Surety Bonds

There are three types of contract bonds: bid bonds, performance bonds and payment bonds. A bid bond is an obligation undertaken by a bidder promising that the bidder will, if awarded the contract, enter into the contract and furnish the prescribed performance and payment bond(s) within a specified period of time. A performance and/or payment bond is specifically intended to cover a particular contract. A performance bond covers the contractor's actual performance of the contract. It guarantees payment -- up to the penal sum -- of such things as cost of completion or cost to correct deficiencies which are the responsibility of the contractor. A payment bond is intended to pay laborers, suppliers and other contract-related costs which the contractor owes to third parties. The benefit to a private (as opposed to public, i.e., governmental) Obligee is that it provides a source of funds for those who might otherwise be able to enforce a lien against an owner's property.

Performance and payment bonds may be two separate documents, each with its own penal sum, or they may be combined in one document with a single penal sum. The penal sum is usually the contract amount at the time the bond is executed. The penal sum usually does not increase when items are added that change the contract price.

It is wise to be sure that the payment bond's language explicitly gives such persons a direct right to claim against the bond. Otherwise the bond may be interpreted to be an Indemnity bond. An Indemnity bond reimburses only the Obligee for loss sustained by the Obligee due either to the contractor's failure to perform the contract or failure to pay persons with lien rights. Since a supplier or laborer cannot claim directly against an indemnity bond, an Obligee runs a greater chance of the inconvenience of a lien foreclosure suit. A payment bond lessens this chance, although an owner can never force a lien claimant to look to the bond instead of the owner's property.