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The Importance of Surety Bonds in Construction

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The Importance of Surety Bonds in Construction construction contractors, and special trade contract amount, depending on the size, type, and Surety Information Office contractors operating in 2009, only 702,618 were still duration of the project and the contractor. Typically, (SIO) in business in 2011—a 21.72% failure rate. Despite there is no direct charge for a bid bond. In many www.sio.org the surety’s rigorous prequalification process and cases, a performance bond incorporates the [email protected] The Surety Information Office (SIO), formed in 1993, disseminates best judgment about the qualifications of the payment bond and a maintenance period. information about the benefits of contract and other forms of The Importance contractor, sometimes contractor default is The contractor includes the bond premium surety bonding in private and public construction. SIO, a virtual unavoidable. However, when a contractor fails on a amount in the bid and the premium generally is office, is supported by the National Association of Surety Bond bonded project, it is the surety company that payable upon execution of the bond. If the contract Producers (NASBP), www.nasbp.org, and The Surety & Fidelity of Surety Bonds remedies the default—not the project owner and not amount changes, the premium may be adjusted for Association of America (SFAA), www.surety.org. For information on the benefits of surety bonds in construction and in other at taxpayers’ expense. the change in contract price. Contract surety bonds contexts, contact the Surety Information Office at [email protected]. In the unfortunate event that a bonded contractor are a wise investment—protecting public owners, does default, the surety has legal obligations to the private owners, lenders, and prime contractors from National Association of Surety Bond Producers project owner and the contractor. First, the owner the potentially devastating expense of contractor and (NASBP) must formally declare the contractor in default. Then subcontractor failure. 1140 19th St. NW, Suite 800 the surety company conducts an impartial Washington, DC 20036 investigation before settling any claim. This protects Benefits of Bonds (202) 686-3700 the contractor’s ability to pursue legal recourse in the (202) 686-3656 Fax www.nasbp.org event that the owner improperly declares the After analyzing the risks involved with a construction project, consider how surety bonds protect against [email protected] contractor in default. When there is a proper default, The National Association of Surety Bond Producers (NASBP), the surety’s options often are spelled out in the bond. those risks. Owners, lenders, taxpayers, contractors, founded in 1942, is the association of and resource for surety These options may include the right to re-bid the job and subcontractors are protected because: bond producers and allied professionals. NASBP producers for completion, bring in a replacement contractor, n The contractor has undergone a rigorous specialize in providing surety bonds for construction contracts and other purposes to companies and individuals needing the provide financial and/or technical assistance to the prequalification process and is judged capable of fulfilling the obligations of the contract; assurance offered by surety bonds. NASBP producers engage in existing contractor, or pay the penal sum of the contract and commercial surety production throughout the U.S., bond. n Contractors are more likely to complete bonded Puerto Rico, Guam, and a number of countries. They have broad projects than non-bonded projects since the knowledge of the surety marketplace and the business strategies surety company may require personal or and underwriting differences among surety companies. As trusted corporate indemnity from the contractor; advisors, professional surety bond producers act in many key roles to position their clients to meet the underwriting n Subcontractors have no need to file mechanic’s requirements for surety credit. liens on a private project when a payment bond is in place, and because mechanics’ liens cannot be The Surety & Fidelity Association of America placed against public property, the payment bond (SFAA) may be the only protection these claimants have if 1140 19th St. NW, Suite 500 they are not paid for the goods and services they Washington, DC 20036 (202) 463-0600 provide; (202) 463-0606 Fax n Bonding capacity can increase a contractor’s or www.surety.org subcontractor’s project opportunities; [email protected] n The surety bond producer and underwriter may be The Surety & Fidelity Association of America (SFAA) is a District able to offer technical, financial, or management of Columbia non-profit corporation whose members are engaged in the business of suretyship worldwide. Member companies assistance to a contractor; and collectively write the majority of surety and fidelity bonds in n The surety company fulfills the contract in the the United States. SFAA is licensed as a rating or advisory In Construction event of contractor