There are few achievements that demonstrate human ingenuity and accomplishment as impressively as the feats of engineering, architecture, and construction projects that house businesses, link cities, and transform skylines throughout the nation. Major construction projects bring together an amazing collection of talent, skills, knowledge, and resources and require a high degree of coordination and oversight to make all the moving parts mesh to produce the desired outcome.
Surety Bond Professionals is a family owned and operated bonding agency with over 30 years of experience. With access to a broad range of surety markets, our expert agents are ready to assist with all of your construction bond needs.
Construction Projects
To the average person, the size of the capital investment involved is mind-boggling, and there is always the risk of financial loss stemming from delays, errors, and all sorts of unforeseen events. For example, look at the cost of each of these construction projects currently underway or slated to launch in 2022.
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Amazon HQ2—Arlington, Virginia, $2.5 billion +
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Amazon’s highly publicized search for an east coast home for its second headquarters, dubbed Amazon HQ2, ultimately resulted in a plan for construction on two sites in Arlington, Virginia.
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Buffalo Bills Stadium—Buffalo, New York, up to $2.1 billion
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The lease on the Buffalo Bills’ current home, Highmark Stadium, expires in 2023, and planning efforts for relocating to a new stadium started in 2014.
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California High-Speed Rail—Central Valley Phase, $13.1 billion
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The California High-Speed Rail (CAHSR) grew out of a vision of a “bullet” train spanning the 800 mile distance from Sacramento to San Diego. The environmental benefits of a system of zero emission trains powered entirely by renewable energy are undeniable. When completed, the electrified high-speed rail will keep more than 3,500 tons of pollutants out of the air per year.
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Enbridge Line 5, Great Lakes Tunnel—Michigan, $500 million
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Enbridge Inc., a multinational pipeline company headquartered in Calgary, Alberta, Canada, is embroiled in a decade-long controversy over the construction of the Great Lakes tunnel beneath the Straits of Mackinac connecting Lake Michigan to Lake Huron.
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Hyperloop project—Nationwide, Cost TBD
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The hyperloop project concept was inspired by an idea dating back to 1799 and further developed in 1904 by a freshman at Worcester Polytechnic Institute, who dubbed it the vactrain. It came to the attention of Elon Musk, who first mentioned it publicly in 2012.
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Samsung Chip Factory—Austin TX, $17 billion
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On November 24, 2021, South Korean tech giant Samsung Electronics announced its selection of Taylor, Texas as the site for its new semiconductor manufacturing facility (Samsung Chip Factory), known as a “fab.”
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Edwards Sanborn Solar Storage Facility —Mojave, California, $1.15 billion
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Intended to help California reach its carbon reduction goals when completed in 2023, the Edwards Sanborn solar storage facility is expected to be the largest integrated solar-powered battery storage installation in the world!
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U.S./Mexico Border Wall—U.S. southern border, $15 billion.
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If there was ever a cautionary tale illustrating what can go wrong with a construction project, this is it—the US-Mexico border wall that was a major campaign promise and presidential goal of Donald Trump.
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With so much money at stake, risk management must be a key consideration for project owners and investors. The most powerful risk mitigation strategy in the construction industry is the practice of bonding, specifically the requirement for various types of surety bonds from contractors who are bidding on or awarded major contracts. Different types of construction or contractor bonds serve different purposes, as described below.
Contractor License Bonds
Many states, but not all, require construction contractors to be licensed at the state level. In some states, contractors are licensed only at the local level. And there are wide discrepancies in terms of which types of contractors must be licensed. At both the state and the local level, purchasing a contractor license bond is a common prerequisite for obtaining a contractor license or a building permit.
In purchasing a contractor license bond, a contractor commits to operating in full compliance with all applicable state laws and regulations. A violation that causes financial harm to the project owner, subcontractors, workers, or suppliers can be grounds for the injured party to file a claim for damages against the bond.
Bid Bonds
To bid on large government-funded projects, and increasingly on private projects as well, contractors typically must purchase a bid bond. A bid bond is a bidder’s guarantee to accept a contract if awarded the job and complete it in accordance with the terms of the bid. A bid bond also guarantees the bidder will provide a performance bond if awarded the contract. The amount of a bid bond usually is between 5% and 10% of the total contract amount.
