Types of Bonds
1. Commercial Bonds -
Can guarantee a variety of business obligations. Commercial Surety Bonds
include all non-contract surety bonds, including numerous types of license
and permit, miscellaneous and court bonds.
2.Contract Bonds - Guarantees that an entity awarded a contract will
meet its obligations under that contract. Included in this group are bid
bonds, performance bonds, payment bonds, maintenance bonds and supply
bonds.
The Three Parties to a Contract Surety Bond:
Principal - The
entity that is bonded. It is the principals obligation that is being
guaranteed by the Surety.
Obligee - The party to whom the bond
is payable and with whom the principal has a contract. Often called the
owner or the contractors client.
Surety - The entity giving
the bond (the party that issues the bond). The Surety guarantees the
performance of the obligations of the Principal under a contract.
Why Are Bonds Used?
Publicly Funded Projects - Most
municipal, provincial and federal government bodies require contractors to
post bonds to protect taxpayers funds used to fund the project.
Privately Funded Projects - More and more frequently bonds are
requested on private projects. This trend is at least partially due to the
financial institutions financing these projects seeking the comfort of a
pre-qualified contractor and the security of a bonded project.
Subtrade Bonding - General contractors benefit from bonding
their subtrades by avoiding the financial impact of the subtrade failing
to complete the contract.
There are several advantages to the use of surety bonds:
- Ability to provide bonds opens up job opportunities for contractor.
- Bonding Company has engineering, accounting and legal counsel
resources.
- Levels playing field by ensuring only qualified contractors are
bidding.
- If there is a dispute on a job, the owner can simply cash your letter
of credit whereas with a bond there is a process and investigation wherein
the owner must prove his case before they can access funds. You have a
chance to defend yourself first.
- The letter of credit it almost always more expensive and often it must
be provided in an amount in excess of the contract price and remains in
effect until substantial completion and sometimes beyond.
- A labour and material payment bond gives comfort to suppliers and
subcontractors which usually result in better terms. They have no
protection under a letter of credit.
The Benefits to bonding your Subcontractors if you are the
General
- Only qualified subs can submit prices.
- If subcontractor defaults the extra expense is paid by their bonding
company.
- Unpaid creditors are paid by labour and material payment bond which
means less chance of liens on the project.
- Can mean better prices due to protection of labour and material
payment bond which means better chance of getting the job.
How are bonds different from insurance?
An insurance policy assumes that there will be a loss, so the premium for an
insurance policy is calculated to cover losses that may occur.
A bond, on the other hand, is an
extension of credit with the assumption there will be no loss. The bond premium covers only the
underwriting expenses of the surety company.
There are 2 parties to an insurance contract – the insured and the insurer. In a surety bond there
are three parties. If there is a claim the principal will have to repay whatever loss the surety
company experiences.
In most cases personal indemnities of shareholders are also provided and
would be called upon in a loss situation. Both the contractor and each individual project are
underwritten so you must have a bond facility; somewhat comparable to a bank line of credit set up
first.
The Stages of Construction
PREQUALIFICATION STAGE
Often contractors are required to submit a prequalification package prior to a job being let for
tender which may include a letter from their bonding company.
At this stage there is no spec
available to underwrite so the bonding company cannot commit to bonding.
They will also
sometimes be required to provide the contractor’s limits. Surety facilities don’t have limits –
just guidelines. Depending on the contractor’s workload at the time this project progresses to
Tender Stage it may or may not fit within those guidelines. The letter provided would typically
be worded as follows:
It is our understanding that «principal» wishes to be prequalified as a tenderer on the above
captioned project, which we understand has an estimated contract value of $«estimate».
We are the Surety Company for «principal», a highly valued client of ______________.
Should «principal» be successful in their submission, any request by our client for the
requisite bonding support will be given our full consideration at such time.
Our decision to extend the required suretyship will be subject to our normal underwriting requirements.
TENDER STAGE
Agreement to Bond (Surety’s Consent)
A guarantee by the surety that it will provide the Performance and/or Labour and Material Payment
Bond is the contractor is the successful bidder.
There is no standard wording and the document does not exist in the USA and has never been
to court in Canada.
Many owners have developed their own forms.
Bid Bond
A guarantee from the Surety (bonding company) to the Obligee, the good faith of the Principal
(contractor) when tendering. l lIf the principal fails to enter into a formal contract after
the bid has been accepted, the Principal is obliged to pay the Obligee either a fixed amount
or the difference in money between his tender and the contract price the Obligee eventually enters
into with someone else. l lThe amount cannot exceed the amount of the bid bond. If the Principal
does not do this then the Surety (bonding company) must do so. The Surety (bonding company) will
look to the Principal and it’s indemnitors to repay them. l lThere is a time limit to the bid bond
which corresponds to the time the tender is open for acceptance as per the spec. This time limit
prevents an Obligee (owner) from deciding not the get the final bonds unless a problem occurs.
CONTRACT STAGE
Performance Bond
To guarantee the Principal’s completion of the contract as per the plans and specifications.
If the Principal fails then the Surety will do so as long as the Obligee has performed it’s obligations
under that contract and satisfied any conditions in the Performance Bond.
The Surety’s liability is limited to the penal amount of the bond.
Suit within one year of date of final payment due.
CCDC wording preferred.
CCDCOnce a default by the Principal (contractor) has occurred the Surety can either
a) finance the Principal (contractor) if lack of money was the cause of the default
b) re-let the project to another contractor
c) let the Obligee (Owner) hire someone else to
complete the project and reimburse them up to the limit of the bond
Labour & Material Payment Bond
Guarantees the Principal pays all labour and material suppliers having direct contracts with
them for labour and supplies for use on the project.
The Obligee is designated as a trustee for those suppliers and subs.
If the principal fails
to pay, claimants can collect from the principal or surety, up to the penal sum of the bond.
Payments under the bond will deplete the penal sum.
Claimants required to give the Principal,
Obligee and Surety notice by registered mail within 120 days of that date he last performed work
or supplied material.
The surety industry feel that some of the obligations under the performance
bond are carried into the labour and material payment bond. For this reason if you order only a labour
and material payment bond and not a performance bond you will be charged for both since that is a
better representation of the risk being accepted by you and your bonding company.
