Revision 01 - 8th December 2018
A07 - CONSTRUCTION BONDS
A07-1 Introduction
A07-2 Suretyship and surety bonds
A07-3 Bonding prerequisites
A07-4 Bid bond
A07-5 Performance bond
A07-6 Labour and materials (L&M) payment bond
A07-7 Maintenance Bond
A07-8 Benefits of surety and construction bonds
A07-9 Terminology
A07-10 In summary
A07-2 Suretyship and surety bonds
A07-3 Bonding prerequisites
A07-4 Bid bond
A07-5 Performance bond
A07-6 Labour and materials (L&M) payment bond
A07-7 Maintenance Bond
A07-8 Benefits of surety and construction bonds
A07-9 Terminology
A07-10 In summary
Preface:
This reference guide covers construction bonding requirements. Individuals using this guide should confirm this information with a Bonding agency and verify project bonding requirements in project Bid and Contract documents.
Another useful resource for information regarding Surety and Bonding is the Surety Association of Canada.
1 • INTRODUCTION
.01 Because of the difficulty in visualizing all situations in which surety and construction bonds may be used this information must be considered as a general guide only.
.02 For a thorough explanation and guide refer to the Canadian Construction Documents Committee CCDC 22 - Guide to Construction Surety Bonds.
.03 Although surety bonds may be a requirement on many publicly funded projects, their use on privately funded projects is at an Owner's discretion. Alternative forms of financial security, such as letters of credit and self-insurance, do not provide 100% performance and payment protection of surety bonds nor do they assure a competent Contractor. With surety bonds, the risks of project completion are shifted from the Owner to the Surety company. For that reason, many private Owners require surety bonds from their Contractors to protect their company and shareholders from the enormous cost of Contractor failure. Bonds are therefore a useful means of ensuring responsible contract performance and financial security and, consequently, are often an essential requirement in construction procurement today.
.04 The requirements to bond a project are specified in the project Bid documents. Obtaining bonds and delivering them to the Owner is the responsibility of the Contractor, who will consult with a surety bond producer. Subcontractors may also be required to obtain surety bonds to help the prime contractor manage risk, particularly when the subcontractor is a significant part of the job or a specialized contractor that is difficult to replace.
.05 Provision of Surety and a Bid Bond is not normally a requirement for a flooring Subcontractor bidding to a General Contractor unless specifically requested by the Contractor or Owner or required by a Bid Depository system.
This reference guide covers construction bonding requirements. Individuals using this guide should confirm this information with a Bonding agency and verify project bonding requirements in project Bid and Contract documents.
Another useful resource for information regarding Surety and Bonding is the Surety Association of Canada.
1 • INTRODUCTION
.01 Because of the difficulty in visualizing all situations in which surety and construction bonds may be used this information must be considered as a general guide only.
.02 For a thorough explanation and guide refer to the Canadian Construction Documents Committee CCDC 22 - Guide to Construction Surety Bonds.
.03 Although surety bonds may be a requirement on many publicly funded projects, their use on privately funded projects is at an Owner's discretion. Alternative forms of financial security, such as letters of credit and self-insurance, do not provide 100% performance and payment protection of surety bonds nor do they assure a competent Contractor. With surety bonds, the risks of project completion are shifted from the Owner to the Surety company. For that reason, many private Owners require surety bonds from their Contractors to protect their company and shareholders from the enormous cost of Contractor failure. Bonds are therefore a useful means of ensuring responsible contract performance and financial security and, consequently, are often an essential requirement in construction procurement today.
.04 The requirements to bond a project are specified in the project Bid documents. Obtaining bonds and delivering them to the Owner is the responsibility of the Contractor, who will consult with a surety bond producer. Subcontractors may also be required to obtain surety bonds to help the prime contractor manage risk, particularly when the subcontractor is a significant part of the job or a specialized contractor that is difficult to replace.
.05 Provision of Surety and a Bid Bond is not normally a requirement for a flooring Subcontractor bidding to a General Contractor unless specifically requested by the Contractor or Owner or required by a Bid Depository system.
