The construction business is very high risk. Many new contractors won’t even be in business in a few years. Contractors are often too aggressive and try to expand too fast, not having the proper personnel, not having the capital to sustain themselves and not having done proper research about new markets. For these reasons and many others, owners are at great risk which exponentially increases depending on the job. Bad business practices and false claims from owners are also common, so the contractor also needs protection. The solution is the surety bond, a three-way agreement protecting all parties involved.
Everyone needs Protection
Imagine you have a new restaurant location set to open one year from now. You have your own financial obligations and deadlines to meet. And suddenly the progress on the project comes to a halt, you find out that the contractor you hired has gone bankrupt six months into the project. They seemed reputable, they seemed experienced, they may have even come recommended. The reality is construction companies come and go, even the large ones with a twenty-year history. This occurrence is not just unique to private enterprise, in 1984 Congress passed the Heard Act which protects federal projects from default.
How does it work?
The surety company will conduct a rigorous investigation on the contractor. If the surety company finds the contractor worthy than the obligee will be able to shift the risk of the contractor defaulting on the project. Here are some examples of what the surety company will investigate.
- Does the contractor have an established relationship with a bank? Is there a line of credit?
- Does the contractor own the necessary equipment and tools to perform the job? Do they have means to obtain the equipment?
- What is their credit history?
- Do they have strong references?
This bond may sound like it’s one-sided only protecting the owner but there is a long history of abuse from the obligee. And thus because of disputes that often arise between the two parties, if the owner formally declares the contractor in default another investigation is performed by the surety company. The terms may vary but if the contractor is in fact found in default, the owner can take different actions such as replacing the contractor or providing assistance in the form of subcontractors and so on. The most important part of this agreement is that in the event of a definitive default by the contractor. The surety company will fulfill the contract. Here is a number to chew on for confidence. According to The Surety and Fidelity Association of America, Since 1995 surety companies have paid an estimated $10 billion due to contractor default. Successfully protecting owners from potential financial loss and other problems which could arise in the event a contractor does not complete the work as per the agreement. Whether you be the owner, contractor or sub-contractor it seems hard to make a case against a surety bond providing investigation, support, and financial security.