Bonding is surety, the state of being sure, certain and secure".Surety bonding is essentially an agreement between three parties whereby one party guarantees that another party will perform the work that is stated in contract to the best of his/her ability. It is a guarantee that the owner of a job will receive the quality and completion of work that he/she anticipates.
Depending on what type of business you are in, you may be required (by law) to obtain bonding before you can start work. For those of you who are not required to seek bonding, you may decide that the benefits of obtaining it is well worth the hassle. Whatever your case, there are many different kinds of bonds to choose from and each of them serves a different purpose.
Most often used in the construction industry, bid bonds ensure owners that the contractor who is the lowest bidder on their job, can and will enter into contract at the tendered price. If the contractor fails to fulfill his/her obligations under the bid bond, he/she must compensate the owner for the difference between his/her bid and that of the next lowest bidder.
When applying for a bid bond, surety companies look at much the same characteristics in an applicant as a bank does when issuing a loan. First, the surety will conduct a review of the company's management performance. This will give the surety knowledge of the company's history, as well as provide information on whether or not the company is respected in the construction community. Next, the surety will examine the qualifications and background experience of the contractors personnel. Finally, the tangible net worth of the contractor will be determined through financial statements and the net worth of its shareholders. This will help the surety determine whether or not the contractor will have the financial capacity to complete the project.
In addition to the basic criteria, when qualifying for a bond, surety companies also examine contract-related characteristics. These may include: The Nature of the Work, does the project fall into the contractor's range of expertise; Project Location, is there more risk involved because of the project's distance or remote location; Completion Date, will the long duration of the project create greater risk of incompletion; Legal Conditions, are there any legal clauses stating what will happen under unusual situations; Communication, does the contractor exhibit good management skills including the ability to make accurate cost projections?
There are several reasons why a contractor should apply for bid bonds. First, bid bonds assure the business owner that the contractor is acting in good faith. Secondly, it guarantees the business owner that those who are bidding on his/her work have the financial and technical knowledge to complete the work. Finally, bid bonding reduces the demand that is placed on a contractor's assets and bank credit.
Since most surety companies use the applicant's work experience to determine whether or not he/she will qualify for bonding, it is not uncommon for new businesses to be denied. If you find your business in this situation, do not be discouraged. There are many smaller contracting jobs that do not require bonding. As you complete more jobs and prove your company's viability, you will build a name for yourself in the industry and will qualify for bonding soon enough.
A Performance Bond is required in most instances:
For a federal construction project under The Miller Act (40 U.S.C., Sections 3131-3134)
Public work for Texas governmental entities (when the contract is in excess of $100,000) under Government Code, Chapter 2253
An owner may also request a Performance Bond for private work. The Performance Bond coverage guarantees that the principal will faithfully perform the terms and conditions of the written contract.
Payment or Labor and Material Bonds
A Payment or Labor and Material Bond is also required for:
Federal construction projects (The Miller Act);
When a contract is in excess of $25,000 for public work
Private work under Property Code, Chapter 53. The coverage provided by the Payment or Labor and Materials Bond guarantees that the contractor will pay for labor and material used to complete the project that is the subject of the contract. When both a Performance Bond and Payment Bond are required, they are issued for limits in the amount of the contract.
Maintenance Bonds or Maintenance Guarantees for a term of up to 12 months are normally included with the Performance Bonds. Separate Maintenance Bonds may also be executed where no Performance Bond is required. The coverage provided by a Maintenance Bond is a guarantee against defective workmanship and materials.