A Guide to Construction Bonding Requirements with the New Infrastructure Investment Jobs Act

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A Guide to Construction Bonding Requirements with the New Infrastructure Investment Jobs Act

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What Is the Infrastructure Investment and Jobs Act?

The November 2021 passage of the Infrastructure Investment and Jobs Act authorized a total of $1.2 trillion in spending, including $550 billion in new spending on a variety of infrastructure projects intended to upgrade, expand, and/or replace the nation’s aging and overburdened infrastructure—roads and bridges, the electric grid, rail systems, transit, ports, airports, water systems, and so on. Broadband expansion and the creation of a network of electric vehicle chargers address two pressing 21st century infrastructure needs that didn’t even exist only a couple of decades ago. The Inflation Reduction Act signed into law in August 2022 added another $369 billion to the total funding for infrastructure-related projects. As a result of this unprecedented investment in infrastructure, the construction industry is likely to see a similarly unprecedented boom.

Impact on Construction Bonding Requirements

One rule included in the Infrastructure Investment and Jobs Act is intended to address a gray area in the federal construction bonding requirements established by the Miller Act of 1935. The Miller Act requires prime contractors on federally funded projects to provide certain surety bonds for contracts in excess of $100,000 that involve building, remodeling, or repairing Federal buildings.

However, the Federal Acquisition Regulations (FAR) established uniform policies and procedures for the federal procurement process to ensure transparency, fairness, and impartiality. These procurement regulations take precedence over the contract amounts specified in the Miller Act, and FAR Part 28 requires bonding only for contracts exceeding $150,000.

The problem, however, is not a matter of project size but rather in the applicability of bonding requirements for non-government projects. The gray area lies in the fact that many states are encouraging public-private partnerships (known as P3s) on projects arising from the Infrastructure Investment and Jobs Act. Yet the Miller Act and FAR apply only to contracts funded by the federal government. Although most states have their own version of the Miller Act (referred to as Little Miller Acts), they apply only to projects financed by state funds. Consequently, the Infrastructure Investment and Jobs Act includes a rule requiring payment and performance bonds on all federally financed infrastructure projects, including P3 projects.

One of the things the Infrastructure Investment and Jobs Act did was direct the Secretary of Transportation to submit to Congress a report analyzing the regulatory barriers to the increased use of P3s and private investments in transportation infrastructure projects. The Infrastructure Investment and Jobs Act also amended some aspects of the Transportation Infrastructure Finance and Innovation Act (TIFIA), which provides credit assistance for qualified transit-oriented infrastructure projects to state and local governments, transit agencies, railroad companies, special authorities, and private entities. Some of the changes are related specifically to P3 projects. For example, both public and private sector borrowers receiving TIFIA financing now are required to obtain both payment and performance bonds.

What Construction Bonds May Be Required?

The term “construction bonds” (sometimes referred to as “contractor bonds”) encompasses a variety of different types of surety bonds. Not all of them are required for every project. Which bonds are required for a particular infrastructure project depends on such factors as the nature of the contracting relationship and the type of work being done.

Bid Bonds

Federal and state procurement processes are exacting and time-consuming. By the time a contractor has been selected through competitive bidding, a public project owner has invested a great deal of time and effort in the search. Unfortunately, sometimes the winning bidder backs out at the last minute. It’s not uncommon for contractors to bid on multiple projects at the same time, hoping to increase their chances of landing at least one of them. Being selected for one project may cause them to turn down another because they don’t have the capacity to take on more than that. And sometimes a contractor will low-ball a bid only to arrive at the conclusion that the work can’t be done for that amount and withdraw their bid after being selected.

A bid bond protects the project owner against the financial burden of having to go through the entire solicitation, evaluation, and selection process again. A bid bond also provides financial protection for the project owner if the winning bidder cannot qualify for the performance and payment bonds required of the chosen contractor.

[Bid Bonds]

Performance Bonds

A performance bond protects the project owner from the financial consequences of a contractor’s failure to complete the job in accordance with contract requirements and specifications, including defaulting on the contract. The performance bond ensures funds will be available to remediate the problem, whether that means working with the original contractor or bringing in another contractor to finish the job.

Payment Bonds

A payment bond ensures that the contractor will pay subcontractors, suppliers, and workers according to contractual requirements. If the contractor becomes insolvent before the project’s completion, without paying them, these parties can file a claim against the bond and be compensated for what is owed them, up to the full amount of the bond. Payment bonds help prevent liens against the property. In some cases, performance and payment protections are combined in one surety bond.

[Payment and Performance Bonds]

Supply Bonds

Supply chain disruptions can cause major delays on large projects. Suppliers working on major construction projects may be required to furnish a supply bond to guarantee on-time shipments. In most cases, it’s the project owner rather than the prime contractor requiring a supply bond.

