Bonding Over Bonds
By Eric Kizak, P.E.
The preparation of a project specification may seem like a rather mundane process. Assemble the “standard” front end sections, add the references to the appropriate AIA documents, prepare a bid sheet and add the technical sections. However, like most things within the design and construction industry, it is not that simple.
For example, while discussing one of my project particulars such as: ‘What are acceptable work hours?’ ‘Where will the contractor receive material deliveries?’ ‘Who is providing the construction utilities?’ etc., I also asked about the bonding requirements. The Owner’s response: silence. Then a tentative, “What will they cost?” My reply was for this project they would add about 2.5%-3% of the total construction cost. Again, a pause, and then, “What do I get for that money?”
Perhaps some general education is in order. What are bonds? What are they for? Do I really need them? In the most basic terms, bonds are a type of assurance or a form of a guarantee to protect the Owner against an adverse event that disrupts the award of a contract, failure to complete the project due to contractor insolvency, or failure to meet specific contract specifications. Bonds, unlike insurance (think about your house or car), are three party agreements where the Bonding Agent or Surety is acting as the Contractor’s co-signer or guarantor for a specific performance or contract. Bonds typically come in three flavors: Bid Bonds, Performance Bonds, and Payment Bonds.
Bid Bonds, if required, are submitted with the Contractor’s bid. Their intent is two-fold; first to cover the Owner’s additional cost to rebid the project in the case that the Contractor refuses to honor their bid. Second, to offset the difference in price between the bid and the next lowest bid in the case that the Contractor awarded fails or refuses to execute all contractually required documents and the contract is terminated for default. The penalty amount for a bid bond is often 10%-20% of the bid amount. Bid bonds are returned to unsuccessful bidders after all bids are opened and returned to the successful bidder after all contractually required documents and other bonds are executed.
Performance Bonds guarantee the Owner that the Contractor will complete the contract according to the agreed terms including price and time. If the Contractor defaults, or is terminated for default by the Owner, the Owner may call upon the Surety to complete the contract. Most performance bonds allow the Surety several options to complete the contract. These include completing the work themselves (acting as a construction manager), selecting a different contractor to contract with the Owner, or allowing the Owner to complete the work with the Surety paying the costs. The value of performance bonds are typically for the full contract amount and often are increased when change orders are issued.
Payment Bonds are similar to performance bonds in that they are issued after award and are in effect during the construction period. However, they guarantee the Owner that the Contractor will pay their subcontractors and material venders all monies they are due. In effect, a payment bond attempts to prevent a subcontractor or supplier from placing a mechanics lien on the property. The penal sum in a payment bond is often less than the total amount of the prime contract and is intended to cover anticipated subcontractor and supplier costs.
Ultimately bonding was not required for this particular project because the Owner could accept the inherent risk. In my opinion, it was a good call because the estimated construction cost of $250,000 was below the reserve budget for the work and only established, preselected contractors would be invited to bid on the work. However this is an exception rather than a rule.