Thursday, August 12, 2010

Construction Bonds: How They Can Protect Your Project

From time to time, the Texas Construction Law Blog would like to feature guest bloggers who offer different perspectives on issues affecting the construction instrustry. The following article is the second of a two-part series about the legal protection and financial security surety bonds offer those involved in construction projects. The guest author is Danielle Rodabaugh, a principal for Surety

In her last piece, Danielle discussed the basics of the bonding process in the construction industry. Today she will be delving further into the subject matter, explaining each of the three major kinds of construction bonds:

* bid bonds
* performance bonds
* payment bonds

As with other surety bonds, construction bonds provide legal financial protection to guarantee the work done by professionals within the industry.

Bid Bonds: Locking in the Price
Contractors must get bid bonds to assure a project’s developer that—if selected—they will enter into a contract for the amount quoted in the original bid. Contractors provide the bid bond along with their bid proposal. Doing so keeps contractors from increasing their bids on projects after being contracted by the developer. Additionally, the language in bid bonds requires the contractor to secure performance and payment bonds as necessary throughout the project.

If the contractor breaks the bond’s terms, the bond’s financial guarantee allows the developer to collect reparation. Usually this is in the amount of how much more the developer has to pay to contract the next-lowest bidder for the project. If the contractor cannot cover the cost, the surety will be held accountable for paying reparation up to the bond’s full face value.

Performance Bonds: Guaranteeing Execution
Performance bonds guarantee that a contractor will perform all aspects of a project according to the contract. Contractors secure this bond to guarantee their work to whoever requests the bond—usually a government entity. If the contractor does not complete the project satisfactorily, the performance bond keeps the project owner from losing the investment.

If a contractor does not perform his work satisfactorily, then the performance bond will require the surety to fulfill all facets of the contract. The surety could also be responsible for paying retribution up to the bond’s full face value for delay damages and other fees incurred due to the principal’s inability to perform.

Payment Bonds: Assuring Compensation
Contractors get payment bonds to assure that they will pay all necessary labor and material costs. These bonds confirm that workers will be paid according to the terms set forth in the contract. Because mechanic’s liens—which ensure payment of outstanding debts upon sale of a property—can only be used on private property projects, payment bonds are essential to making sure that all bills are paid in full. The payment bond essentially takes the place of a mechanic’s lien when a contractor or subcontractor is working on a public property project.

If the contractor fails to issue payments or otherwise breeches the contract, subcontractors and/or other workers can make a claim against the bond so that they can receive their deserved compensation. Once again, if the contractor does not have the funds to do so the surety will be left footing the bill.

***Performance bonds and payment bonds are often issued in conjunction with one another, and are sometimes issued as one contract called a “performance and payment bond.”

Construction Bond Regulations
Before searching for a surety agency, you need to check with both state and local regulations about bonding in your area. Federal, state, and local laws all mandate that bid bonds, performance bonds, and payment bonds be utilized for most public projects. The federal Miller Act dictates the use of surety bonds for all projects in excess of $100,000. Many states have have passed “Little Miller Acts,” which elaborate further on the federal act regarding construction bonding regulations. For example, Illinois surety bond requirements mandate that bonds be used on all public construction projects that cost $5,000 or more, whereas requirements in other states keep the limit at $100,000. This huge variance in regulations means its crucial for those working on a construction project to check the regulations set forth by their jurisdiction before seeking out a surety provider.


JoeyWalden87 said...

This was a very informative article. My company is just starting up and I didn't know if I needed this insurance at all. Now I know that there are 3 types of bond insurances that I can choose from.


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