Go to archive
Vol. 2007-10 | October, 2007

Construction; Surety Bonds

Defaulting contractors are a sad statistic: 81,308 contractors failed in the United States between 1990 and 1997, leaving liabilities of $21.8 billion. These failures were not limited to new or small contractors; of the 10,867 contractors who failed in 1997, one-third were in business for 10 or more years. $7.3 billion was paid on claims against bonded contractors since 1985.

Definition: a surety bond is a three-party agreement whereby one party – the “Surety” or “Bonding Co.”, guarantees to another, the “Obligee” or “Owner”, that a third party “Principal” or “Contractor” will perform and timely complete a construction project, according to construction documents prepared by the Architect or Engineer, and/or administered by the Construction Manager.

Types of Bonds:

  1. Bid Bond – provides financial assurance that the bid has been submitted in good faith and that the contractor intends to enter into the contract at the price bid and provide the required performance and payment bonds.
  2. Performance Bond – protects the owner from financial loss should the contractor fail to perform the contract in accordance with its terms and conditions.
  3. Payment Bond – guarantees that the contractor will pay certain subcontractors, laborers and material suppliers associated with the project.
  4. Maintenance Bond – covers defective workmanship or faulty materials discovered after the project has been completed. In most cases the performance bond covers defective materials and faulty workmanship for a specified period of time after completion of the contract. However, maintenance bonds may be obtained separately to cover both patent (observable) defects and latent (hidden) defects.

Whom does the bond protect? Primarily, the Obligee / Owner of the project, as follows:

  1. Only qualified contractors, with the required financial qualifications will bid on the job.
  2. More competitive pricing; contractors and subcontractors know they have the protections of a bond, backed by a reliable surety.
  3. Higher likelihood of timely project completion.
  4. Consistency and quality may be expected of the finished product.
  5. Warranty against defective materials and workmanship.

Protection for Contractor, Subcontractors, and Suppliers: Bonds may also provide protection for the contractor and lower tiers of the construction industry supply chain:

  1. Surety can provide experienced technical, management or financial assistance to the contractor.
  2. If a contractor defaults, (and a payment bond is in place) the contractor is assured that subcontractors, laborers and suppliers will be paid.

Surety companies and, of course, contractors as well, want to avoid default, inasmuch as default avoidance is better and less expensive than cleaning up the legal and financial entanglements after default.

Many of the functions of a surety may benefit contractors either before or when they begin to experience trouble on a project. For example, surety companies may arrange temporary financing for a contractor to meet payroll. This can be done without notification to the owner, and saves good will and reputation developed over many years.

Sureties may also step into the contractor’s shoes and take over the contractor’s operations, to implement the completion of the project, thus avoiding default.

Caveat: Due diligence mandates providing notice to the surety before problems on the project result in default.

AUTHOR / EDITOR: J. NORMAN STARK is an Attorney-at-Law, a Registered Architect, (AIA, NCARB) Registered Landscape Architect, Interior Designer, Planner and Senior Appraiser (ASA), admitted to practice law before the Bar of Ohio, the US District Courts, Ohio and Illinois (Central Dist.), the US Court of Appeals, and the United States Supreme Court. He is a Mediator, Arbitrator and Litigator with experience in Business, Construction Law, and Public Works, and with additional experience in Real Estate, Construction Attorney (Legal Project and Crisis Management), and as an Expert Witness (Forensic Architect). His office is in Cleveland, Ohio.