Contract bonds (also known as construction bonds) are required in most jurisdictions. A lot of times the benefits are overlooked and they’re seen as a hassle. But in fact, contract bonds provide essential guarantees to both parties involved in the contract.
Contract Bonds Provide Value to Clients:
They ensure the original bid.
A bid bond is a type of contract bond that guarantees a contractor will stick to the terms they originally bid. This type of surety bond is submitted along with the bid, guaranteeing the entire process, from start to finish.
They require the contractor to accept responsibility for mistakes.
We all know a project can require maintenance even after it’s complete. A maintenance bond serves as a warranty against defective materials or shoddy workmanship. Maintenance bonds are not always required, but it’s never a bad idea to protect your company from sticky situations once the contract ends.
They provide the contractor with a backup if it defaults.
If your contractor defaults, a payment bond will make sure everybody involved in the project gets paid and you don’t get saddled with that debt.
They guarantee that the client performs the work according to contract.
This is where a performance bond comes in. It’s another required bond that you’ll be happy to have on your side should the unfortunate event occur that the contract is not carried out correctly.
Contract Bonds Provide Value to Contractors:
The client feels safer and more assured.
Being backed by a contract bond provides a level of assurance to the client that the contract will be honored. Having this financial guarantee will help facilitate a better working relationship.
They guarantee completion of the project.
Sometimes you get near the end of a project and realize your company simply doesn’t have the resources to complete it. It happens to the best of companies, but you still want to see the project completed and know that all your hard work didn’t go to waste.
They provide assurance for subcontractors and vendors.
As you’re gearing up for a project, the best subcontractors and suppliers may want to see proof that you are holding a bond. It also serves as an assurance to them that they’ll receive their due compensation.
Despite a large spike in 2007 of state legislation for public private projects (PPPs), last year saw a significant decrease in the number of states that passed such permits. This is likely a result of the diminishing private funding for PPPs due to the current economic conditions within the United States. Additionally, recent reports from the U.S. House Transportation Committee on PPPs could have reflected negatively on them as well. However, international funding may still be an option seeing how PPPs were originally an overseas model. While many are concerned with the concept of PPPs in the United States, state officials should be able to protect public interest in PPPs with concession contracts, in which they have been able to provide oversight and address work force issues.
If passed, Rhode Island Senate Bill (SB) 2323 and 2229 would have allowed anyone who is under a performance, payment or fiduciary bond (claimants, principals and obligees) to file claim against the surety bond company for a bad faith refusal to pay a claim, settle on a claim, or for failing to perform their obligations in a timely manner. The Senate Bill would have authorized claimants to go after both punitive and compensatory damages, and even attorney fees, and other costs associated with the lawsuit.
To understand surety bonds, and how they work, it is best to start off by breaking them down into larger groups or categories. There are two major categories of surety bonds: Contract and Commercial Bonds. In this article, I will briefly explain what each of the previously listed bond types guarantees, and will also provide you with a few examples of each.
The first category of bonds I will discuss are contract bonds. Contract Bonds are purchased by a contractor (or principal) from a surety at the request of a project owner (obligee), and essentially provide obligee with assurance that the principal will perform in accordance with the terms of the contract (i.e. complete the work, pay subcontractors, material suppliers, etc.).
Examples of Contract Bonds:
- Bid Bonds – Bonds that guarantee that a contractor will enter into a contract at the amount bid and post the appropriate performance bonds.
- Construction Bonds – These are bonds designed to guarantee the performance of obligations under a construction contract.
- Payment Bonds – These bonds guarantee payment of the contractor’s obligation under the contract for subcontractors, laborers and materials suppliers associated with the project.
- Performance Bonds – Guarantee performance of the terms of a contract by a contractor.
- Site Improvement Bonds – These bonds guarantee that any public property that was disturbed or altered during the conduct of a private project will be completely restored upom completion of the project.
- Subdivision Bonds – May be required by local government to ensure that landowners follow-through and complete mandatory public improvements made to their property by builders.
