CONS-6003 - Debate - Bonds

School: Fanshawe College - Course: CPJ2 6033 - Subject: Accounting

CONS-6033 - Debate - Bonds Bonds are a type of contract where a surety, also known as a bonding company, guarantees the performance of certain obligations by a principal to an obligee. In a suretyship agreement, there are three parties involved: the principal, the surety, and the obligee. While bonds are similar to contracts of indemnity such as insurance policies, they are subject to additional rules like the right of subrogation. The three main types of bonds commonly used in construction projects are bid bonds, performance bonds, and payment bonds. Bid Bonds Bid bonds are primarily used in the construction industry and serve as a guarantee to the project owner that the contractor, who submitted the bid, will enter into the contract if their bid is accepted. If the contractor fails to do so, the surety will pay the penalty specified in the bond, up to the maximum value of the bond. Invitations for bid often require that the bid be accompanied by a bid bond in the amount of 10 percent of the bid amount. If the bid is revoked, the contractor may be liable for the difference between its bid and the next lowest, even if that amount exceeded 10 percent of the bid amount. By requiring contractors to submit standard form bid bonds, owners may end up limiting the damages available from contractors to the amount of the bond. The surety is dependent on the obligations of the contractor to the project owner, and any defense available to the contractor is also available to the surety. If a claim is made against a surety on a bid bond, the surety will first look to any defenses available to the contractor. The contractor should seek legal advice immediately if they realize they made a mistake in their bid or need to revoke it for any reason. Failure to take appropriate action could result in the bid being accepted, and if the contractor refuses to sign the contract, the bond could be forfeited, and the cost would ultimately fall on the contractor and other indemnitors. Performance Bonds A performance bond is a type of surety bond used in the construction industry to guarantee a contractor's performance of a construction contract. The surety, in this case, guarantees the contractor's obligation to perform their contract with the owner. The bond's face value is usually 50% of the value of the construction contract and represents the maximum potential liability of the surety. The contract between the obligee and the principal is incorporated by reference into the bond. In case the principal defaults on their obligations, the obligee notifies the surety, who has six options. These options include requiring the principal to remedy the default by performing their obligations, completing the contract themselves, soliciting bids for completion of the work, paying the obligee the amount of the bond, asserting a defense, and refusing to do anything, or taking a "wait and see" approach to determine whether the principal was in default. The surety should conduct a thorough investigation before choosing a course of action. If the cost of completing the unfulfilled contractual obligations is related to the amount owing to the

contractor, the surety will likely solicit bids for completion. However, if the cost to complete the project is well in excess of the amount owing, the owner may have inadvertently overpaid the contractor, which could provide a defense to the surety. Payment Bonds A payment bond is a type of guarantee for the performance of a payment obligation in a contract. It is requested when there is a concern that the other party may default on a payment obligation. Payment obligations in a contract can flow in different directions, and any party to a contract may have payment obligations, which, if breached, could cause problems. In a construction contract, for example, the owner has an obligation to pay the contractor, who in turn has an obligation to pay subcontractors, suppliers, and workers. Failure to meet these obligations could result in liens being filed and prejudice to the owner. To protect against liens by unpaid subcontractors, suppliers, and those working below them in the contractual chain, owners and general contractors sometimes require a labor and material payment bond. Payment bonds are typically required in two situations: an owner may require one from the contractor, or a contractor may require one from each of its major subcontractors. The payment bond creates a trust relationship, where the obligee is named as a trustee, and claimants under the bond are the beneficiaries of the trust. In a claim situation, the surety who has issued the payment bond is entitled to any defenses available to the principal. The surety's obligation is limited to the face value of the bond, and the surety is entitled to raise as a defense any limitation period contained in the bond that has not been complied with. A lien bond is a useful form of payment bond for the construction industry, used as security to discharge a lien that has been filed against the land on which a project was constructed. The bond is used in substitution of the land as security for the lien, so that the lien may be removed from title to the land. The surety is required to pay a lien claimant if the lien is found to be valid and the principal does not pay the amount ordered by the court. Unlike a labor and material payment bond, a lien bond is not put in place until after the lien has been filed.