What is bonding and how does it relate to items such as the Grande Prairie Regional Hospital?
When it comes to construction, surety bonds are an important part of the equation to keep a project on track, and to ensure that there’s a backup plan in place if the general contractor defaults on the contract.
A surety bond is a guarantee by a surety company (often an insurance carrier) to pay the project owner (the “obligee”) a specific amount if the general contractor (the “principal”) does not fulfill the terms of the contract. Bonds protect the project owner against a loss as a result of the general contractor's failure to meet this contractual obligation.
Let’s use a hypothetical new hospital construction project to explain how bonds are used in the context of construction. Public funds are contributing to the construction of the hospital, and the project’s owner is requiring that the general contractor bond the project for 100% of its value upon project award.
As we’ll see, at every point along the project’s lifespan—from bid to after project completion—bonding will play an important role.
When submitting a bid package for consideration to the owner, the contractor will also include a bid bond, generally up to 10% of the bid amount. This will guarantee to the project owner that the winning contractor will enter into a contract if awarded the job and will deliver the required performance and payment bonds. If the contractor fails to do this, the owner can then submit a claim to the surety company to be compensated for the difference between the low bidder’s price and the second bidder’s price.
Contractors prefer the use of bid bonds because they are a less expensive option (vs. a cash or letter of credit guarantee) and do not tie up cash or bank credit lines during the bidding process.
Owners also like bid bonds because they provide reassurance that the bidding contractor has gone through a rigorous underwriting process and has been pre-qualified by a surety company.
Once a general contractor has been awarded the contract, they will submit to the owner the performance and payment bonds, along with the executed contract to construct the new hospital. The performance bond provides a guarantee to the owner that the contractor will complete the hospital job, consistent with the terms and conditions of the contract. If not (usually due to contractor default due to insolvency) the owner can be compensated by the surety company up to the amount of the bond.
The payment bond guarantees that subcontractors and vendors on the project will be paid. Like the performance bond, the payment bond is issued for 100% of the contract amount.
These bonds will remain in place for the life of the contract until the hospital is built and accepted by the owner. At that point, a maintenance bond may be issued to protect the owner against defects in materials and workmanship for some period following project completion, usually 1-2 years.
Because the construction business is one that is rife with risk and uncertainty—particularly on large, multi-million dollar projects like a new hospital—bonds work to remove some of that risk for project owners and allow projects to move forward to successful completion.