This article was written with the contractor in mind — specifically contractors new to surety bonding and public bidding. While there are many kinds of surety bonds, we’re going to be focusing here on contract surety, or the kind of bond you’d need when bidding on a public works contract/job.
First, be thankful that I won’t get too mired in the legal jargon involved with surety bonding — at least not more than is needed for the purposes of getting the basics down, which is what you want if you’re reading this, most likely.
A surety bond is a three party contract, one that provides assurance that a construction project will be completed consistent with the provisions of the construction contract. And what are the three parties involved, you may ask? Here they are: 1) the contractor, 2) the project owner, and 3) the surety company. The surety company, by way of the bond, is providing a guarantee to the project owner that if the contractor defaults on the project, they (the surety) will step in to make sure that the project is completed, up to the “face amount” of the bond. (face amount usually equals the dollar amount of the contract.) The surety has several “remedies” available to it for project completion, and they include hiring another contractor to finish the project, financially supporting (or “propping up”) the defaulting contractor through project completion, and reimbursing the project owner an agreed amount, up to the face amount of the bond.
On publicly bid projects, there are generally three surety bonds you need: 1) the bid bond, 2) performance bond, and 3) payment bond. The bid bond is submitted with your bid, and it provides assurance to the project owner (or “obligee” in surety-speak) that you will enter into a contract and provide the owner with performance and payment bonds if you are the lowest responsible bidder. If you are awarded the contract Fingerprinting you will provide the project owner with a performance bond and a payment bond. The performance bond provides the contract performance part of the guarantee, detailed in the paragraph just above this. The payment bond guarantees that you, as the general or prime contractor, will pay your subcontractors and suppliers consistent with their contracts with you.
It should also be noted that this three party arrangement can also be applied to a sub-contractor/general contractor relationship, where the sub provides the GC with bid/performance/payment bonds, if required, and the surety stands behind the guarantee as above.
OK, great, so what’s the point of all this and why do you need the surety guarantee in first place?
First, it’s a requirement — at least on most publicly bid projects. If you can’t supply the project owner with bonds, you can’t bid on the job. Construction is a volatile business, and the bonds give an owner options (see above) if things go bad on a job. Also, by providing a surety bond, you’re telling an owner that a surety company has reviewed the fundamentals of your construction business, and has decided that you’re qualified to bid a particular job.
An important point: Not every contractor is “bondable.” Bonding is a credit-based product, meaning the surety company will closely examine the financial underpinnings of your company. If you don’t have the credit, you won’t get the bonds. By requiring surety bonds, a project owner can “pre-qualify” contractors and weed out the ones that don’t have the capacity to finish the job.