Understanding Surety Bonds
We’ve already done an in-depth explanation of what surety bonds are, but we’ll sum it up briefly. A surety bond is a three-party agreement, a written contract between the principal, the obligee, and the surety.
The document is issued by a surety and legally compels the principal to fulfill contractual services or to adhere to laws and regulations that is required by the obligee. The surety provides a financial guarantee to the obligee if the principal fails to meet their obligations as stipulated in the bond.
There are thousands of different surety bonds and surety bond obligations. However, one example, a bonded moving company is hired by a family to transport fragile goods to their new house. The bond is a legal promise that the company will fulfill its contractual duty to the obligee – that is, they’ll get the family’s goods to their destination in perfect condition.
To help hold the company (the principal) to their promise, their surety provider has agreed to compensate the family (the obligee) if their belongings are damaged or destroyed. If the obligee files a claim and the surety pays out, the principal will, in turn, must indemnify the surety for their loss. Basically, a surety bond is a failsafe protective measure to ensure that the obligee gets what they pay for and that the principal performs their service as promised.
Why Bond?
The number one reason is because it is required by the owner. Whether it is a public job and required by law, or a private owner wants the added protection that the project will be completed as agreed, typically a surety bond will be part of the agreed-upon contract.
Although most contractors will never have a bond claim, it’s good to have the added protection that it provides. Being bonded makes your company look professional, conscientious, and dependable.
And although it’s not required for all contractors, a surety bond can be a big selling point for clients who care about good practice. When providing quotes to unbonded bonds, there may be a requirement to provide a bondability letter. This essentially lets the owner know that the contractor has the capability to provide bonds if needed.
Terms to Know
Here are some other terms you’ll want to familiarize yourself with as a bonded—or soon-to-be bonded—contractor.
Surety Bond Claim
An obligee can file a claim against the principal’s surety bond if they believe that the principal has violated the terms of their contract. If the surety ends up stepping in and releasing funds for the completion of the job in any way, the principal will subsequently be forced to repay their debt to the surety.
Penalty Sum/Bond Amount
The maximum payout that a surety will provide in the event of a valid bond claim being filed.
Surety Underwriting
Before issuing a bond, the surety will first determine the principal’s risk level by examining their financial and business history. The surety bond cost will then be set depending on the principal’s assessed risk level.
General Indemnity Agreement
The general indemnity agreement is the contract that legally binds the surety and the principal, ensuring financial compensation for valid bond claims.
*Note that the bond cost and the penalty sum/bond amount are not the same. The bond cost is what the principal pays to the surety company to be bonded. The bond amount is the maximum sum that the surety will offer to the obligee in the event of a valid claim. The bond cost is typically between 1% and 15% of the total bond amount.
The Name’s Bond
There are also a handful of different bond types required for public construction projects that you should be aware of. These are all specific subsets of surety bonds.
Bid bond
Bid bonds are a contractual guarantee that the successful bidder will take on the contract and provide the necessary performance and payment bonds.
Payment Bond
Payment bonds help protect certain suppliers, subcontractors, laborers, and other involved parties from non-payment by the bonded party.
Performance Bond
A performance bond solidifies the bonded party’s agreement to perform the duties as stipulated in the contract. This means they will abide by the terms and conditions of the contract, timeline, price, and more.
The Miller Act
Enacted in 1935, the Miller Act is a law that requires all contractors bidding and working on federal construction projects to post surety bonds. The Miller Act also applies to all contracting projects that exceed the scope of $100,000. Under the Miller Act, both payment and performance bonds are required for contractors bidding and working on applicable projects.
Because the U.S. government doesn’t qualify for the protections offered by a traditional lien, the Miller Act was created to protect federal project workers and affiliates from non-payment. Anyone working on federal construction projects must be bonded by a corporate company registered as a qualified surety under the U.S. Department of Treasury.
While comprehensive recordkeeping is vital for all construction projects, it’s especially critical under the Miller Act. Be sure to note and catalog all records of related contracts, delivery tickets, invoices, and the like. You should also mark down comprehensive details about which materials were supplied, where they were supplied, and which team members received and supervised the delivery.
Federal Construction
But what exactly is the difference between, say, a residential construction project and a federal construction project? It’s worth exploring since the Miller Act applies specifically to federal projects. It’s quite simple. Federal construction projects are performed on sites and buildings owned and controlled by the federal government, including government buildings, courthouses, public works projects, and the like.
Rules & Regulations
To comply with the Miller Act, contractors must:
- Supply a performance bond to protect the government.
- Supply a payment bond to protect other affiliated parties, including laborers, suppliers, subcontractors, and subcontractors and suppliers hired by the initial subcontractors (these are called ‘second-tier claimants’).
- Note that a contracting officer can waive the bond requirements if the work is being performed abroad.
- Note that the Federal Acquisition Regulation may request additional protections/bonds to contractors working on jobs costing between $25-100,000.
- Not require a subcontractor to waive its payment bond rights before beginning work.
Before launching into a new job, it’s essential to understand the rules and regulations that govern the work. You should be able to protect not only yourself and your reputation but also the security of your team members and clientele.
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