Common Types of Surety Bonds
A Bid Bond is given to a Federal, State, County or Municipal Government agency at the time of a bid to guarantee the good faith of the Contractor (Principal). If the Principal is awarded the contract, the Principal will enter into the contract and post the required Performance and Payment Bonds. Bid bonds are typically required as a percentage of the bid, usually 5%, 10% or 20%.
Failure to enter the contract and post the Performance and Payment Bonds generally leads either to forfeiture of the Bid Bond (usually 5% to 20% of the bid) or more commonly, payment of the difference between the bidder’s price and the second low bidder’s price or the bond amount, whichever is less. Bid bonds are usually required on public projects with formal competitive bidding, but are less frequently used on private projects.
The Performance Bond follows the Bid Bond if the Principal (Contractor) is awarded a contract by the owner. The Performance Bond is a non-cancellable obligation which guarantees that the contractor will complete the contract in accordance with the terms, conditions and specifications of the contract. It is required as a condition of being awarded the contract.
If the Principal defaults, or is terminated for default by the owner, the owner may call upon the surety to complete the contract. Many performance bonds give the surety three choices:
- completing the contract itself through a completion contractor (taking up the contract);
- selecting a new contractor to contract directly with the owner;
- or allowing the owner to complete the work with the surety paying the costs
The penal sum of the Performance Bond is usually 100% of the construction contract, and is automatically increased when change orders are issued. The premium charged for the Performance Bond is always based on the final contract price.
A Payment Bond is usually required as a companion to the Performance Bond, guaranteeing that material suppliers and direct labor suppliers will be paid. There is no charge for Payment Bonds when issued in conjunction with a 100% Performance Bond.
Payment Bonds guarantee payment of the contractor’s obligation for subcontractors, laborers, and materials suppliers associated with a project. Since liens may not be placed on public jobs, the Payment Bond may be the only protection for those supplying labor or materials to a public job.
License and Permit Bonds
These bonds are required as a condition of receiving a license to engage in certain construction activities or as a condition of receiving a permit. These bonds are generally compliance-related and guarantee that the Principal will adhere to his or her obligations under the license or permit. These bonds are designed to protect the general public as well as the governmental agency issuing the permit or license. License or Permit bonds are required from businesses as well as individuals. Typically these bonds are cancelled by the surety with written notice to the Obligee, when no longer needed by the principal.