The 4 Main Types of Construction Bonds Explained
Construction bonds are required by a variety of project owners when they are looking to build a construction asset or have a service performed. Construction owners are spending significant sums in procurement and construction and want assurance that the bidders are qualified, serious about the project and have the ability to complete the scope of work. There are four main types of Construction Bonds that can be required in these cases. Those are as follows:
1) Bid Bond
A bid bond is a document that is provided with a contractor’s tender package and submitted to the project owner on the closing date of the tender. The bid bond guarantees to the owner that if the contractor is the low bidder and awarded the project that they will enter into a contract.
If they do not, then the project owner can place a claim against the bid bond for either the value of that bond or the difference between the first and second bidder, whichever is less. The purpose of this bond is to ensure that if a contractor backs out, an owners costs of having to re-tender or award to the second bidder are covered. Take the following example:
Contractor A submits a bid to the City of Toronto. Unfortunately, Contractor A makes a significant error in their bid and doesn’t include a price for a division of work. They are low bidder and Contractor A is awarded the work. They refuse to enter into the contract because the project would lose money. At this stage the owner could place a claim against the bid bond.
2) Agreement to Bond (a.k.a. Surety’s Consent or Consent of Surety)
This is a document that is included with the bid bond and submitted with the contractor’s tender package to the project owner on the closing date of the tender. The Agreement to Bond is a promise from the contractor’s surety that if the contractor is awarded the contract, the surety company will issue the required final bonds (performance bond and/or labor and material payment bond). The purpose of this construction bond is to avoid having the surety refuse to issue final construction bonds.
Contractor A submits a bid to the City of Toronto. Contractor A is low on the project and an award is issued by the City of Toronto. Prior to the issuance of the performance bond the surety asks the contractor for a routine financial update to access the results of the contractor.
Unfortunately, the contractor sustained a significant loss which has made the surety unwilling to provide the performance bond. If an agreement to bond was issued on this project then the surety would be required to provide this despite Contractor A’s financial hardship.
3) Performance Bond
This is a document provided by the contractor to the project owner if they are successful on their tender and are awarded the contract. This is submitted to the owner shortly (usually within 10 days) after contract award and signing. The performance bond guarantees to the owner that the contractor will perform the conditions of its contract with the project owner.
If the contractor fails in its obligations and is placed in default and terminated according to the contract terms then the project owner can claim again the performance bond to have the surety remedy the claim using the options under the bond. In most cases, this would involve the surety finding a new contractor and paying them to complete the remaining work and fix any issues on the project.
Contractor A is the successful contractor on a bid to the City of Toronto. They are awarded the contract and supply a performance bond to the owner. During the project, Contractor A runs into financial difficulties and is unable to complete the contract.
The project owner places Contractor A in default and subsequently terminated their contract. They could then place a claim against the performance bond which the surety would investigate and if valid, would remedy the claim according to the provisions of the performance bond.
4) Labour and Material Payment Bond
This is a document that is provided by the contractor to the project owner if they are successful on their tender and are awarded the contract. This is submitted to the owner shortly (usually within 10 days) after contract award. It is issued in conjunction with a performance bond and is never issued on its own.
The labour and material payment bond guarantees to sub-trades and suppliers of the contractor that they will be paid according to the conditions of their contracts, purchase orders or applicable legislation. If a sub-trade or supplier is not paid within these terms they can place a claim against this bond.
Contractor A is successful on a bid to the City of Toronto. They are awarded the contract and supply a performance bond and labour and material payment bond. During the course of the project, Contractor A runs into cash flow issues and is unable to pay Sub-Trade A. Sub-Trade A can then claim against the labour and material payment bond to be made whole on their legitimate unpaid invoices.
The above are the main types of construction bonds that a general contractor, sub-trade or supplier will run into on a bonded project. To provide these bonds the contractor will need an established surety facility. An experienced construction bond broker can assist with establishing that facility for your organization. This will ensure that you have competitive terms and also that you understand your obligations under these bonds.