[Supply Bonds]

Timber Sales Bonds

Infrastructure projects may require the clearing of federal or state-owned lands, and that often involves paying a fee to the government. A timber sales bond provides a way to compensate the government when a contractor fails to remit the necessary fees in a timely fashion.

Maintenance Bonds

Also known as warranty bonds, maintenance bonds are purchased by the contractor after project completion. A maintenance bond is a guarantee of the quality of the work and that no defects will surface for a specific period of time after project completion (the warranty period). The bond provides compensation for the project owner should it become necessary to pay for repairs while the bond is in force.

[Maintenance Bonds]

Who Is Party to a Surety Bond Agreement?

Any construction surety bond establishes a legally binding contract among three parties with distinctly different roles and responsibilities.

  • The project owner, as the party requiring the bond and protected financially by it, is known as the bond’s “obligee.” The obligee establishes the required bond amount based on the risk exposure.
  • The contractor, the party required to provide the obligee with the bond, is referred to as the bond’s “principal.” The principal must operate in full compliance with the terms of the surety bond agreement, which spells out what constitutes a violation that could result in the obligee (or other injured party) filing a claim against the bond. The principal is legally obligated to pay all legitimate claims that cannot be settled to the obligee’s satisfaction.
  • Finally, the “surety” is the party guaranteeing the bond, or more accurately, guaranteeing the principal’s payment of valid claims. The surety has the right not to approve a bond applicant that is considered to be too risky. The surety also determines which claims are valid and need to be paid, and sets the premium rate on a case-by-case basis.

How Do Construction Surety Bonds Work?

The biggest misunderstanding about construction surety bonds is that they work the same as insurance. That is a fallacy, insurance protects the person who buys it. That is not the case with surety bonds. A surety bond protects the obligee, not the principal.

In approving a surety bond application, the surety is agreeing to extend credit up to the full amount of the bond, if that’s what it takes for the principal to pay a valid claim against the bond. There may be some instances where the principal is able to pay a bond claim without borrowing from the surety, but those are few and far between.

Typically, upon receipt of a claim against a construction bond, the surety will investigate it thoroughly, and if it is found to be valid, may attempt to negotiate a settlement with the obligee. But if no settlement is possible, the surety will live up to its guarantee by paying the claim on behalf of the principal, though only initially.

Any payment the surety makes directly to a claimant is a loan from the surety to the principal. It does not relieve the principal of the legal obligation to pay all valid claims. It simply transforms that obligation into a legal obligation to repay the debt to the surety. Like any other creditor, the surety has the right to take legal action against a principal that fails to repay the outstanding debt. If legal action becomes necessary, the principal will end up owing court costs and legal fees as well as the amount fronted by the surety.

How Much Do Construction Surety Bonds Cost?

The annual premium for a construction surety bond is determined by multiplying two factors: the required bond amount established by the obligee and the premium rate assigned to the principal by the surety at the time the bond is purchased.

The premium rate is the result of an underwriting assessment of the risk to the surety—specifically the risk of a loss, and risk of not reimbursing the surety for claims paid on the principal’s behalf. The underwriters give weight to the principal’s financials, along with personal and business credit score, which reflects how responsible the principal has been about paying debts and managing credit in the past. A high credit score is viewed as a sign of low risk to the surety, while a low credit score is a red flag for a higher risk level.

The principal’s credit score, as important as it is to the underwriting risk assessment, is not the only factor considered, however. The surety takes into account the size and nature of the project, the principal’s industry experience and track record for successful job completion, any prior claims history, and the principal’s assets and overall financial strength. The lower the risk to the surety, the lower the principal’s premium rate. A higher risk level warrants a higher premium rate.

Help is Available for Meeting Bonding Requirements

Newer construction companies may find it difficult to obtain the construction bonds required to make the most of the opportunities presented by the Infrastructure Investment and Jobs Act. Surety bond providers are understandably wary of contractors that don’t have a substantial track record demonstrating their capacity to bring a project to successful completion.

The Small Business Administration’s bonding guarantee program can help. SBA guarantees the surety bonds issued through certain participating surety bond providers, reducing the risk those sureties would otherwise be taking in helping smaller and newer contractors meet bonding requirements. The SBA guarantees bid bonds, performance bonds, payment bonds, and other types of construction bonds for contractors that:

  • Meet the SBA’s definition of a small business,
  • Have a non-federal contract for up to $6.5 million or a federal contract for up to $10 million, and
  • Meet the surety’s credit, capacity, and character requirements.

P3s Are Here to Stay

Public-private partnerships have been gaining in popularity for civil construction projects since the early 2000s. The fact that P3s are mentioned in the Infrastructure Investment and Jobs Act 42 times is a good indication that this trend will continue, opening up new opportunities for U.S. construction firms, particularly if the prediction of historic growth in the construction industry proves to be accurate. Along with those new opportunities come new bonding requirements that contractors must be prepared to meet. This is the time to focus on building a relationship with a trusted surety bond provider.

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