default. organization in all states, as well as in the District of Columbia and Puerto Rico, and it has been designated by state insurance Any contractor—whether in business for one year departments as a statistical agent for the reporting of fidelity and or 100, large or small, experienced or novice—can surety experience. SFAA represents its member companies in experience serious problems. Through the years matters of common interest before various federal, state, and Bond Rates surety bonds have held fast as a comprehensive and local government agencies. reliable instrument for minimizing the risks in Surety bond premiums vary from one surety to construction. another, but can range from 0.5% to 2% of the © 2012 Surety Information Office The Importance of Surety Bonds do not provide the 100% Prequalification of the Contractor performance protection and 100% in Construction payment protection of surety Sureties are able to accept the risk of contractor bonds nor do they assure a failure based on the results of a thorough, rigorous, competent contractor. With and professional process in which sureties prequalify the contractor. This prequalification process is an in- commitment or qualification is uncertain or surety bonds, the risks of Historical Perspective depth look at the contractor's business operations. who could become bankrupt halfway project completion are shifted Before issuing a bond the surety company must be Surety bonds have been a valuable tool for through the job can be a costly decision. from the owner to the surety fully satisfied that the contractor has, among other centuries. The first known record of contract How can a public agency using the low-bid company. For that reason, criteria: suretyship was an etched clay tablet from the system in awarding public works contracts be many private owners require Good references and reputation; Mesopotamian region around 2750 BC. According to sure the lowest bidder is dependable? How can surety bonds from their n The ability to meet current and future obligations; the contract, a farmer drafted into the service of the private sector construction project owners contractors to protect their n The experience matching the contract king was unable to tend his fields. The farmer manage the risk of contractor failure? company and shareholders from the n requirements; contracted with another farmer to tend them under Surety bonds provide financial security and enormous cost of contractor failure. The necessary equipment to do the work or the the condition they split the proceeds equally. A local construction assurance by assuring project owners To bond a project, the owner n ability to obtain it; merchant served as the surety and guaranteed the that contractors will perform the work and pay specifies the bonding requirements The financial strength to support the desired work second farmer’s compliance. specified subcontractors, laborers, and material in the contract documents. n program; Suretyship was addressed in the first known suppliers. A surety bond is a risk transfer Obtaining bonds and delivering An excellent credit history; and written legal code, the Code of Hammurabi, around mechanism where the surety company assures the them to the owner is the n An established bank relationship and line of credit. 1792-1750 BC. A Babylonian contract of financial project owner (obligee) that the contractor (principal) responsibility of the contractor, who n The surety company must be satisfied that the guarantee from 670 BC is the oldest surviving written will perform a contract in accordance with the will consult with a surety bond contractor runs a well-managed, profitable surety contract. The Roman Empire developed laws contract documents. producer. Subcontractors may of surety around 150 AD that exist in the principles of also be required to obtain enterprise, keeps promises, deals fairly, and suretyship today. surety bonds to help the performs obligations in a timely manner. Surety While suretyship has a long history, it wasn’t until Types of Bonds prime contractor manage bonds have played an important role in the the 19th century that corporate surety bonds were risk, particularly when the construction industry’s success, allowing the used. Recognizing the need to protect taxpayers There are three basic types of contract surety subcontractor is a significant industry to sustain its position as one of the largest from contractor failure, Congress passed the Heard bonds: part of the job or a contributors to the nation’s economic stability and Act in 1894, which required surety bonds on all n The bid bond assures that the bid has been specialized contractor that is growth. federally funded projects. The Miller Act of 1935 (40 submitted in good faith and that the difficult to replace. U.S.C. Section 270a et. seq.) was the last major contractor will enter into the contract at the Most surety companies are Contractor Failure price bid and provide the required change in public sector surety, and is the current subsidiaries or divisions of Construction is a risk-filled enterprise, and even performance and payment bonds.
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