The Importance of Performance Surety Bonds In Construction
Construction of any kind holds both, excitement and risk. On one hand there is the concept of new creations and/or structures being made, but on the other there is a definite possibility of problems along the way. These problems can include such things as a contractor that does not adhere to agreements made regarding the process, or even a contractor that goes bankrupt before the job is complete, leaving the project owner in a costly mess.
These dilemmas do happen, but protection is available that can prevent such costly situations from being an obstacle to completion of a project. Surety bonds provide both, financial security and construction assurance. The purpose of these bonds is to assure project owners (obligee) that the contractors (principal) involved will complete the work and pay any subcontractors, laborers, and/or material suppliers as specified in agreements.
There are three basic types of bonds that come under this category:
1) Bid Bond – as the name implies, this bond assures that the bid has been submitted appropriately and in good faith. This bond provides protection that the contractor will perform the work at the price bid and provide the required performance and payment bonds.
2) Performance Bond – structured to protect the owner from financial loss if the contractor fails to fulfill the contract in agreement with its terms and conditions.
3) Payment Bond – this bond provides assurance that the contractor will pay designated subcontractors, laborers, and material suppliers on the project.
Performance bonds are ordered or mandated by law on public works projects, but the owner of a privately owned construction project has the option of determining if he wants to pursue a Surety Bond. That protection will insure that the risks of project completion are shifted from the owner to the surety company.
In order to bond a project, the owner must specify the bonding requirements in the contract agreements. It is the contractor’s responsibility to obtain and deliver Performance Surety Bonds to the owner. Surety companies operate in an effort to prevent loss. Contractors are prequalified based on financial strength and construction expertise. There is little expectation of loss because the prequalification process includes the following: assessing the contractor’s references and reputation, his ability to meet current and future obligations, as well as the experience correlating to the contract requirements, the equipment (or ability to acquire the needed equipment) to do the work, financial power to support the project, excellent credit history and an established bank relationship with a line of credit.
In essence, these bonds protect both the project owners and the contractors. The owner knows that the contractor has been judged capable of fulfilling the contract and that can result in an increase in a contractor’s project requests and opportunities. In the end, both the contractor and the project owner can rest easier when the project is protected in this manner.
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