Several types of bonds exist in the development world. So, which type of bond is best for your project?
A payment and performance bond is a combination instrument. It’s first a payment bond that guarantees that the contractor will pay the labor and material costs they are obliged to pay. But it’s also a performance bond that guarantees satisfactory completion of a project by the contractor. By design, a payment bond is designed to provide security to subcontractors and materials suppliers, ensuring payment for their project work, labor and/or materials. A performance bond (also called a surety bond), is issued by an insurance company or a bank. It protects the owner from the contractor’s failure to perform in accordance with the terms of the contract.
A job requiring a payment and performance bond may require a bid bond just to bid the project. A bid bond (often required on public construction projects, but not exclusively) is designed to protect the owner in the event the bidder refuses to enter into a contract after the contract is awarded or if the bidder withdraws the bid before award. In short, a bid bond is an indemnity bond. When the job is awarded to the winning bid, a payment and performance bond is issued.
Bid bonds, performance bonds and payment bonds are all indemnity bonds. Let’s be clear; these bonds are not insurance policies. If a claim arises and is paid out on a bid, performance or payment bond, the surety (the party issuing the bond) will look to the contractor to indemnify and defend it. If a claim is asserted against a contractor performance bond, the surety is going to look to the contractor to defend the lawsuit and to pay any damages.
A completion bond (sometimes called a completion guarantee) is a form of insurance offered by a completion guarantor company. In return, the guarantor receives a percentage fee based on the project budget. The parties to the completion bond agreement are typically the developer/owner, the financier(s), the completion guarantor company and the contractor. If the bank requires one, a completion bond can be provided to give the lender the required level of security against the risk of non-delivery of the project by the developer or owner. The bond fee itself is negotiable depending on the risks as assessed by the completion guarantor. The completion guarantor will require a regular flow of project schedule paperwork. Under the bond agreement, the completion guarantor has the contractual right to “take over the project” (which will include wide “hire and fire” rights over any personnel) since they are financially liable if the project goes over budget.
With several options available, what is the best bond choice? Cost is a consideration, as the premium for a payment and performance bond is about half the cost of a completion bond. We recommend clients pursue a payment performance bond linked where appropriate to a sub-guard insurance policy.