How surety bonds work in case of contractor default

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Construction contractors sometimes go through hoops to receive payments. A client may experience a financial hardship that forces them to stop a project. They may also claim the work provided by the contractor does not match their standards.

However, contractors may also go through default due to performance or financial issues. A surety bond helps protect both parties so that a construction project reaches completion: It provides a remedy if one party to the contract defaults on the project.

Why do contractors default on projects?

Most contractors do everything possible to complete the project to the client’s satisfaction. Yet even with the best-laid plans, they experience a default and cannot continue with the project’s completion. 

The surety bond is an assurance to the client that the work is completed as specified and/or damages are paid. Reasons why the contractor defaults may vary from unforeseen issues with the contractor’s operations or poor work performance. These issues fall into three distinct categories: financial reasons, performance, or overextension.

Financial reasons

A contractor may undergo a financial hardship that forces them to stop their work. This reason may involve cash flow problems, or bad accounting practices for operations. They could also have overwhelming debt that has crippled the company. 

Another issue often experienced by contractors involves slow work seasons. Due to increased competition in their area, the contractor may find themselves without projects to keep their operations running.

Performance reasons

Performance reasons focus on issues experienced at the construction site. The contractor may go so far over the established project budget that continuing the work is not feasible for the client. The contractor may also not have the required skills to complete the job, or they may be behind schedule.

Overextension reasons

Overextension reasons typically occur when the contractor took on too much work that is beyond their capabilities. They may have dozens of projects lined up but not enough manpower or resources to complete any of them to the clients’ satisfaction. When the project begins to suffer due to non-completion, a client could file a claim against the surety bond to get the surety agency to step in.

How does the surety agency’s claim process work?

With a valid surety bond obtained and agreed on by both the contractor and the claim before the start of the project, all the claim has to do is file the claim with the surety agency.

The surety agency starts their investigations to determine whether the claim is valid. If they discover that the contractor defaulted on the contract for a specific reason, then four different solutions may commence.

1. Providing additional contractor assistance

The surety agency may allow the contractor to finish the work while offering financial or labor assistance. Contractors who receive this option typically have a good relationship with the surety agency and have shown to be reliable with their work.

2. Taking over a project

In this instance, the surety agency takes over the entire project. The contractor is off the job as the surety agency brings in a completion contractor to finish the work. All further work is overseen by the surety agency.

3. Tendering an approved contractor

With this solution, the original contractor no longer completes the project. Instead, the surety company and client may select a new contractor. In these cases, the new contractor takes control of the work as they oversee the rest of the project.

4. Client obligation/damage compensation

In these cases, the client may desire to hire the contractor on their own or select a different option to complete the project. The surety agency steps away from the project while ensuring that the client’s plans are within reason and that their agency will avoid additional risks. In some circumstances, the surety agency may pay the client for any incurred losses up to a specified contract threshold.

Contract surety bonds offer project safeguards

Contractors may view surety bonds as safeguards for their operations. It helps to build business trust with the client as it ensures that the contractor has their best interests in mind.

Any type of business emergency may occur that forces the contractor to default on a project. With the surety bond in place, everyone gains a guarantee that the project reaches completion.

Learn more: How Construction Contractors Can Reduce Surety Bond Costs