Construction Contracts: Ch. 8 - Surety Bonds

Avoiding Double Bonding

CM should only cover their fees; the subcontractors will then provide 100% performance and payment bonds for their own work

What party/parties are given the most protection by a performance bond?

The owner/obligee is given the most projection against a contractor that does not perform and build the project to the specified drawings in the set timeline.

Obligee

owner to whom the promise of the principal's [general contractor's] performance is made; the beneficiary on the bond

$2 million

A contractor with a bonding capacity of $4 million will be given bonds for projects up to what dollar amount?

Advantages to Payment Bonds

Allows the ability to get lower subcontractor and supplier bids because they will lower their pricing if they know they are going receive payment

Performance Bond

Assures that a financially-responsible party will stand behind the general contractor if they do not perform properly; if one party cannot complete their obligations, the bond is paid out the other party to compensate for damages or cost

What does the bid bond promise to the owner?

Assures that the contractor will enter into a binding construction contract and will provide the required bonds if they are awarded the contract. If the contractor defaults, the surety will pay the owner and may sue the contractor. Helps to prevent inappropriately low bids just to win a contract.

Payment Bond

Gives protection to the owner if the subcontractors and suppliers are not paid by the general contractor; prevents liens

What is the limit of liability of a surety if the contractor defaults?

If a contractor defaults, the surety will force the contractor to fulfill the terms of the contract despite bids being in excess. AKA performance is promised to the owner.

Give an example in which a surety may NOT be forced to honor the bond in the event of a contractor default.

If there was a major change to the project that greatly impacts the price and amount of work required, because the surety was not able to look at the new work and make a better decision on whether or not to keep the bond.

Double Bonding

In a CM at Risk Contracting Method, the owner could require the CM to provide 100% performance bond; the CM could also require 100% performance and payment bonds from the subcontractors

Stop Notice

Informs the owner that the subcontractors and suppliers have not been paid and that further payments are to be withheld from the contractor; happens in public works projects without a bond

Miller Act

States that surety bonds are required of construction contracts on all federal and federally-assisted projects

10%

The government adopted a rule that a surety cannot assume a single obligation that exceeds __% of the surety's equity/surplus; sureties will need to join together to issue bonds for large projects

What party/parties are given the most protection by a payment bond?

The owner/obligee is given the most protection if the subcontractors and suppliers are not paid by the contractor. Payment bonds prevent liens and the change for needing to pay twice for the same work.

How is it determined that a contracting firm has exceeded its bonding capacity?

The surety looks at the contractor's character, capacity, and capital. A general rule of thumb is 10-15 times the net working capital of the firm.

Subcontractors

To minimize the risk of the general contractor, they may require each major ______ to provide a surety bond; making the general contractor the obligee on the bond

Comparison of Surety to Credit

When a minor must have an elder sign a contract to purchase an item on credit s that the merchant is assured the debt will be paid --> if the minor fails to make the payment, the elder cosigner is responsible for the debt

In what ways are surety bonds NOT like insurance policies?

[1] An insurance policy involves two parties that makes certain the insured is protected against loss, where in a surety the contractor is not providing a guarantee for their loss, but for the owner's. A surety agreement is one-sided. [2] Insurance policies cover specified loss, surety bonds cover all loss. [3] insurance premiums are based on going rates, surety premiums are fixed fees.

what rights does a surety have in the event of a contractor default?

[1] The surety can recover debt from the contractor [2] The surety can sue the owner from claims that the contractor could have made [3] Surety can try to get the retainage held by the owner

In times of economic uncertainty

[1] When sureties are cautious about issuing surety bonds to construction firms because failure in the industry is high [2] When general contractors are more likely to require surety bonds from the subcontractors

Bonding Limits for Contractors

[1] assessment based on contractor's character, capital, and capacity general rule of thumb: $10 of uncompleted work for each $1 of capital

Stipulations of a Bid Bond

[1] if the contractor defaults, the surety will pay the damages [2] damages may consist of the forfeiture of the face value of the bond [3] OR may be limited to the difference between the amounts of the low bidder and the next lowest bidder up to the face value of the bond

Differences between surety bonds and insurance policies

[1] in a surety agreement, the contractor is NOT providing the guarantee for themselves, but to the owner [2] insurance covers a specific loss, but surety bonds cover losses of any kind [3] insurance transfers risk, while a surety agreement does not

Surety Bond

a guarantee provided by a firm that states the contractor will fulfill the terms of the conttrac

Bid Bond

issued to give assurances that the contractor will enter into a binding construction contract and will provide the required payment and performance bonds if the contract is awarded to them; prevents contractors from submitting inappropriately low bids to win a contract

Subrogation

the act of one person/party standing in the place of another person/party ex. after insurance pays you for a claim, it sometimes has the right to seek reimbursement of those payments from the at-fault party --> the surety can seek redress from the principal

Surety

the bond company that is obligated to perform or pay a specified amount of money if the principal/contractor does not perform; the guarantor on the bond

Principal

the debtor [the general contractor] whose performance is promised/guaranteed

Equitable Subrogation

the surety does NOT seek reimbursement from the principal, but will seek compensation from other offending parties [owners, subcontractors, suppliers] in simpler terms --> the surety essentially steps into the shoes of the principal/contractor and can file suits that the contractor would have been able to file

Performance Bond Duration

time limit will be spelled out in the contract; most last for 12-36 months and can be renewable or non-renewable

100%

to guarantee the contractor's performance, a performance bond of ___% of the contract amount is required; payment bonds are often the same as or more than the amount of the performance bond

Indemnification

to secure against or compensate in the event of injury, loss, or damage; a means by which the principal/debtor is obligated to the surety for any debts in incurs as a result of default by the principal

Face-Value Penalty

usually between 5-20% of the contract amount; for federal projects this is mandated at 20% of the project cost ex. if the project cost = 500k, the sum is 50k