A construction bond is a surety bond that protects against financial loss on a construction project. It is a contract between a contracting entity or the person who is having work done, the contractor or the person doing the work, and the bond issuer or surety company who is making sure that the work gets done.
How Does a Construction Bond Work?
These bonds function as financial security for contracting entities and they guarantee compensation if the contractor violates the conditions of the agreement. Construction bonds are issued for a specific value which represents the maximum compensation that the surety may extend to the contracting entity. Compensation is made if the contractor violates the agreement, causing losses or damages, and the contracting entity files a claim against the bond. Simply put, if the work isn’t completed or if there is damage as a result of the work, then the surety company will pay the damages to the customer. However, they do not stand the final liability. Even if they cover the claim, the bonded contractor must reimburse the surety in full.
Types of Construction Bonds
There are three types of construction bonds. These are Bid bond, performance bonds and payment bonds.
Bid bonds – these are sometimes required by governments to guarantee that contract bids are made in good faith. They are meant to protect the contracting entity against any frivolous or low-ball construction bids. Before bidding on a public works project, a contractor will need to secure a bid bond. This bond guarantees that if the bid is selected, the contractor accepts the job and will perform it for the price bid. If they default, the public entity can make a claim against the bond as a penalty.
Performance bonds – these ensure the construction work will be completed on time and to the required standard. A performance bond guarantees that the contractor will fulfill all their obligations under the contract. If the contractor fails to perform according to the contract, the entity can submit a claim against the bond. The surety company can decide to pay for the cost of completion, finance the current contractor, or takeover the completion of the project by hiring their own contractor.
Payment bonds – these give financial protection to subcontractors and others who provide services and materials to the construction company. If a project participant goes unpaid, they can make a claim against the bond. Consider a payment bond as a “pile of money” that protects the property from lien claims.
Are Construction Bonds Refundable?
There is no straightforward answer to this question since there are many factors to consider. There are many aspects involved when determining whether a construction bond is refundable or not. For instance, when a construction bond is first purchased, it is fully earned during the first term. In this case, the contractor may not be eligible for a refund. However, if the bond was never submitted to the contracting entity, then it may be possible to qualify for a full, partial, or pro-rated refund depending on the situation. Other situations that may determine eligibility for a refund include a business being bankrupt, or if the contractor purchased the wrong bond. It is important to speak directly with the surety company as they will provide guidance on this process.
Construction bonds are important for contractors and contracting entities in order for them to protect their financial assets. While they may seem complicated, there is always help available to get started on these. At Risiko, we can help. We protect your company through bonds and insurance.