Introduction To Contract Surety Bonds - Forms & Functions

Forms and Functions of Bonds
Bid Bonds (CCDC Form 220)
Performance Bond (CCDC 221)
Labour and Material Payment Bond (CCDC 222)


Forms and Functions of Bonds

Bonds make it possible for the Principal (contractor) to provide the Obligee (owner) with the guarantee of a responsible Surety that the Principal will satisfactorily perform his obligations under the contract provided that the Obligee performs his obligations. Bonds are therefore a useful means of ensuring responsible contract performance and financial security and, consequently, are often an essential requirement in construction procurement today.

It is emphasized that a Surety Bond is not an Insurance Policy. A Surety Bond is a three-party undertaking, naming a "Principal", and "Obligee" and a "Surety", under which the Surety agrees to indemnify the Obligee against loss arising from the failure of the Principal to perform his obligations. Furthermore, if the Surety suffers monetary loss as a result of fulfilling its obligations under the Bond it will look to the Principal and any indemnitors for reimbursement of such loss.

There are numerous forms of Bonds in use. Some government bodies and even private owners use their own particular wordings, which they believe will augment the protection afforded by the bond. The CCDC and its constituent bodies continue to strive for adoption of its Standard Bond forms as these forms were designed with the intent of being fair to all parties to the contract/surety relationship. In addition to the fairness and balance, standard wordings have compiled a history of solid legal precedent which has clearly defined the meanings of the various provisions of the document. While non-standard forms may seem to provide a short term legal advantage, any such benefits are forfeited by the enhanced likelihood of litigation due to this lack of legal certainty.

Bidders are cautioned to obtain a proper understanding of the obligations they are required to assume before tendering or entering into a contract, including their ability to provide the required contract security. It should be borne in mind that the Surety does not assume a greater obligation than that of the Principal and that the Surety looks to the Principal for the fulfillment of all obligations under the Bonds. Potential claimants under special forms of Labour and Material Payment Bonds should determine precisely what such Bonds specify in defining a claimant and the procedure to be followed in making a claim.

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Bid Bonds (CCDC Form 220)

The purpose of the Bid Bond is to ensure the integrity of the tendering process and to ensure that only qualified companies submit a tender. If the Principal's tender is accepted he is obligated to enter into a formal contract with the Obligee within the time required and to provide the specified security (Bonds or other forms of security) to secure the performance of the contract. If he fails in this obligation then he is obliged to pay to the Obligee the difference in money between the amount of his tender and the amount for which the Obligee legally contracts with another party to do the work, up to the face amount of the Bid Bond. If the Principal fails to meet this obligation the Surety is obliged to do so and will charge the total costs involved back to the Principal. It should be noted that the Principal might prefer to forfeit the obligation under the Bid Bond rather than undertake the contract at a greater loss.

The provision of a Bid Bond does not by itself guarantee the performance of the contract by the Principal. Therefore, it is dangerous practice to waive the requirement for the provision of a Performance Bond by the successful bidder because he has demonstrated financial and technical qualifications by his ability to obtain a Bid Bond. Defaulted contracts are becoming more numerous. Experience has shown that in many of these cases, notwithstanding that Bid Bonds were provided, defaults occurred. In such cases, if the Bid Bonds were not followed by the provision of Performance Bonds, no protection was available to the Obligees. Obligees are cautioned that Performance Bonds and Labour and Material Payment Bonds should be obtained promptly after acceptance of the tender. It should be noted that any suit under the Bid Bond must be instituted before the expiration of six months from the date of the Bond.

To assist users of Bid Bonds the following is a basic check list:

(a) the Bid Bond should properly identify the Principal, the Obligee, the tender closing date and the project (including a brief description of the work and location);
(b) the amount of the Bid Bond should not be less than the amount specified for bid security. Tender specifications may require that this amount be shown as a percentage of the tender price or as a fixed dollar amount;
(c) the Bid Bond must be properly executed by Principal and Surety
(d) tender must be accepted within the time specified in the tender documents or the time set out in the bid bond itself, otherwise the Bid Bond is null and void;
(e) if the tender cannot be accepted within the specified time period, consents for the extension of the acceptance period should be obtained in writing from the Principal and Surety. Execution of such consents from the Principal and Surety should be completed properly under seal;
(f) written notice must be given by the Obligee to the Principal and the Surety if the Bid Bond is called upon and any suit must be instituted within six months from the date of the Bid Bond.
In summary, the basic function of a Bid Bond is to guarantee to the Obligee the good faith of the Principal in tendering. In the case of a Bid Bond it should not be overlooked that any payment made thereunder is first the obligation of the Principal (bidder) and therefore an unreasonable bid bond amount or an obligation which goes beyond that of the CCDC Standard form of Bid Bond could have disastrous results for the Principal.

