Bonds and the construction process sponsored by BUSINESS TIP What is a bond? No party enters into a construc- tion contract expecting any party to default. Contracting parties, howev- er, must manage the inherent risk of the unexpected during construction projects. Construction bonding is a method commonly used by con- tractors, subcontractors and owners to redistribute the risks associated with defaults during the life of a construction project. A bond is a contractual obligation undertaken by a surety company (often, an insurance company) to perform or pay a specific amount of money if the principal (often, the general contractor or installation contractor) does not perform or pay. A surety relationship is a three-party contract that guarantees that the principal will fulfill its obligations to the third party, the obligee (often the project owner for performance bonds, and subcontractors for pay- ment bonds). In other words, by taking out a bond, the principal and surety have made a contractual promise to complete the principal’s obligations or to pay the obligee the costs of completion up to the agreed-upon surety amount (called the “penal sum”). The principal will thereafter have a reimbursement obligation to the surety for any amounts the surety may pay out on the bond to the obligee. Types of bonds The three most common con- struction surety bonds include: • Performance bonds which secure the general contractor’s promise to perform the contract in accor- dance with its terms and condi- tions.The surety bond provides for compensation to the obligee (gen- erally the owner/developer for the project) for financial losses if the principal (traditionally the general contractor) fails to perform. • Payment bonds which guarantee the principal’s obligation (typical- ly being the general contractor) to make payments to subcontractors By Daniel A. Dorfman, JD, LEED Green Associate – Chair, Construction Law Group, Fox Swibel Levin & Carroll LLP 32 TileLetter | December 2018