2 • SURETYSHIP AND SURETY BONDS
.01 Suretyship is a loss-avoidance mechanism to pre-qualify contracting firms based on their credit strength, experience, and capability to successfully complete contracts. The economic risk of Contractor default stays with the bonded Contractor, who must sign an indemnity agreement holding the Surety harmless. When it issues a surety bond, the Surety or Bonding company has pre-qualified the Contractor and offers assurance to a project Owner that the Contractor is capable of performing the Contract according to its terms and conditions. In addition, the Surety company guarantees that the Contractor will pay certain labourers, Subcontractors, and Suppliers associated with the project.
.02 A Surety Bond is a three-party undertaking, naming a "Principal" (the Contractor or Subcontractor when applicable), an "Obligee" (the Owner), and a "Surety", under which the Surety agrees to indemnify the Obligee against loss arising from the failure of the Principal to perform his obligations. In addition, if the Surety suffers monetary loss as a result of fulfilling its obligations under the Bond it will look to the Principal and any indemnitors for reimbursement of such loss.
.03 A Surety Bond is not an insurance policy notwithstanding that it may well be issued by an insurance company.
.04 A Consent of Surety or Agreement to Bond is an undertaking by a Surety (Bonding) agency to provide bonds in the form specified (usually a Performance Bond and a Labour and Material Payment Bond) within the time period specified in the Agreement, should the Principal (General Contractor, or a flooring contractor where the contract is directly with the Owner) be awarded the Work by the Obligee (the Owner or by the General Contractor where the General Contractor requires bonding from the flooring Subcontractor). The obligation to provide Bonds (with the exception of the Bid Bond) is a requirement only when the Contract between the Obligee and the Principal comes into effect.
.01 Suretyship is a loss-avoidance mechanism to pre-qualify contracting firms based on their credit strength, experience, and capability to successfully complete contracts. The economic risk of Contractor default stays with the bonded Contractor, who must sign an indemnity agreement holding the Surety harmless. When it issues a surety bond, the Surety or Bonding company has pre-qualified the Contractor and offers assurance to a project Owner that the Contractor is capable of performing the Contract according to its terms and conditions. In addition, the Surety company guarantees that the Contractor will pay certain labourers, Subcontractors, and Suppliers associated with the project.
.02 A Surety Bond is a three-party undertaking, naming a "Principal" (the Contractor or Subcontractor when applicable), an "Obligee" (the Owner), and a "Surety", under which the Surety agrees to indemnify the Obligee against loss arising from the failure of the Principal to perform his obligations. In addition, if the Surety suffers monetary loss as a result of fulfilling its obligations under the Bond it will look to the Principal and any indemnitors for reimbursement of such loss.
.03 A Surety Bond is not an insurance policy notwithstanding that it may well be issued by an insurance company.
.04 A Consent of Surety or Agreement to Bond is an undertaking by a Surety (Bonding) agency to provide bonds in the form specified (usually a Performance Bond and a Labour and Material Payment Bond) within the time period specified in the Agreement, should the Principal (General Contractor, or a flooring contractor where the contract is directly with the Owner) be awarded the Work by the Obligee (the Owner or by the General Contractor where the General Contractor requires bonding from the flooring Subcontractor). The obligation to provide Bonds (with the exception of the Bid Bond) is a requirement only when the Contract between the Obligee and the Principal comes into effect.
3 • BONDING PREREQUISTES
.01 Sureties are able to accept the risk of Contractor failure based on the results of a thorough, rigorous, and professional process in which they pre-qualify the Contractor. This prequalification process is an in-depth review of the Contractor's business operations. Before issuing a bond the surety company must be fully satisfied that the Contractor has:
.02 Before issuing any bond, the Surety company must be fully satisfied that the Contractor runs a well-managed, profitable enterprise, keeps promises, deals fairly, and performs obligations in a timely manner.
