In the construction industry, there are a lot of moving parts. There is the contractor, subcontractors, suppliers, and other third parties that work together to complete the project. In this industry, it is not uncommon for projects to be left half completed, companies to go out of business, suppliers and subcontractors to not get paid, and similar problems. To protect project owners and other parties from unfulfilled obligations, contractors are most often required to purchase a surety bond.
How Does a Surety Bond Work?
A surety bond is an agreement between three parties; the principal, the obligee, and the surety. In the construction industry, the principal would be the licensed contractor who is required to be bonded in order to be hired for a project by a government entity or private party. With Federal government projects and most state-sponsored public projects, Maryland included, surety bonds are required. Many private businesses and consumers will also want the contractor to be bonded in order to be considered for the project.
The surety bond essentially “assures” the obligee that something will happen. The project owner/consumer receives assurance that the work will be performed as outlined in the contract. Subcontractors and suppliers receive assurance that they will be paid for the materials they provide and/or the work that they perform.
The surety is the entity from which the bond is purchased. The principal pays a premium to the surety, and the surety provides financial backing for the bond and assurance that the obligee will obtain the desired result.
Common Misconceptions about Surety Bonds
There is some confusion among those in the construction industry and others about exactly how surety bonds work. Here are four of the common misconceptions people have about this type of product:
Surety Bonds are the Same as Insurance
While there are similarities between a surety bond and an insurance product, there are significant differences as well. With insurance, the insurance provider assumes the risk on behalf of their own client. For example, if someone purchases a homeowner insurance policy and their house is destroyed by fire, the insurer will cover the loss for the homeowner based on the terms and conditions of the policy. The individual who purchased the policy does not have to reimburse the insurance company for their cover losses.
With a surety bond, the risk remains with the principal, or in the case of the construction industry, the contractor who purchases the bond. Protection is provided to a third party, the obligee, who is provided assurance of a certain result. If the principal does not perform their obligations, this does not mean they are off the hook. Although the surety will make sure that the obligee is satisfied, the principal is still ultimately responsible to pay the claim.
Performance Bonds and Payment Bonds are the Same Thing
While they are usually purchased together before beginning a construction project, performance and payment bonds serve two different purposes for two different groups of obligees. Performance bonds provide assurance to the project owner/customer that the work will be completed as specified in the contract. Payment bonds provide assurance to subcontractors who are working on the job and/or suppliers who provide materials for the job that they will be paid as agreed.
Large Construction Companies do not Need Surety Bonds
One common misconception in the construction industry is that large companies who are well-established do not need to be bonded, and that they can get by with a letter of credit or some other type of insurance product. Aside from the fact that in most states, publicly funded projects will require a surety bond, large companies are not immune from financial difficulties, mismanagement, and other problems. Even large companies get overextended, fail to pay suppliers and contractors, fail to finish a job, or file for bankruptcy. Without a surety bond, those affected by this risk would have no way of recovering their losses if something should go wrong.
All Sureties are the Same
Some people think it does not matter much where they get their surety bond from. But the truth is, not all bond companies are created equal. Like insurance companies, bond companies have different areas of specialty. For example, some will only provide backing to a principal with strong credit, while others have high-risk programs designed to accommodate almost anyone. And of course, bond premiums vary from company to company, as do ratings, certifications, and regions in which they are approved to provide bonds.
Need Legal Help with Surety Bonds in Maryland? Contact a Skilled Construction Law Attorney
Surety bonds are complex contracts, and legal complications can often arise between the parties. Working with an established and experienced construction law lawyer can help you determine the best way to approach legal matters that come up, and how to successfully navigate the complexities involved with these issues.
Whether you are a principal, obligee, or surety, if you need any type of legal guidance related to surety bonds in Maryland, call the Law Offices of Matthew S Evans, LLC at 410-431-2599 for a personalized consultation. You may also message us through our online contact form or stop by our office in person at your convenience.