What is a Contractor Surety Bond?

Putting up a structure is usually a very expensive project to undertake. It’s for this reason, that as an investor, you have to seek protection against any loss when undertaking such a project. A contractor surety bond, therefore, is a type of construction bond that you use as a project owner to protect yourself against any sort of financial loss just in case the contractor is unable to complete your project or unable to meet the specified standards that have been agreed upon.  A contractor surety bond can also be referred to as a contractor bond.  There are different types of bonds, here is a look at them.


Why You Need a Bond

When you want to put up a construction project, you will usually require contractors to submit bids. At the same time, a contractor that is looking for a job will have to put up a contract bond. The contract bond assures the project you, the owner of the project that the work will be done according to the standards that you have agreed upon.

Generally, a construction surety bond involves three stakeholders: the owner of the project, the contractor or he that does the actual construction work and the third party backs the bond. The investor is also called the obligee. The obligee us in most cases a government parastatal that wants a certain project undertaken.

The investor will usually pick on the contractor that has the lowest bid in order to lower the costs of construction. The contractor is also known as the principal. When the principal submits a surety construction bond, he is in a way assuring the obligee that he has the capacity to finish the work as agreed in the contractual document. the obligee is assured that the principal has the financial capabilities to complete the work in the maximum possible quality that can be achieved as agreed.

How the Bond Works

A construction bond is backed by a guarantor, otherwise known as a surety. His work is to guarantee the investor that the work will be done accordingly by the obligee. A surety guarantees the obligee by carrying out the necessary financial evaluations on the principal to ascertain that the principal can actually do the work. Sometimes, a surety may help a contractor that has problems with cash flow. Also, when the contractor abandons the job before completion, a surety has the responsibility to look for another contractor to finish the job.

A surety can provide three types of construction bonds namely: bid bond, performance bond, and payment bond.

Construction surety bonds are almost always a requirement since many things can go wrong in a construction project. A contractor will be mandated to provide a construction bond when undertaking a government project or any public works.

Why Your Construction Company Needs a Performance Bond

A performance bond is a type of contractor bond. Contractor bonds (also known as construction or surety bonds) are bonds which must be paid by the contractor to a project’s investors before starting on a project. They are meant to reassure the project owners that the contractors can complete the project within the deadline and to the specified quality requirements in the agreement.

Given the enormous risk involved with large scale construction work, contract bonds act as a financial safety net from those risks (e.g. contractor declaring bankruptcy)

There are three types of contractor bonds:

  • Bid Bonds – Bid bonds are paid during bidding to ensure that the contractors don’t bail out after being chosen.
  • Performance bonds- This bond protects a project’s investors from poor quality work from the contractors
  • Payment bonds- These are paid by the contractors to ensure investors they can financially support material and labour costs

There are usually three parties involved during contract bond agreements: project investors (obligee), contractor and a surety company. Normally an obligee is a government agency or organization that hires contractors for large scale public infrastructure projects (although more private sector entities are now requesting contractor bonds too).

Surety Companies

A surety company acts as a guarantor for the contractor obtaining the bond. If the contractor defaults on the project (either by performance or payment), the surety company is responsible for compensating the project’s investors. They either must make financial compensation or find other contractors that can complete the project. A surety company evaluates a contractor’s financial and performance history to see how likely they are to adhere to the terms of the contract. Premiums will then be charged accordingly.

A contractor can estimate the cost of the performance bond to be around 1-2% of the contract value (but this obviously depends on the contractor’s credit profile).
Surety companies will usually require the following documents:

  • Copy of the contract
  • Application of surety
  • Minimum 2 years of financial statements from CPA.

Benefits of performance bonds

So, how does using performance bonds benefit you as a contractor? Well, because a surety company will carry out an extensive pre-qualification process analysing your financial and performance history, being able to secure a performance bond is seen as a badge of honor as a contractor. It shows that a contractor is reliable and can complete a construction project within the deadline and to the quality specified. It builds up a reputation for a contractor, helping them secure contractor bonds more easily in the future.

Performance bonds also reassure project investors of the quality of your work, enabling you to build a positive rapport with them from the start.
Only project investors or owners are eligible for payment from a performance bond.