.01 Sureties are able to accept the risk of Contractor failure based on the results of a thorough, rigorous, and professional process in which they pre-qualify the Contractor. This prequalification process is an in-depth review of the Contractor's business operations. Before issuing a bond the surety company must be fully satisfied that the Contractor has:
- A good references and reputation;
- The ability to meet current and future obligations;
- The experience matching the contract requirements;
- The necessary equipment to do the work or the ability to obtain it;
- The financial strength to support the desired work program;
- An excellent credit history; and
- An established bank relationship and line of credit.
.02 Before issuing any bond, the Surety company must be fully satisfied that the Contractor runs a well-managed, profitable enterprise, keeps promises, deals fairly, and performs obligations in a timely manner.
4 • BID BOND
.01 The purpose of a Bid Bond is to guarantee to the Obligee (the Owner), the good faith of the Principal (the General Contractor or flooring contractor where a flooring contract is directly with the Owner) to provide the type of security specified or requested (typically a Performance Bond and a Labour and Materials Payment Bond). If the Contactor's Bid is accepted, the Contractor's (Principal's) obligation is to enter into a formal Contract with the Obligee and provide the noted security within the time required. If the Principal fails in this obligation, they will be required to pay to the Obligee the difference in money between the amount of their Bid and the amount for which the Obligee legally Contracts with another party to do the same Work to the limit of the Bond or security. Only if the Principal is financially unable to meet this obligation is the Surety obliged to do so but will expect to recover such payment from the Principal.
.02 In order for an Owner to claim on a Bid Bond the following must occur:
.01 The purpose of a Bid Bond is to guarantee to the Obligee (the Owner), the good faith of the Principal (the General Contractor or flooring contractor where a flooring contract is directly with the Owner) to provide the type of security specified or requested (typically a Performance Bond and a Labour and Materials Payment Bond). If the Contactor's Bid is accepted, the Contractor's (Principal's) obligation is to enter into a formal Contract with the Obligee and provide the noted security within the time required. If the Principal fails in this obligation, they will be required to pay to the Obligee the difference in money between the amount of their Bid and the amount for which the Obligee legally Contracts with another party to do the same Work to the limit of the Bond or security. Only if the Principal is financially unable to meet this obligation is the Surety obliged to do so but will expect to recover such payment from the Principal.
.02 In order for an Owner to claim on a Bid Bond the following must occur:
- The Owner must accept a Bid within the time allowed (the "open time" as noted in Instruction to Bidders) creating a "new contract", and
- The Contractor of the selected Bid refuses to enter into a Contract with the Owner. This creates a breach of this new contract and results in the Bidder being in default, and
- The Owner must proceed to accept some other offer and enter into contract with someone else (not necessarily one of the other bidders), and
- The Owner calls on the Bid Bond Surety for financial satisfaction if the new contract price is higher than the original accepted bid price.
5 • PERFORMANCE BOND
.01 The function of a Performance Bond is to provide indemnity to the Obligee (the Owner, or General Contractor if such a Bond is required from the flooring Subcontractor by the General Contractor) up to the amount of the Bond in the event of default on the part of the Principal (the General Contractor, or flooring contractor where the contract is directly with the Owner). Provided the Obligee has met their obligations under the Contract, they will claim against the Principal and the Surety and will expect to be indemnified by the Surety within the amount of the Bond for any loss suffered by reason of the Principal's default. Again, it should be borne in mind that the Surety will look to the Principal for recovery of its loss. Right of claim under the Bond cannot be assigned to others without the written consent of the Principal and the Surety.
.02 A Performance Bond is not intended to cover payment of labour and material claims. Owners and Contractors should not depend upon the Performance Bond for payment of a Labour and Material Payment Bond if such coverage is desired. It is also important to determine if the Performance Bond covers financial obligations of the Principal (e.g., liquidated damages) and any warranty obligations.
.01 The function of a Performance Bond is to provide indemnity to the Obligee (the Owner, or General Contractor if such a Bond is required from the flooring Subcontractor by the General Contractor) up to the amount of the Bond in the event of default on the part of the Principal (the General Contractor, or flooring contractor where the contract is directly with the Owner). Provided the Obligee has met their obligations under the Contract, they will claim against the Principal and the Surety and will expect to be indemnified by the Surety within the amount of the Bond for any loss suffered by reason of the Principal's default. Again, it should be borne in mind that the Surety will look to the Principal for recovery of its loss. Right of claim under the Bond cannot be assigned to others without the written consent of the Principal and the Surety.