Performance Bond
Project owners usually require a performance bond from the winning bidder before work on a project can begin. A performance bond is a contractor’s guarantee to complete the project in accordance with the terms of the contract. It provides financial protection for the project owner and investors in the event the contractor defaults or fails to complete the work to the project owner’s satisfaction. By filing a claim against the performance bond, we can compensate the project owner for a financial loss stemming from the contractor’s failure to live up to the terms of the contract.
Payment Bond
Contractors awarded large construction jobs typically are required to purchase one or more payment bonds to ensure timely payment of their subcontractors, workers, and suppliers in accordance with the terms of the construction contract and with federal and/or state laws. It’s not the project owner that is protected by a payment bond, but rather the individual subcontractors and suppliers who provide workers and materials for the job.
Federal legislation known as the Miller act requires prime contractors on federal public works projects valued in excess of $150,000 to post both a performance bond and a payment bond. Most states have comparable legislation requiring performance bonds and payment bonds from contractors working on state-funded projects over a certain amount.
Maintenance Bonds
Maintenance bonds are required for most federal and state construction projects. They ensure the cost of remedying construction defects discovered after the completed project is paid by the contractor and does not become a financial liability for project owners. The required duration of maintenance bonds varies, and only construction flaws that are discovered while a bond is active are covered. This type of bond protects project owners against the financial consequences of poor workmanship.
Supply Bonds
A project owner or general contractor can require key suppliers to purchase a supply bond as a guarantee that they will deliver all materials in accordance with the contract. The supplier guarantees the right materials will be delivered on time, in the proper quantity, and at the price agreed upon in the contract. Failure to do so can result in costly construction delays. Supply bonds provide financial protection for project owners and general contractors against the monetary consequences of such failures.
Site Improvement Bonds
Major construction projects often involve making improvements or alterations to public property, such as installing sewers, access roads, sidewalks, utilities, and so on. When this is the case, federal, state, or local authorities can require the contractor to purchase a site improvement bond to ensure the work is done. This bonding requirement protects the government and taxpayer funds if the contractor fails to complete such improvements in accordance with legal and contractual obligations.
General Purpose of Contractor/Construction Bonds
Major construction projects are complicated undertakings, with a lot of “moving parts,” tight budgets and schedules, and numerous opportunities for error. Project owners and investors have a lot of money at stake and need some financial protection against monetary losses caused by a contractor’s failure to live up to contractual and legal obligations. A surety bond provides that protection by indemnifying project owners against liability for such losses and holding contractors responsible for them.
How Contractor/Construction Bonds Work
A surety bond creates a contractual relationship between 3 parties:
- the project owner requiring the bond (the bond’s obligee),
- the contractor required to purchase the bond (the bond’s principal), and
- the company guaranteeing the payment of claims (the surety).
The terms of the surety bond agreement spell out the conditions the principal must meet to avoid claims against the bond.
The obligee establishes the required bond amount, also known as the bond’s “penal sum.” This is the maximum amount that will be paid out on claims and is proportional to the total value of the construction contract. The surety investigates each claim filed against the bond and determines whether it is legitimate. In many cases, the surety will try to negotiate a settlement, but when that is not possible, the claim must be paid.
Paying a claim against a surety bond is not quite as straightforward as it might seem. The principal is legally obligated to pay all valid claims. However, the surety has guaranteed the payment will be made. Therefore, it’s common practice for the surety to pay a claim initially, on the principal’s behalf. That initial payment does not eliminate the principal’s legal obligation. But now the principal must repay the surety because the claimant has already received payment, and the principal must reimburse the surety for having paid the claim on the principal’s behalf. It’s an arrangement whereby insurers prompt payment of a valid claim while giving the surety some time to gather the funds necessary to cover the claim amount.
Like the obligee, the surety is indemnified against any legal responsibility for any financial losses caused by the principal’s default or unlawful or unethical business practices. Consequently, the surety has the right to take legal action against a principal who fails to provide reimbursement for the claim amount.
How Much Do Construction Surety Bonds Cost?
In providing a contractor with a bond, the surety agrees to extend credit to the contractor by paying claims on the contractor’s behalf should the need to do so arise. Even though the surety conducts an underwriting assessment of each bond applicant’s credit history, financial statements, and industry experience, there is always a risk of not being reimbursed for paying a claim. The surety’s main concern in setting a premium rate for the bond is the extent of that risk.
A bond applicant with a high personal credit score typically will be assigned a low premium rate, because the risk is most likely low. Conversely, a low personal credit score suggests a higher level of risk for the surety, which warrants a higher premium rate.
