The Importance of Surety Bonds in Construction – Getting Prepared for the Bidding Process…
How one evaluates and manages risk on construction projects and makes responsible decisions to ensure timely project completion is the key to success. To gamble on a contractor whose level of commitment or qualifications are uncertain, or who could go bankrupt halfway through the job, can be a costly decision.
Surety Bonds provide financial security and assurance to the project owners that the contractor will perform the work and pay the specified subcontractors, laborers, and material suppliers. A Surety Bond is a risk transfer mechanism where the Surety Company assures the Project Owner (referred to as the Obligee) that the contractor (referred to as the Principal) will perform a contract in accordance with the contract specifications.
There are three basic types of contract surety bonds:
- The Bid Bond assures that the bid has been submitted in good faith and that the contractor will enter into the contract at the bid price and will provide the required performance and payment bonds.
- The Performance Bond protects the owner from financial loss should the contractor fail to perform the contract in accordance with its terms and conditions. The Surety must fulfill the contractual obligation under the bond.
- The Payment Bond assures that the contractor will pay specified subcontractors, laborers, and material suppliers on the project as specified within the term of the contract.
Prequalification of the Contractor with the Use of the Surety Bonds
Sureties are able to accept the risk of contractor failure based on the results of a thorough, rigorous, and professional underwriting process in which the Surety prequalifies the contractor. The process includes an in-depth look at the contractor’s business operations. Before issuing any bond, the surety company will analyze and look for the following:
- Experience matching the contract requirements
- Sufficient equipment and access to staff and adequate labor
- The financial strength to support the work program the contractor is seeking
- Good references and reputation
- An excellent credit history
- An established bank relationship and line of credit
- The ability to meet current and future obligations
The key to success of a well managed, profitable enterprise is to fulfill promises and commitments, make deals fairly and perform obligations in a timely manner. Surety bonds have played an important role in the construction industry’s success, allowing the industry to sustain its position as one of the largest contributors to the nation’s economic stability and growth.
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