What Is a Construction Bond?

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A surety construction bond is a surety issued for construction projects to ensure that the project would be accomplished as specified in the contract. It would mean the investor or owner of the project was assured financially should there be performance defaults by the contractor, like non-adherence to deadlines, quality standards of work, or performance requirements. What it really means is that the contractor will meet the conditions set in the contract, or the bond producer comes forward to reimburse losses incurred.

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How a Construction Bond Works?

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A construction surety bond can also be referred to as a contractor license bond and is a surety required for most construction projects, particularly those concerning government or public works. Contractors that bid on such jobs are usually mandated to provide application bonds, either construction or contract bonds.

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This bond ensures the contractor fulfills the terms as described in the contract to the owner, or obligee, of the project. In larger projects, construction bonds are usually set up in two parts: one bond covers the complete end of the project and another for payment to suppliers and subcontractors for materials and work. 

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There are three primary parties directly involved in a construction bond:

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Obligee: The project owner or investor, often a government agency, that requires the bond.

Principal: The contractor or party responsible for carrying out the project.

Surety: The company that issues the bond and backs the contractor’s financial and professional obligations.

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Government agencies, obligees, necessitate bond submissions by contractors to mitigate financial risks in this regard. These bonds are often awarded to the lowest bidding contractor, as an investor would want to complete the project at the lowest cost.

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By issuing the construction bond, the principal or contractor guarantees that they are capable of undertaking the project to satisfactory completion according to the terms and stipulations of the contract. The surety bond offers both financial and quality assurance by the obligee. The surety company shall conduct an investigation of the background and finances of the contractor concerned prior to the execution and issuance of the bond to ascertain their competency to handle and provide the project according to agreement.

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Types of construction bonds

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Bid Bond

A bid bond is issued along with a bid proposal and serves to protect the owner against refusal of the bidder to enter into the contract upon selection. In case of this occurrence, owner can sue the issuer. This claim is for either the amount of the bond or the difference between the lowest and the second-lowest bid, whichever amount is lesser. The bond given is a protection to the owner against financial loss in case the contractor is getting cold feet, to cover the cost of re-tendering the contract or award it to the next lowest bidder.

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Agreement to Bond (Surety's Consent or Consent of Surety)

An Agreement to Bond is provided with a bid bond in the contractor's bid. It is, in effect, an agreement of the contractor's surety company that the bonds which will be required at the conclusion of the project—the performance bond and/or labor and material payment bond—will be provided if the contractor is the successful contract award. The agreement provides assurance for the surety to issue the bonds without possibility of the surety declining to provide the surety backing when the contract has been awarded to the contractor.

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Performance Bond

The performance bond is provided to the project owner by the contractor after being selected for the job. Normally this happens within 10 working days from the date of contract award. The performance bond signifies that the bond will perform as per the contract. If, based on underperformance or failure to deliver the work according to agreement, the contractor is fired, then the company could be held liable on the performance bond. It can then step in to undertake completion of the project either by hiring another contractor to complete the project or to pay off for any remaining defects.

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Labor and Material Payment Bond

The labor and material payment bond is issued along with the performance bond at the time a contract is awarded to any contractor. The bond guarantees that subcontractors, suppliers, and tradespeople on a project are paid in conformity with their contract terms or relevant applicable laws. In event of failure on such a situation, a subcontractor and supplier may file against the bond claimants, making them secure financially for the work undertaken by them.

Requirements for Construction Bonds

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This is the general sequence in which companies normally begin working to secure construction bonds:

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• Reviewing job requirements to determine if a construction or contract bond is needed.
• Obtaining a bid bond from a surety agent and submitting it with the project proposal.
• If awarded the contract, requesting a performance bond from the surety agent to guarantee project completion.
• Completing the job according to the contract terms.
• If required, securing a maintenance bond once the project is finished to cover any necessary repairs or issues.

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Construction bonds are typically required of most government projects. Not all types of work are permitted construction bonds, but the specific project at hand may be a government project. Projects overseas, projects on Indian reservations, renovation on private homes, or projects where construction spans over several years do not obtain construction bonds from surety companies in the United States.

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Surety companies view these projects in America as very high risk, considering that some projects are either international or reservation-based with different laws, regulations and terms of contract. Additionally, the uncertainty of a long-term construction project reduces the qualifications of contractors with time, making the bonding more complicated in the case of such jobs.

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Conclusion:

Construction bonds are indispensable for mitigating financial risks and ensuring the successful completion of projects. By offering security to project owners and accountability from contractors, these bonds maintain the integrity of the construction industry. However, while construction bonds protect against project risks, investors looking to benefit from real estate opportunities without direct involvement in construction can explore Compound Real Estate Bonds (CREB). Backed by real assets and offering a fixed 8.5% APY, CREB allows investors to enjoy consistent returns and financial security. Whether you're involved in construction or seeking alternative investments, CREB can be a strategic addition to your portfolio for long-term growth and income stability.