Owners Guide to the Design and Construction Process – part 10

IV. Bonding and Surety Underwriting

A performance bond, provided by a surety, gives protection against the contractor’s failure to perform the contract in accordance with its terms. The surety’s obligation under the bond terminates on satisfactory completion of the work required by the contract.

However, if the contractor should fail to perform in accordance with the contract, the surety is obligated to the Owner to fulfill the provisions of the contract.

A payment bond (or “labor and materials” bond) is commonly provided by a surety as a companion to the performance bond. This bond protects vendors of labor, material, and other suppliers to the project.

In providing the various types of bonds in the construction industry, the primary function of the surety is to pre-qualify the contractor. The surety examines the contracting entity to see if it has the management, experience, resources, and financing capability to get the job done. An established contractor has an ongoing relationship with a quality surety, and if, in the judgment of the surety, the contractor can perform on a specific contract, the surety will provide the required bonds.

Surety underwriting is similar to extending credit. For a fee, the surety provides a guarantee to third parties that the contractor will fulfill obligations of performance and payment. Just as a banker will not knowingly make a loan without satisfying himself regarding a borrower’s ability to repay the loan in accordance with its terms, a surety will not knowingly issue a surety bond without similar knowledge of the contractor’s ability to meet obligations in accordance with the terms of the contract. However, the Owner should be aware that because the primary function of the surety is to pre-qualify the contractor, the bond should not be looked at as an insurance policy.

If the contractor abandons the project due to financial difficulties, the surety is obligated to take prompt action by one of the following procedures:

a) provide financing to the contractor;

b) contract with another contractor for completion of the work;

c) make payment to the Owner for damages. The surety will make a decision based on lowest anticipated cost to the surety. The surety cannot actively respond to an Owner’s demand if the contractor is alleging a just dispute with the Owner. This would prejudice the rights of the contractor and reduce the surety’s right of recovery under the indemnity agreement between contractor and surety. Therefore, in a dispute between Owner and a solvent contractor that cannot be resolved, the Owner will probably have to litigate against the contractor and surety. These delays could result in substantial costs to the Owner which he may never fully recover.

Summary

The Owner’s best assurance that he will get the results desired is the reputation and past performance record of the contractor, demonstrating the skill, responsibility, integrity, and financial capability to complete the project in the best interest of the Owner. However, ability to furnish appropriate bonds is an added pre-qualifier in selection of a contractor or builder, and does provide valuable assurances for the Owner (even if the bond is not purchased.)

I. Our Recommendations

JOSEPH Construction Company has been in the building business for over 40 years. During that time we have been involved as general contractor in all four of the building processes described in this booklet.

In our early years, we got most of our jobs as the result of being the low bidder. In recent years nearly all of our work has been in Design-Build or Partnering methodologies.

Our stand now is that early involvement of a broadly competent construction staff having a full understanding of all phases of the building process can greatly enhance the efficiency and end result of the project. This has been borne out again and again in our recent experience with hundreds of buildings of all types.

The traditional approach with its bidding process has developed into something of an adversarial procedure with Owner and architect on one side and the contractor on the other. This serves no one’s best interest.

In his or her desire to get the job with a low bid, a contractor might make certain concessions with regard to time or quality. He might shop for subcontractors to the point where their low bids reflect their ability to perform. The hungry contractor might develop his bid with an unreasonably low margin for contingencies, so that he must constantly cut corners during construction.

These are some of the inherent pitfalls of the traditional bidding process for the Owner. There are some for the contractor too. Through error or omission in his bid, he might find himself with a job he wishes he had never been awarded, and that situation works to the disadvantage of both sides.

We conclude that the only place for traditional low-bid process is on government jobs on which negotiation is precluded by law or regulation.

We’re reminded of the story about the astronaut at the final press conference before his space flight. He is asked: “How do you feel about the reliability of the system that will carry you on this mission?” His reply: “All I can think of is that every part in it was made by the lowest bidder.”

You might think of using the traditional process with the variation of negotiating construction. But if you’re going to do this, why not use the Design-Build or Partnering method with the contractor involved at the beginning, and obtain all the benefits previously described?

We stand strongly for the benefits that arise from the Design-Build and Partnering methods. These methods pull together all phases of the building process, produce at the outset a more complete plan, and assure the completion of the work on time, at the expected level of quality, within budget.