It is important to understand the purpose of a contract surety bond because it becomes easier to comprehend the connection to contract terms and conditions. A performance bond is a guarantee that the construction contractor will complete the project to the specifications outlined in the contract. The performance bond does not state the conditions on which a claim can be made on the bond that verbiage is in the contract itself. Therefore, it is critical for underwriters to read through the contracts to determine what the obligations are because that is what claims will be made on. The exact level of risk for the surety company is determined by reviewing contract terms, the amount of perceived risk factors into the premium rate charged. The higher the risk and exposure of the surety company then the premium rate will increase and vice versa. Key terms the surety underwriters are looking for are:
- Payment Terms – In this section of the contract the surety company wants to find the payment schedule for the project to ensure it will allow the contractor to cash flow the project. The underwriter does not want to contractor to be strapped for cash if the contractor does not get paid within the first 60 days of the project because he/she will have to pay their subs regardless if they have been paid. This is truly the surety company working on behalf of the contractor because not being able to cash flow a project will lead to bankruptcy.
- Time for Performance – Surety underwriters prefer short term projects because it requires less future projects for the viability of the contractor. The surety company only has past and current information and has to make a decision for a project that lasts 24 months. The surety company has to be sure the contract has the resources to complete a project that complex within said number of days.
- Liquidated Damage Provisions –These are expressed as a fixed dollar amount per day for every day the contractor extends beyond the completion date. The surety company wants to make this is listed in the contract because it is preferred to have actual damages.
- Termination for Default Provisions – These set the terms for which the project owner may terminate the contractor’s right to proceed under the contract. This is where forfeiture language is found which causes the surety company to pay the entire bond amount regardless of the amount of default.
- Warranty Obligations – Surety companies will normally only bond projects within a 1 year warranty. Any damage discovered after the work was completed is difficult to trace directly to the contractor. Normally, manufacture warranties will remain on the complex machinery or solar panels for many years after installation.