contracts of completion arranged under this paragraph) sufficient funds to pay the cost of completion less the balance of the contract price; but not exceeding, including other costs and damages for which the Surety may be liable hereunder, the amount set forth in the first paragraph hereof. The term 'balance of the contract price' as used in this paragraph, shall mean the total amount payable by Owner to Contractor under the Contract and any amendments thereto, less the amount properly paid by Owner to Contractor.
Any suit under this bond must be instituted before the expiration of two years from the date on which final payment under the contract falls due.
No right of action shall accrue on this bond to or for the use of any person or corporation other than the owner named herein or the heirs, executors, administrators, or successors of Owner.
Analysis
A performance bond guarantees that a project will be completed according to contract specifications and lien-free, if the principal pays the contractor. Some forms are limited to indemnification of the owner for loss sustained and against liens incurred through the fault of the contractor. The owner, therefore, must advance sufficient money to complete the project. The owner must also contest any liens on the project and determine the amount of loss before turning to the surety.
Other, more complete bonds are called “gilt-edge” forms. Under such a form, the surety must not only pay the obligee if the principal defaults, but [the surety] must step in and complete the project. If this is not possible, the surety must advance the cash for completion.
Under both forms, the project owner must live up to his or her obligation to pay the contractor. If the project owner does not meet this responsibility, neither the contractor nor the surety has any further obligation to complete the project.
Payment Bonds
This bond inserted for its interest. On private work in [state] the original of this bond is filed with the county clerk in the jurisdiction where the work is being performed. Bond provides payment only — not performance — to all lienors supplying labor, material, and supplies used directly or indirectly by Principal in the prosecution of the work provided in the contract, and pay the owner for all loss, damage, expenses, costs and attorney's fees, including appellate proceedings that owner sustains because of default by the Principal under the contract. . .
THE CONDITION OF THIS BOND is that if Principal:
1. Promptly makes payments to all lienors supplying labor, material, and supplies used directly or indirectly by Principal in the prosecution of the work provided in the contract dated ______________ between Principal and Owner for construction of _______________, the contract being made a part of this bond by reference, and
2. Pays Owner all loss, damage, expenses, costs, and attorney's fees, including appellate proceedings, that Owner sustains because of default by Principal under paragraph 1 or this bond; then this bond is void; otherwise, it remains in full force.
Any changes in or under the contract documents and compliance or noncompliance with formalities connected with the contract or with the changes doe not affect Surety's obligation under this bond.
Analysis
A payment bond is for the benefit of those supplying labor and materials to a construction project. It agrees to indemnify the owner for any loss sustained because the principal does not pay his or her suppliers. As mentioned elsewhere, the provisions of a payment bond are usually included in the performance bond. If a payment bond is written separately from a performance bond, there is no charge for the payment bond.
Maintenance Bonds
WHEREAS, the Principal and the Obligee entered into a written contract on [date] for the [description of the project], all in accordance with Item No. ____ of the plans and specifications and drawn up by ____, and
WHEREAS, said contract provides that the Principal will furnish a bond in the penalty of (5 percent) of the contract price conditioned to guarantee, for the period of (one) year(s) after approval of the final estimate on said job, by the owner, against all defects in workmanship and materials which may become apparent during said period, and
WHEREAS, the said contract has been completed, and was approved on [date];
NOW, THEREFORE, THE CONDITION OF THIS OBLIGATION IS SUCH that, if the Principal shall indemnify the Obligee for all loss that the Obligee may sustain by reason of any defective materials or workmanship which become apparent during the period of (one) year(s) from and after [date].
Analysis
Often a contractor must agree to fix any defects in his or her workmanship for a period of time after the project is complete. A maintenance bond guarantees to the project owner that the contractor will meet this maintenance obligation.
Completion Bonds
WHEREAS, the Principal and Obligee have entered into a written agreement dated ___________, copy of which is or may be attached hereto, but the terms of which the Obligee agrees to lend the Principal the sum of $_____, to be used wholly for the construction of __________ located on Lot(s) ______________, in accordance with the plans and specifications therefore, approved and signed by the Principal and Obligee, and in accordance with the conditions and covenants of such agreement, and
WHEREAS, in consideration thereof, the Principal has executed and delivered to the Obligee his mortgage on said property described above, accompanied by his note, in the sum of $_____, as security for said construction loan.
NOW, THEREFORE, the condition of this obligation is such that, if the Principal shall well and truly perform and fulfill all the covenants and conditions of the aforesaid agreement, and shall promptly erect and construct the said __________ according to the above mentioned plans and specifications, at or within the time required, and shall save and keep harmless the Obligee, and the above property, from any and all liens and claims for labor, materials, or otherwise, arising out of or incurred by reason of the construction and erection of the said ________, and shall turn over said property to the Obligee free and clear of all such liens and claims.
Analysis
When a contractor receives a loan to complete a construction project, the lender often requires a completion bond. Such a bond guarantees to the lender that the project will be completed without any liens against the property. While the same surety may provide both the contractor's performance bond and the completion bond, such a procedure is usually not recommended.
Remember, one of the things that distinguish suretyship from insurance is that if the surety must pay money to the obligee, the surety may then go back against the principal to collect whatever is possible. However, if the same surety provides both bonds, it has no recourse against the principal.