.02 A Performance Bond is not intended to cover payment of labour and material claims. Owners and Contractors should not depend upon the Performance Bond for payment of a Labour and Material Payment Bond if such coverage is desired. It is also important to determine if the Performance Bond covers financial obligations of the Principal (e.g., liquidated damages) and any warranty obligations.
6 • LABOUR AND MATERIALS (L&M) PAYMENT BOND
.01 The function of Labour and Materials (L&M) Payment Bonds is to guarantee that all Claimants will be paid for labour and materials furnished to the Principal (the Contractor) for use on the job described in the Bond. Under the CCA (Canadian Construction Association) approved form of Bond, a "claimant", or beneficiary, is one who has a direct Contract with the Principal for labour, materials or both, used or reasonably required for use in the Contract. In this case the potential Claimants would be Subcontractors and/or Suppliers of material or labour having Contracts directly with the General Contractor. Under these circumstances, Subcontractors of the Subcontractor and material persons supplying material to such Subcontractors would not be claimants of the L&M Payment Bond between the General Contractor and the Owner.
.02 Potential claimants are cautioned to familiarize themselves with the terms and conditions as well as limitations of the L&M Payment Bond. Potential claimants should obtain a copy of the L&M Payment Bond from the Principal that they are contracted with or from the Obligee (the Owner). Particular attention should be paid to the limitation of time for filing claims and it should also be noted that notice of claim must be filed with the three parties to the Bond, namely; the Principal, the Obligee, and the Surety (Bonding company).
.03 An L&M Payment Bond is not a substitute for sound credit practice. Such Bonds do not necessarily pre-qualify the credit worthiness of a client. It should also be understood that, for various reasons, a Claimant cannot expect to receive immediate payment of an account from a Surety. The Surety at that point in time may not have the legal right to step in and pay the bills of the Principal. It is also necessary for the Claimant to prove beyond a reasonable doubt that the goods and/or services were in fact supplied to the particular job in connection with which the Payment Bond was issued.
.01 The function of Labour and Materials (L&M) Payment Bonds is to guarantee that all Claimants will be paid for labour and materials furnished to the Principal (the Contractor) for use on the job described in the Bond. Under the CCA (Canadian Construction Association) approved form of Bond, a "claimant", or beneficiary, is one who has a direct Contract with the Principal for labour, materials or both, used or reasonably required for use in the Contract. In this case the potential Claimants would be Subcontractors and/or Suppliers of material or labour having Contracts directly with the General Contractor. Under these circumstances, Subcontractors of the Subcontractor and material persons supplying material to such Subcontractors would not be claimants of the L&M Payment Bond between the General Contractor and the Owner.
.02 Potential claimants are cautioned to familiarize themselves with the terms and conditions as well as limitations of the L&M Payment Bond. Potential claimants should obtain a copy of the L&M Payment Bond from the Principal that they are contracted with or from the Obligee (the Owner). Particular attention should be paid to the limitation of time for filing claims and it should also be noted that notice of claim must be filed with the three parties to the Bond, namely; the Principal, the Obligee, and the Surety (Bonding company).
.03 An L&M Payment Bond is not a substitute for sound credit practice. Such Bonds do not necessarily pre-qualify the credit worthiness of a client. It should also be understood that, for various reasons, a Claimant cannot expect to receive immediate payment of an account from a Surety. The Surety at that point in time may not have the legal right to step in and pay the bills of the Principal. It is also necessary for the Claimant to prove beyond a reasonable doubt that the goods and/or services were in fact supplied to the particular job in connection with which the Payment Bond was issued.
7 • MAINTENANCE BONDS
.01 These bonds are provided to an Obligee only after a Contract has reached Substantial Completion, and they guarantee the Contractor will come back as required to repair any
defective materials or workmanship which come to light within the warranty period.
