The Construction sector is one of the riskiest businesses. A study has shown that about a half of the construction firms operating today will be out of business in about five years. Numerous factors could lead to the failing of a company. Some of them are labor difficulties, equipment issues, economic downturn, and also shortages of materials. These problems could lead to a construction company to leave their projects at a standstill. No single building owner whether private or public will be able to gamble on a contractor whose responsibility is not assured. They also cannot risk hiring someone who could end up being bankrupt halfway down the line. Therefore the public agencies that make use of the low-bid system have to be sure that their lowest bidder is someone they can depend on.
Types of Surety Bonds
A surety bond is a three-party contract. The three parties involved are; the contractor (Principal), the owner (Obligee), and the Surety. The Principal will make a promise to perform according to the obligations of the contract. The Surety bonds used in construction are known as Contract Surety Bonds. The Contract Surety Bonds are of three kinds. One is the Performance Bond which works to protect the owner from loss of finances when the contractor does not perform according to the details stated in the contract. When the owner finds the contractor in default and terminates the contract, then the Surety can be called on to meet its obligations under the bond. Another type is the Bid Bond. This one offers financial protection to the obligee. It works when the bidder is given a contract to bid documents and does not sign the contract. There is also the Payment Bond. This one will provide assurance that the contractor will make payment of the materials and also pay the other workers.
These surety bonds are by law mandated on the public projects. However, for the privately-owned projects, they are just at the owner’s discretion. There are alternative types of financial security. These include the one getting a personal insurance cover or the credit letters. However, these security alternatives do not cover all the risks of construction as the surety bonds can. Therefore, more private owners are now opting to take the surety bonds from their contractors.
Importance of Surety Bonds
The surety bond will assure the owner that the mechanism for risk transfer is in place. Therefore, the risks from the construction are shifted from the proprietor to the surety. In the case where the contractor defaults, the surety will be able to pay for a replacement contractor. They will also manage to finance the new contractor who has been hired. In addition to this, they will provide any technical help that may be needed. A surety bond offers the financial security and assurance in the construction and building projects. The bond will assure the owner of the project that the contractor will perform the work and that they will also pay their laborers. The surety bond is a way of transferring the risks. It allows one party to guarantee the other party that the third party will follow the contract.