Bonds in Construction Contracts: Everything You Need to Know
Investors use bonds in construction contracts to prevent any financial loss due to a failure to meet contract specifics or finish a project by a contractor.3 min read
Investors use bonds in construction contracts to prevent any financial loss or disruptions due to a failure to meet contract specifics or finish a project by a contractor. These bonds are most often used in the construction field to make sure projects finish according to the specifics of the contract. This bond is also known as a contract bond or construction surety bond.
What is a Construction Bond?
When a contractor bids on a construction job, they're often required to put up a construction bond or contract bond. This bond promises the owner of the project that the contractor will perform the terms listed in the agreement. These bonds protect assets of the project owner or investor against the project not being completed or mediocre work. Some construction bonds have two parts, including one that protects against the job not being completed and another making sure labor from subcontractors and materials from suppliers get paid.
Three parties are often involved when it comes to a construction bond, including the following:
- The party completing the project.
- The project owners and investors
- The company that supports the bond.
The investor or project owner is also known as the obligee. They're often a government agency that puts out a contractual job that they want done. To decrease the chances of losing money, they often make it mandatory that any contractors put a bond up. The contractor who's picked for the job is often the one with the bid price that's the lowest since investors will want to pay the least amount for a contract.
When a bond is submitted, the principal, or the party in charge of the construction work, agrees to finish the job to completion according to the contract. They'll also provide quality and financial assurance to the obligee that they have the appropriate finances to complete the project, but they'll also finish it with the highest quality.
Sureties and Construction Bond Types
A financial guarantor of any construction bond is a surety. This promises the obligee that the contractor will follow all terms that the bond established. Surety companies look at the principal builder's financial merits and decide what premium to charge based on their assumption that a negative event will happen. The surety can help a contractor if they're having cash problems and can also replace a contractor with a new one if the first one abandons the project.
A bid bond is mandatory when it comes to the competitive process bidding, and every potential contractor has to submit their bid bond with their bids so that the project owner has protection in case a contractor decides not to go through with the contract after not providing a performance bid or winning the bid.
Bid bonds help assure project developers that contractors will put in serious proposals and have enough financial credentials to take on the job. If the bid gets selected or the contractor retracts the bid or declines the job, the developer can decide to claim the bond to get the difference between the first bid and the bid that's next highest. Not all projects need bid bonds, but they're often requested with financial proposals that are given to project owners.
If necessary, owners will make it mandatory for contractors to get a bid bond before they can accept the bid and give out the contract. The bond helps guarantee that if the contractor gets the job, they'll sign the contract and will finish all required payment and performance bonds. A contractor license bond is a permit bond and type of license that requires contractors to buy the bonds before they get their contractor's license to make sure they comply with all regulations and licensing laws. If an issue occurs with the project, the project owner is able to file a claim and receive compensation paid out by the construction bond.
Counties, cities, states, or subdivisions can require a contractor license bond. If the proper license bonds aren't in place, the contractors cannot receive a license. Maintenance bonds will protect against workmanship or materials that are defective after a project is complete. If it is found that the project is defective after it's finished, the bond amount pays for necessary repairs.
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