.02. Construction contracts contain a ‘warranty’ or ‘maintenance’ obligation which extends for one year (or longer) from the date of Substantial or Total Completion. Even though
the Performance bond guarantees all terms and conditions of the underlying contract (thereby also guaranteeing the maintenance period), Obligees may prefer a separate
bond instrument over and above the Performance bond. Further, where no Performance Bond exists, the Obligee may wish to ensure this obligation is performed, hence the
need for a Maintenance Bond.
.01 These bonds are provided to an Obligee only after a Contract has reached Substantial Completion, and they guarantee the Contractor will come back as required to repair any
defective materials or workmanship which come to light within the warranty period.
.02. Construction contracts contain a ‘warranty’ or ‘maintenance’ obligation which extends for one year (or longer) from the date of Substantial or Total Completion. Even though
the Performance bond guarantees all terms and conditions of the underlying contract (thereby also guaranteeing the maintenance period), Obligees may prefer a separate
bond instrument over and above the Performance bond. Further, where no Performance Bond exists, the Obligee may wish to ensure this obligation is performed, hence the
need for a Maintenance Bond.
8 • BENEFITS OF SURETY AND CONSTRUCTION BONDS
.01 There are many risks for all those associated with a construction project (Owners, lenders, taxpayers, Contractors, Subcontractors, Suppliers, and Manufacturers). Any contractor, for instance, whether experienced or novice, large or small, or in business for one or a hundred years, can experience serious problems. Such risks can be minimized by the use of surety and construction bonds because:
.02 There are a number of advantages to the Owner when using bonds:
.03 There are a number of disadvantages to the Owner when using bonds:
.01 There are many risks for all those associated with a construction project (Owners, lenders, taxpayers, Contractors, Subcontractors, Suppliers, and Manufacturers). Any contractor, for instance, whether experienced or novice, large or small, or in business for one or a hundred years, can experience serious problems. Such risks can be minimized by the use of surety and construction bonds because:
- The Contractor has undergone a rigorous prequalification process and is judged to be capable of fulfilling the obligations of the Contract;
- Contractors are more likely to complete bonded projects than non-bonded projects since the surety company may require personal or corporate indemnity from them;
- Subcontractors have no need to file a lien on the project when a payment bond is in place;
- Bonding capacity can increase a Contractor's or Subcontractor's opportunities;
- The surety bond producer and underwriter may be able to offer technical, financial, or management assistance to a Contractor; and
- The surety company fulfills the Contract in the event of Contractor default.
.02 There are a number of advantages to the Owner when using bonds:
- There is a greater pool of financially qualified Contractors bidding for jobs, resulting in greater likelihood of timely project completion and less likelihood of Contractor failure.
- The Owner receives a measure of protection against default, breach of Contract, and non-performance by the Contractor.
- The Owner can be assured completion of a defaulted project because of the involvement of a surety.
- The Owner receives additional assurance of financial stability of the Contractor. Bonded Contractors are usually financially stable and are audited by the Surety on a regular basis.
- The Owner has reasonable protection against liens on the project. This will smooth the transition from construction to permanent financing.
- Manufacturers, Suppliers, and Subcontractors are protected against non-payment of amounts due them. (Subcontractors and suppliers may submit more competitive prices if they know they're protected by a payment bond).
- The indemnity agreement generally provides added incentive for the principals of the Contractor to properly perform since they may be personally liable to the bonding company (indemnity) for amounts paid on a bonded project.
- There is a guarantee of correction of defects as a result of faulty material or workmanship for at least one year.
- They tend to satisfy statutory requirements for financial responsibility for publicly funded projects.
.03 There are a number of disadvantages to the Owner when using bonds:
- Bonding requirements may restrict certain categories of bidders and may reduce the number of bidders. Capable Contractors may not be bondable for various reasons other than financial reasons.
- Owners may misconstrue the nature and extent of the surety's involvement.
- Construction costs may be increased somewhat by requiring bonds.
- Bonding will add roughly 0.3% - 5% to a project costs if bonds are requested within the Bid price.
9 • TERMINOLOGY
.01 Principal - Flooring Contractor.
.02 Obligee - Contractor or project owner requesting the Bond.
