The construction industry is a huge business, and there are countless construction companies, small and large, making deals on projects every day around the world. Construction contracts can be too complicated, and with such huge amounts of money, resources, and workforce involved, both the rewards and risks of construction are enormous. In order to mitigate the risks between construction companies, customers, and contractors, surety bonds are often used to protect the interests of all parties.
While incredibly useful, surety bonds are sadly misunderstood by some people, and so they fail to take advantage of the benefits that they can bring to a construction contract. Here is a guide to how surety bonds work and four types of bonds you need to know about to help all the folks in the construction industry who are looking for extra security in their deals.
Surety Bonds 101
In a standard contract, two parties agree to a series of terms that usually involves the exchange of goods or services for money. In construction terms, this may be a homeowner paying a building firm to put an extension on their house or a construction company hiring a subcontractor to work on a certain job. We have all seen TV shows exposing cowboy tradespeople who do not fulfill the terms of their contract and leave people spending a lot of time and money trying to resolve the problem. In a surety bond agreement, alongside the two parties who are directly involved in the transaction, there is a third party who acts to ensure that the other two keep up their side of the agreement.
To understand how this works, you must first understand the role of each party:
Principal, Obligee, and Surety
These are the three parties involved in a surety bond arrangement, and the role of each is vital in ensuring that a construction contract is fulfilled. The principal pays for certain construction services, the terms of which are agreed in the construction contract. One typical example of a principal is a big construction firm which subcontracts a plumbing firm to work on their project.
The obligee provides the construction services which have been paid for by the principal. In this example, the obligee is the plumbing company that agrees to do certain work on a project for a predetermined amount of money. The surety is the defining party in a surety bond, which ensures that the principal and the obligee both honor the construction contract.
To understand how this works in principle, let’s look at the four types of surety bonds that are commonly used in construction.
In a performance bond, the surety ensures that the obligee does the work that was agreed with the principal in the contract. The experts at SwiftBonds.com explain that in the above example, this means that the plumbing company must complete all of the plumbing work to the standard, which is set out in the agreement. If they fail to do this, the surety will then pay the construction company the money that is required to complete or fix the job and then go after the plumbing company for the money plus extra.
In a bid bond, the surety ensures that the obligee has the money required to do any job which they bid for. One easy to understand example is if a local government plans to build a hospital, local construction companies can bid for the contract. The surety will guarantee that the bidders have the money they bid before they are given the contract.
In a payment bond, the surety ensures that the principal pays the obligee everything. This typically includes everything that is owed for their labor and materials. If they fail to do so, the surety pays the obligee and then goes after the principle for the money plus extra.
In a maintenance bond, the surety ensures that the obligee comes back to do them if extra maintenance or repairs are required. If they do not, then the surety will pay the principal to hire someone else and will then go after the obligee for the cost of the work plus extra.
There are so many uses of surety bonds across the construction industry, and both principals and obligees must sign up for one so that their interests are protected. There are huge sums of money and labor involved in construction projects, so being left unpaid or with substandard work can be a major problem. If you are looking to add security to your construction contracts, speak to a surety bond provider to get useful advice on the best bond for you.