How does a construction bond work?

If a contractor fails to fulfil their contractual requirements, a client or developer can face severe disruption or financial loss. To protect against this risk, developers often require contractors to provide a construction bond. A construction bond or surety is a contractual guarantee or promise ensuring that the client is compensated if something goes wrong. The bond acts like an insurance policy for the project, providing financial security for developers while enabling contractors to bid for projects with confidence.

Why do developers require a construction bond?

The need for a construction bond is typically specified by the developer within the contract, and the contractor is expected to purchase the bond, with the developer or client being the beneficiary of any payment.

By requiring a construction bond, developers gain peace of mind knowing that any financial losses due to non-performance or contractor failure can be mitigated.

Common types of construction bonds

There are several types of construction bonds, but the most common are: 

Performance Bonds

Performance bonds are designed to protect the developer if a contractor fails to complete a project as agreed. A frequent concern is that the contractor may become insolvent before finishing the contract. Performance bonds are commonly set at a figure of around 10% of the total contract price, which is usually considered sufficient to cover the cost of disruption in rectifying any failure in the performance of the contract.

Advance Payment Bonds

Contractors will often request that the developer or client give them an advance payment or down payment to cover the cost of materials or equipment at the start of a contract. A concern for the client in such a situation is that they might pay a large sum up front, but the contractor fails to fulfil the contract or goes insolvent. An advance payment bond would compensate the client for the lost advance payment.

On-demand vs conditional construction bonds

Construction bonds generally come in one of two types, either ‘on demand’ or ‘conditional’:

• On-demand bonds: The employer or client can call upon this bond to be paid at any time, even if the contractor is not in breach of contract. There have even been cases where the bond has been called upon when the developer actually owes the contractor money.

• Conditional bonds: Payment is only made if the contractor fails to meet contractual obligations and the client suffers a loss.

Obtaining a construction bond

Construction bonds are generally obtained either from a bank or from a bondsman or surety, generally via a broker such as Sutcliffe & Co. Banks will usually issue ‘on demand’ bonds and may well tie up the value of the bond, which restricts the finances of the contractor. A bondsman or surety will more often issue a ‘conditional’ bond and will not tie up any of the contractor‘s finances. As such, most contractors find bonds offered by their bank too restrictive.

At Sutcliffe & Co, we have been providing construction bonds for generations and can guide you to the right type of bond for your project, connecting you with a wide range of trusted providers. If you are a contractor or developer seeking guidance on construction bonds, get in touch with our experienced team can help you ensure your project is fully protected.