Benefits Bonds Are Better For The Construction Project Owner Bonds Are Better For The Contractor Bonds Are Better For Subcontractors and Material Suppliers Conclusion Bonds Are Better For The Construction Project Owner (Obligee) Prequalification Prior to issuing a performance and payment bond, the surety company tries to make certain that the contractor has adequate financial resources, the necessary experience and the management skills to carry on the business and successfully complete the project for which the bond is required. In authorizing the bond, the surety company underwriter is saying, "I believe to the best of my judgement, that this contractor can perform this job." The prequalification process is designed to weed out those contractors whose ineffective money management, poor job supervision, inept estimating, poor coordination and lack of sound management would preclude a smooth running, properly built job. By contrast, when issuing a letter of credit, the banker will probably be interested only in the adequacy of the collateral available to the bank in case there is a call on the letter. If the banker is satisfied that the contractor can reimburse the bank should demand be made upon the letter, no further prequalification investigation is done. When The Contractor Deafults With a Performance Bond, the surety has several alternative methods of responding should the owner of the project declare the contractor in default The surety may step in and finance the original contractor or provide other support necessary to allow the contractor to finish the project. Or, the surety may arrange for a new contractor to come in and perform the contract. Another alternative would be to have the project owner award the remaining work to another contractor with the surety agreeing to pick up any difference in cost. If none of these alternatives prove feasible, a surety may pay the sum of the bond. This option is seldom exercised because the other alternatives are more likely to result in a successfully completed project-certainly the prime aim of the owner. Under a letter of credit, upon default of a contractor all the bank will do is pay the project owner a sum of money. The tasks of administering the completion of the contract is left to the owner. Labour and Material Claimants When a job is bonded, the rightful claims of direct subcontractors, labourers and suppliers are paid by the surety under the Payment Bond. Before making such payments, however, the surety assures that such claims are for the correct amount and are for the work provided or material supplied to the bonded contract. Under a letter of credit arrangement, the unpaid contractors, labourers and material suppliers are usually forgotten. No thought is given to their plight until they begin calling the project owner's office demanding payment. At that point, the owner must decide whether or not to voluntarily allocate some of the letter of credit proceeds to these claimants. If it is decided to honour the claims, someone has to determine the validity of each one. If there is not enough money to cover all of the claims, someone then has to decide which claims will be paid and which will be rejected. Aside from making all these decisions, the owner will face considerable administrative burden and likely wind up in litigation whenever a party disagrees with the decision. Duration of Suretyship Performance and Payments Bonds remain in force subject to the terms and conditions of the bond, the contract documents and conditions of common law. The project owner does not have to make a decision on the release of the Performance Bond.With a letter of credit, the owner is faced with a difficult decision as to when the letter can be released. For example, even if the actual construction is completed, there may be a one-year warranty for defective material and workmanship. Amount of Coverage Performance and Payment Bonds are generally each in an amount equal to 50 percent of the contract price and often in the amount of 100 percent. This gives the project owner as much as 100 percent protection for the performance of the contract and an additional 100 percent to Payment Bond claimants. To afford comparable protection, the letter of credit would have to be provided in an amount of 200 percent of the contract price. The cost of such a letter of credit would be prohibitive not to mention the difficulty in obtaining credit facilities for such a significant amount.
