Mitigating Construction Risks With Surety Bonds – What You Need To Know
Throughout 2015, the construction industry experienced expansion that is expected to wane somewhat pushing into 2017. However, demands continue to rise for new office spaces, hotels, and even recreational locations.
Fortunately, surety bonds through a place like NFP, P & C, Inc. can provide the risk mitigation needed to ensure a job well done. Whether you work in the construction industry or you plan on hiring a construction company in the near future, there are some things you should know about surety bonds. The more you know about surety bonds the risks they help mitigate, the better prepared you will be moving forward with your construction project.
What is it?
To begin with, a surety bond involves three parties, which includes the obligee, or the owner, the principal or contractor, and the surety company. The surety company provides assurance to the obligee that the contractor will perform all the details defined in the contract. If the contractor fails to perform all the details defined in the contract, the surety company assumes the risk of said defaults.
In this case, the owner is then compensated by the surety company to cover the cost of damages, poor workmanship, and other expenses incurred by the owner through a failed contract. Of course, the surety company will pursue the contractor to then recoup their expenses back. However, the most important realization is that a surety bond helps mitigate risks to the owner or the person seeking new construction.
Types of Surety Bonds
There are three different primary surety bonds to consider when hiring a contractor to perform construction work. The first is a bid bond. The bid bond provides assurance that a contractor submitting a bid for work has done so in good faith. When a contractor bids on work, the bid bond ensures that the contractor intends to enter the contract at the bid provided.
Next up is the performance bond. A performance bond is what protects the owner from any financial loss should the contractor fail to perform the details of the contract. Always make sure a contractor has a performance bond before they break ground. Without a performance bond, you may find yourself spending out far too much to correct any mistakes or tasks left unfulfilled by the contractor.
The third and final bond is the payment bond. Many companies both large and small often lack the resources to complete all tasks laid out before them. For that reason, companies will often hire subcontractors to complete tasks for them. Subcontractors are quite common in the construction industry. Perhaps the construction industry has so many tasks to fulfill that they lack the manpower and need to subcontract the work.
Whatever the reason, a payment bond ensures that the contractor will pay subcontractors, workers, and even material suppliers. A contract will often determine the amount that workers and subcontractors will receive for the work performed. If the contractor fails to pay the amount defined by the terms and conditions of the contract, the surety bond will protect those workers and subcontractors from a loss of wages.
To provide a surety bond, the surety company requires that the contractor meet certain rigorous requirements. Considering that the surety company is assuming a large part of the risk involved with a construction project, they want to ensure the contractor is reliable and eligible to carry out their duties. For that reason, surety companies will require stringent criteria, including:
- Excellent references/reputation
- Capacity to meet current and future obligations
- Experience needed to carry out obligations
- Necessary equipment to complete details of the contract
- Financial strength to support obligations
- Excellent credit history
- Established relationship with a bank
- Established line of credit
Because contractors must fulfill the criteria listed above to receive a surety bond, it helps mitigate risks. A contractor that can fulfill all the criteria listed above is more likely to provide you with solid work and great craftsmanship.
Overall, surety bonds are a great way to go because of their state and federal regulations. They are an excellent choice for both the contractor and the owner in terms of mitigating risk. The only party that truly assumes any risk with a surety bond is the surety company, which is why a surety bond is a worthwhile investment for all construction projects.