An unbonded contractor on a public or private construction project is a bad idea. Rarely will such contractors, especially on bigger projects, be contracted at all due to the significant risks at play.
After all, if worse comes to worst, how can an owner avoid delays and financial harms without a performance bond to file a claim against? Yet, many contractors hesitate to require subcontractor bonding because they have the impression it raises the total cost of the project. The question remains: Do the advantages of working with bonded subcontractors outweigh the costs? They certainly do, and here’s why subcontractor bonds are a good idea.
What Are Contract Bonds For?
The two most commonly used contract bonds for general contractors are payment and performance bonds. These usually go together, though they apply to different aspects of a construction project.
Performance bonds are meant to ensure that a contractor will perform and fulfill its contractual obligations in relation to the project owner or obligee. Payment bonds are meant to guarantee that the general contractor will pay subcontractors and materials suppliers whatever is owed them. This bond is also meant to protect the client from claims arising against them due to contractor negligence.
Under the Miller Act, payment bonds also cover all first-tier subcontractors and materials suppliers, as well as second-tier subcontractors and materials suppliers to first-tier subcontractors on public construction projects. In other words, all parties are well covered when a contractor has obtained payment and performance bonds.
Why Subcontractor Bonds?
But what about subcontractor negligence? Aren’t general contractors at risk if a subcontractor defaults on its obligations, or fails to pay its lower-tier subcontractors and suppliers? In fact, they are. Like in any business relationship, there are usually a great number of risks involved. And unless the contractor has established a longstanding and highly trusting business partnership, it’s a very risky bet to leave subcontractors unbonded. Even with well-developed relationships this may not be advisable.
So, apart from the financial guarantee that surety bonds for subcontractors offer to general contractors, there are additional benefits of subcontractor bonding.
Sureties Pick Out Reliable Subcontractors
While there’s no final guarantee that a subcontractor will never experience difficulties or default, chances of such an event are greatly reduced when a subcontractor is bonded. This is due to the fact that obtaining a bond means companies are taken through a prequalification process by sureties. This is the process of a surety company examining and assessing both the financial health of a business, as well as its capacities to perform on a given project, its past projects and industry experience. The surety also assesses the subcontractor’s documentation and how the business operates.
Because obtaining a surety bond can be a double-edged sword, the prequalification process weeds out subcontractors that are either not fit for a project, or may not have the intention to perform well on it. Sureties have no interest in underwriting bonds to unstable businesses, so they make sure to pick the most reliable subcontractors.
Subcontractor Bonding Means Greater Responsibility
Bonded subcontractors are also sure to act more responsibly when performing on a project. This is due to the indemnification agreement signed by principals when obtaining their contract bonds. A subcontractor bond often requires that not only the business entity, but also business owners, provide indemnity in the form of personal assets. Thus, subcontractors that are willing to guarantee their performance through indemnity likely are responsible and interested in doing a good job.
Developing a Good Surety Relationship
Contractors that have an explicit subcontractor bonding policy are also sure to develop a good and trusting relationship with their surety bond company. Sureties will usually request that contractors bond subcontractors, especially on larger and more complex projects. Therefore, contractors that actively engage in this process, and request that subcontractors be bonded without waiting to be told to do so, are effectively creating a more solid partnership with sureties.
Such partnerships are literally worth gold, as construction is a very risky and complicated industry. Contractors that play it safe and develop good relationships with sureties, subcontractors and suppliers are the firms that truly grow and succeed. Requesting that subcontractors get bonded is an essential part of this process.
Why Subcontractors Benefit from Being Bonded
Obtaining a subcontractor bond, while in the greatest interest of the contractor and the project owner, is also good for subcontractors. By being bonded, subcontractors have someone to help in case of difficulty.
Just like a contractor’s surety will help avoid potentials claims and try to resolve any issues in an optimal way, the surety will do just the same for subcontractor it bonds. The surety partnership goes beyond the simple coverage of a claim. Furthermore, being bonded provides legitimacy because it is a form of recognition on the side of the surety that the subcontractor is reliable.