.03 Surety - Bonding company that guarantees the principal performance.
.02 Obligee - Contractor or project owner requesting the Bond.
.03 Surety - Bonding company that guarantees the principal performance.
10 • IN SUMMARY
.01 A Bid Bond or a "Consent of Surety" or "Agreement to Bond" is called for at the time of Bidding and is intended to provide security or an assurance that security will be provided by the Principal (as previously noted herein). It may also be used as a means of pre-qualifying Bidders to the Obligee.
.02 When a Contractor is successful in his Bid and enters into a formal Contract with the Owner, a Performance Bond and a Labour and Materials Payment Bond are provided to guarantee to the Obligee the fulfilment of the Contractor's performance and the payment of accounts for labour and materials to the parties that Contractor has contracts with.
.03 It is important to realize that the bonds required as security on any particular project are specified by the Obligee / Owner on the project, at least with respect to the General Contract. Usually the Owner or their representative will specify the form of bond or bonds to be used by the Surety. In the absence of any specific instruction, it is common practice for Sureties to use the standard CCDC (Canadian Construction Documents Committee) bond forms: CCDC 220 (Bid Bond), CCDC 221 (Performance Bond), and CCDC 222 (Labour and Material Payment Bond). Many Bonding companies do not prepare their own bond wording, as would be the case with many insurance contracts; rather, they simply execute Bonds, or guarantees on the language prescribed by the Obligee / Owner.
.04 The amount of indemnity provided by these bonds is also set by the Obligee / Owner or their representative. These amounts are often expressed as a percentage of a Bid or final Contract Price. This method is simply a means to arrive at a dollar figure for the liability of the Surety under the bond since, at the time the bonds are specified the Owner does not have a firm price for their project. A 50% Bond does not mean that the Surety covers only 50% of any loss in the case of default, but rather, that they will pay any legitimate claims up to a dollar figure equal to 50% of the agreed Bid of final Contract Price.
Note: The terms, Contractor, Subcontractor, and Owner are defined terms in Canadian Construction Documents Committee (CCDC) and Canadian Construction Association (CCA) documents and are capitalized as they are in NFCA documents and specifications as well.
.01 A Bid Bond or a "Consent of Surety" or "Agreement to Bond" is called for at the time of Bidding and is intended to provide security or an assurance that security will be provided by the Principal (as previously noted herein). It may also be used as a means of pre-qualifying Bidders to the Obligee.
.02 When a Contractor is successful in his Bid and enters into a formal Contract with the Owner, a Performance Bond and a Labour and Materials Payment Bond are provided to guarantee to the Obligee the fulfilment of the Contractor's performance and the payment of accounts for labour and materials to the parties that Contractor has contracts with.
.03 It is important to realize that the bonds required as security on any particular project are specified by the Obligee / Owner on the project, at least with respect to the General Contract. Usually the Owner or their representative will specify the form of bond or bonds to be used by the Surety. In the absence of any specific instruction, it is common practice for Sureties to use the standard CCDC (Canadian Construction Documents Committee) bond forms: CCDC 220 (Bid Bond), CCDC 221 (Performance Bond), and CCDC 222 (Labour and Material Payment Bond). Many Bonding companies do not prepare their own bond wording, as would be the case with many insurance contracts; rather, they simply execute Bonds, or guarantees on the language prescribed by the Obligee / Owner.
.04 The amount of indemnity provided by these bonds is also set by the Obligee / Owner or their representative. These amounts are often expressed as a percentage of a Bid or final Contract Price. This method is simply a means to arrive at a dollar figure for the liability of the Surety under the bond since, at the time the bonds are specified the Owner does not have a firm price for their project. A 50% Bond does not mean that the Surety covers only 50% of any loss in the case of default, but rather, that they will pay any legitimate claims up to a dollar figure equal to 50% of the agreed Bid of final Contract Price.
Note: The terms, Contractor, Subcontractor, and Owner are defined terms in Canadian Construction Documents Committee (CCDC) and Canadian Construction Association (CCA) documents and are capitalized as they are in NFCA documents and specifications as well.