Many owners of construction companies know the process of getting a surety bond, but aren’t aware of what type of law contract they’re entering, purchasing that bond. It’s a relationship between the principal (the construction company), obligee (a person or organization who requires such bond), and surety (a company which gives you the guarantee).

Let’s start from explaining what a bond is.
Surety bond is not insurance.
It is a guarantee, given by surety that the construction company will meet the obligations stated in a bond, for example:

1. Obligation of a “payment bond” – it is a guarantee of a payment - in which construction company will pay the remittance to subcontractor and suppliers;
2. Obligation in “performance bond”- a guarantee of proper execution of a contract – completing the project in timely manner and on a given budget;
3. Obligation in “permit & license bond” – in a license bond and a permit for construction – it is a guarantee of performing work in accordance with all of the building codes.

Many times a bond contains a clause that if principal (construction company) in fully complies with all the requirements the bond is invalid, on the other hand it stays in full force.

If a construction company neglects in complying with the requirements, in contrast both the surety and the principal are legitimately responsible for guarantee and they’re responsibility is as joint and several, which means…

The construction company or surety or even both together can have a suit brought against, and the credibility and guarantee might be collected form ether principal or surety.

The amount for which a warranty is assessed is called “penal sum” or “penal amount” and mostly it is a limit of responsibility for surety – the company who issues bond.   

A person or organization that requires such a warranty is called an obligee. In performance bond and payment bond – it’s usually an owner of a household or a building. Often in case of subcontractors it happens that the obligee can be as well the owner as the general contractor. 

There are three types of bonds, let’s look at two most important, mainly for those who are planning of building own house:        

Performance Bond
– guarantee of a proper contract execution.
The owner of a future house in this case is the person that the bond is issued too, and has a right to sue the person doing the work – a construction company and surety (company issuing bond). If the company will not perform and comply with conditions of a contract (which also includes established cost and time of completion). In this case the owner can refer to surety to finish the project.
The surety has three options:

• complete the project, hiring other construction company;
• find other performer, who will sign contract directly with the owner of a building, or
• allow the owner to find a performer, who will finish the project and cover all the costs

In those types of contracts the amount of guarantee, the “penal sum” is equal to contract amount and usually within time increases based on so called “change order” – necessary corrections done to a contract.

Payment Bond
– guarantee of payment to subcontractors and suppliers.
The person who requires such a guarantee is again the owner of a house, but the beneficiaries are subcontractors and suppliers. Advantages of the owner aren’t direct but he has a certainty that the subcontractors and suppliers will receive proper pay, by which they will continue to work on a project. It gives him guarantee that subcontractors won’t put mechanical lien on a house, if general contractor won’t pay out.
nd time of completion). In this case the owner can refer to surety to finish the project.
Owner and the beneficiaries are allowed to sue the construction company or the surety, to make appropriate payments. If such a payment is made, the amount of guarantee is decreasing. The amount of such bond is lower than the total cost of a contract, because the purpose for it is to cover costs of subcontractors and suppliers.

If the owner will require guarantee from the main contractor the main issues are:

• What kind of guarantee and what kind of a bond do we need?
  To obtain performance bond and a payment bond is hard; there is a third bond, which will narrow the number of performers.
  Bid Bond – guarantee that the construction company will be able to get the performance and payment bond, if it will be so chosen for the project through a bid (competing). 
  If the performer will be able to comply with the requirements of this bond, meaning that he will have no problem with receiving and providing us with two of those guarantees, and also stating that his financial stability is good.
  Bid Bond – proposals guarantee – is mostly found in larger construction projects.
• Who pays for the bond?
  All of the costs are covered by the owner, not looking whether - the cost of a project was established at the beginning or the cost plus gratitude. The owner can repay the cost of a bond after such bond is presented to him.
  The cost of such bond isn’t low; it can be anywhere form 0.5% to 3% of total contract. The cost also depends on a type of construction, time and financial stability of a performer.
• What should be the limit of a bond?
  The cost of a bond increases with the increasing guarantee.
  From the analytics point of view the owner of a house has advantages from obtaining such guarantee and high enough amounts can give him protection which he needs to complete project.
  In case of Performance Bond the best method is to agree on amount which is equal to 100% of original amount of a contract and increase it after larger changes occur.
  In case of Payment Bond the amount shouldn’t be less then 50% from a contract amount.