The next category of bonds we will cover are commercial bonds. There are litterally hundreds of different types of Commercial Bonds, which guarantee the obligee that the principal (purchaser of the bond) will perform per the terms outlined on their specific license, etc. The obligee for this type of bond is typically some sort of government entity.
Some examples of the many types of Commercial Bonds are:
- ARC Bonds – Required by the Airlines Report Commission.
- Auto Dealer Bonds – Bonds required by each state to ensure auto dealers abide by state regulations.
- Broker Bonds – The different types of Broker Bonds available are Freight Broker, Insurance Broker and Mortgage Broker Bonds.
- Cigarette Tax Bonds – Cigarette distributors may be required to obtain this type of bond to ensure payment of taxes.
- Collection Agency Bonds – Bonds required by a governing body to ensure collection agencies operate within rules and regulations.
- Freight Broker Bonds (BMC-84) – These federally-mandated bonds must be obtained by freight brokers to ensure delivery of brokered goods.
- License & Permit Bonds (not listed) – Due to the very high number of bonds nation-wide that fall under this category, this link will provide general information on license & permit bonds.
- Liquor Tax Bonds – Bonds required to guarantee the payment of taxes collected on liquor and other alcoholic beverage sales.
- Mortgage Broker Bonds – Bonds that are required by many states to ensure that mortgage brokers operate in accordance with all pertinent rules and regulations of that particular state.
- Sales Tax Bonds – Required by the government to ensure timely payment of sales tax by a company.
- Telemarketing Bonds – These types of bonds are required by the state to ensure that telemarketers, or phone solicitors, follow all rules and regulations set forth by that particular state in the conduct of their solicitation.
Contract and Commercial Bonds can also each further broken-down into many more sub-categories (i.e. A License & Permit Bond is a sub-category of Commercial Bonds), and some of these sub-categories can have numerous different types themselves. Each and every sub-category of surety bond is underwritten differently by the surety bond companies, and there may also be different application requirements for each types as well.
Today, most surety bond consultant firms focus significant effort towards internet sales and marketing. While the development of the internet has made the sale of certain bonds such as commercial bonds much easier, it has not been a major source of new business for all bond types. For instance, construction performance bonds, which generate some of the highest premiums of all surety bonds, have seen relatively small increases in new business generation via the internet, industry wide. To understand the significant difference in internet-based sales volume between commercial surety bonds and construction performance bonds we can look to three reasons:
1. Geographical location
2. Complex underwriting
3. Difficulty adjusting to new ways of doing business
Geographical location: When dealing with a construction performance bond, some sureties may have difficulty providing significant financial backing to a contractor (principal) and is not geographically close to their bond agent.
Complex underwriting: The paperwork involved in writing a construction performance bond (contract bond) can be much more time-consuming and complex than some of the commercial bonds out there.
Difficulty adjusting to new ways of doing business: We’ve all heard the saying “you can’t teach an old dog new tricks.” Historically, most people that have been purchasing construction performance bonds are used to getting such surety bonds from their insurance company. Since that is “the way they’ve always done it”, many people/businesses find it hard to change.
The internet is clearly not just a fad. It is here to stay and be around for the foreseeable future. As more and more people use the internet, internet sales will continue to rapidly grow, and this will most certainly include the sale of construction performance bonds. In today’s high-tech world, sureties will need to stay at the cutting edge. Today, an increasing number of sureties are allowing bond agents to write surety bonds in each and every state in which they are licensed to do so. In an attempt to expedite the often cumbersome, time-consuming underwriting process, many companies are expanding their capacity. Finally, many contractors are beginning to realize that while purchasing a surety bond from the same company that provides them insurance may seem like an efficient way to operate, that is often times not the case. Many of these insurance agents do not have the breadth of knowledge that a surety bond agent can provide them, nor can they match the premiums. As more and more contractors come to this realization most will look to the internet to help them find the surety bond agency that is right for them.