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Performance Bond (CCDC 221)

The basic function of a Performance Bond is to provide financial protection to the Obligee up to the amount of the Bond in the event of default on the part of the Principal. Provided the Obligee has met his obligations under the Performance Bond and the contract he will claim against the Surety and will expect to be compensated within the amount of the Bond for losses suffered by reason of the Principal's default. Again it should be borne in mind that the Surety will look to the Principal for recovery of its loss. Right of claim under the Performance Bond cannot be assigned to others without the written consent of the Principal and the Surety.

A Performance Bond is not intended to cover payment of labour and material claims. Owners and Contractors should not depend upon the Performance Bond for payment of such claims and are advised to purchase a Labour and Material Payment Bond if such coverage is desired.

The time limit for filing a claim under a Performance Bond is two years from the date on which final payment under the contract becomes due, therefore the standard one year warranty period is automatically covered. In the event that a warranty period is specified to extend beyond two years it may be necessary to purchase a maintenance bond to respond the extended warranty period since the time limit for filing claims would otherwise expire before the end of that period. While contract specifications sometimes require extended warranty periods for certain specialty products or work it should be noted that Surety companies are normally reluctant to be exposed beyond two years. The availability of Surety support beyond two years for any particular contract is dependent upon the underwriting assessment of the Principal by the Surety. Such support is usually quite limited for Principals other than the very largest.

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Labour and Material Payment Bond (CCDC 222)

Basically, the function of a Labour and Material Payment Bond is to guarantee that all claimants will be paid for labour and materials furnished to the Principal for use on the project described in the Bond. Under the CCDC Standard form of Labour and Material Payment Bond, a "claimant" is one who has a direct contract with the Principal for the provision of labour and/or material (which includes equipment rental), as defined in detail on the Bond, used or reasonably required for use in the performance of the contract. In a situation where the Principal is a General Contractor and the Obligee is an Owner, the potential claimants would be Subcontractors and/or suppliers of material or labour having contracts directly with the General Contractor. Under these circumstances subcontractors of the Subcontractors and material suppliers to such

Subcontractors would not be claimants within the terms of the Bond between the General Contractor and the Owner. While some non-standard Labour and Material Payment Bonds do provide coverage to second tier subs and suppliers, it must be emphasized again that any additional coverage provided by these Bonds becomes an obligation of the Principal. In the above example, the General Contractor in entering into such a Bond would be assuming liability for payment of accounts which are the responsibility of his Subcontractor and for which the General Contractor may have already paid the Subcontractor.

General Contractors and Subcontractors often purchase or lease supplies, materials and equipment from the same supplier for more than one contract and there is a general tendency to make payment on a bulk monthly or periodic basis without designating the application of such payment. In the event that a claim is made under a Labour and Material Payment Bond this practice could make it difficult for the Contractor to prove that payment had been made for the contract covered by the Bond. Therefore, General Contractors and Subcontractors are cautioned to:
(a) make payment on the basis of a specific invoice amount where such invoice applies directly to a specific contract; and,
(b) designate the amount of payment applicable to each specific contract when making a bulk payment. Potential claimants are cautioned to familiarize themselves with the terms and conditions, as well as the limitations, of the Labour and Material Payment Bond. Particular attention should be given to the time limits for filing claims. To be valid, claims must be filed within the stipulated time and it should be noted that notice of claim must be filed by registered mail with each of the parties to the Bond, namely the Principal, the Obligee and the Surety. If a form other than the CCDC Standard Bond form is used, potential claimants should obtain and carefully review a copy of the proposed Bond form from the Principal or Obligee.
A Labour and Material Payment Bond is not a substitute for sound credit practice. It should be understood that, for various reasons, a claimant cannot expect to receive immediate payment of an account from the Surety. It is necessary for the claimant to prove that the materials and/or services were in fact supplied to the particular project in connection with which the Bond was issued. The specific requirements regarding proof may include a copy of the contract or purchase order, payroll records, signed delivery tickets, properly approved extra work or material orders, proof of acceptance of the work by the owner or architect and other items of this nature.

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