Contract Bond

That doesn't seem familiar, but it might depend on locale.

The setup I have seen is that an owner may require bidders to furnish a bond for some percentage of the bid amount. If the contractor defaults, the bond is paid to the owner (who might use it to hire someone else to complete the work). The contractor obtains this bond in a similar manner to buying insurance. The bonding company will charge a premium depending on the publicly known past performance of the contractor.

Suppose, for example, that a contractor loses several people in a vehicle accident, and is unable to complete the contract. The bond thus protects the owner. Ordinarily, I don't think the bonding would have further recourse against the contractor; it would be like an insurance loss. However, recourse may be possible in cases of fraud or other misconduct.

I am often both amused and irritated by the lack of understanding of the various bonds that pertain to construction contracts, which lack occurs both from within the industry and outside of it.

A Bid Bond, typically in the penal value of 5% or 10% of the bid amount, is simply a guarantee that the successful bidder will honor its bid and enter into a contract for the work proposed. In the event that it decides not to do so, the surety underwriter must pay the owner, or whomever the bond is issued in favor of, the penal sum. In some cases, the Bid Bond converts to a Performance & Payment Bond once the contract is awarded. Also, a surety underwriter who writes a Bid Bond will do so only with the understanding that it will provide the Performance & Payment Bond if the contractor is successful, even if they are not combined.

A Performance Bond or a Performance & Payment Bond is issued upon award of the contract and is underwriten by a surety underwriter, using much the same criteria that a bank would use to evaluate the creditworthiness of a borrower. After all, the Surety Bond is an extension of credit that is based upon the financial strength of the contractor, as well as his experience in successfully completing projects of a similar nature and size. In order for a contractor to be found in default to the extent that the surety underwriter is put on notice, there must have occurred a lengthy series of correspondence, including notices of the issue(s) that could trigger a default under the contract. Reaching the point that a formal claim is tendered to a surety underwriter is not taken lightly, as it impacts many aspects of the owner/contractor relationship. Among other things, it triggers a thorough investigation by the surety underwriter to determine if its underwritten contractor is truly at fault or if there is shared responsibility. In my experience, the process is far from straightforward and predictable. If the contractor is truly in default, it is within the surety underwriter's rights to engage another contractor or to step into the contractor's shoes and supervise the completion of its work, using its forces, physical plant, materialmen, and subcontractors. It really is no different than having your vehicle involved in a wreck which is the fault of another driver. The claims adjuster will evaluate the damage and agree to pay only so much for the repairs, often specifying one or more body shops with whom it has an agreement. If there are pre-accident damages or normal wear and tear evidence, only those damages that are actually the result of the accident will be repaired, and only within the limits of the underwriter's terms regarding salvage or aftermarket parts.

I often find myself really irritated by the advertising claims made by many residential and light commercial contractors stating that they are licensed and bonded. The only bond they have obtained is a license bond which has no value to anyone actually contracting with them for work. It merely insures that the contractor will abide by the terms of the license requirements and the licensing authority. Unless a surety underwriter has issued a Performance Bond or a Performance & Payment Bond in favor of the entity hiring the contractor, the term 'bonded' is meaningless. In fact, surety underwriters will not issue performance bonds in favor of anyone who is not in privity of contract with the contractor.

A surety underwriter does indeed have recourse against the underwritten contractor. It can, if necessary, seize all of the contractor's assets to permit the completion of its contractual obligations. There are many cases of contractors literally being put out of business on account of contract defaults that resulted in a surety taking over the contract(s) in default. In that regard, they function essentially the same way a bank would for a loan default.