To understand the different types of construction bonds, it’s first important to understand what construction bonds are, and more broadly, what surety bonds are.
Surety bonds are a contract between three parties. Two parties are engaged in some sort of contract, while the third party (known as the surety or guarantor) is there to guarantee that if one party lapses in their contractual obligations, the guarantor will cover financial losses of the other party. The party who purchases the surety bond is known as the principal, while the other party is known as the obligee.
When it comes to construction, the obligee is often a public entity, like a municipal, provincial, or federal government. The principal is the contractor who bids on a particular project, and the guarantor is an insurance or surety company.
Obligees will ask for construction companies to obtain bonds in order to protect their investments. Payments are made to principals under the understanding that work will be completed within a given time frame and within a certain budget. Should the principal fail to meet their obligations, obligees will lose money – both because the project won’t be completed on time and because they’ll need to find new contractors, potentially at a higher price than they paid to the principal.
As such, there are three types of construction bonds: bid bonds, performance bonds, and labour and material bonds.
Bid bonds are necessary to engage in the bidding process for any given project. Governments don’t want to go through the bidding process any more than they have to – it’s both time and labour-intensive. Consequently, bid bonds guarantee that contractors will begin work on a project should they win the bid. They also guarantee that the contractor will secure a performance bond (which we’ll discuss next). Should the contractor fail to meet these obligations, the surety will pay out to cover the costs of a new bidding process.
Performance bonds are the cornerstone of construction bonds – they guarantee that the contractor will complete work according to the contract’s terms. They also protect the obligee against defective or below average work. In other words, if the contractor doesn’t fulfill their obligations, performance bonds pay out.
Labour and material bonds are a guarantee that the winning contractor has the means, within the allotted project budget, to pay for subcontractors, materials, and employees. Construction projects are a team effort, and these expenses can add up quickly – labour and material bonds, then, are a guarantee for the people working on the project. Governments and other obligees require these bonds to ensure that the winning contractor can afford to complete their project.
A final note on bonds: they’re not considered insurance. In an insurance contract, the insurer pays out to the insured without an expectation of compensation for what was paid. With a bond, the principal is required to pay the guarantor back for any amounts paid out by the bond. We offer business insurance in Winnipeg as well as construction bonds.