Tuesday, October 2, 2012

Why Two Bonds Are Better Than One

Most public agencies require some form of bond from contractors on public works construction projects.  The bonding company (or surety) issuing the bond stands behind the contractor to guarantee that the contractor will:
  1. Perform the work in accordance with the contract documents, and 
  2. Pay their subcontractors, suppliers, and workers
Separate and combined bonds both available:  Sometimes performance and payment bonds for public works construction projects come in the form of one bond, and sometimes they are obtained as two separate bonds.

Separate bonds protect agency more:  Separate performance and payment bonds, each for 100% of the contract amount, protect the public agency more, without additional cost to the contractor (or agency).
Which bond is more important?  To understand why separate bonds protect a public agency more than a combined bond, we must first understand the purpose of the performance and payment protections.
  • Public agencies care more about the protections of the performance bond.  In other words, the public agency wants to ensure that a surety is backing the contractor and guaranteeing the successful completion of the project.
  • A payment bond, on the other hand, is for the protection of others: subcontractors, suppliers, and workers.
What's the problem with a combined bond?  While a combined performance and payment bond may seem to be more efficient (one bond instead of two), it is not as effective in protecting public agencies.  In other words, for every claim filed (and paid) against the payment protections of a combined bond, there is correspondingly less money available under the bond to protect the public agency and ensure that the contractor successfully performs the work.  On a project with multiple payment claims, it may be an indicator that there will be performance problems as well.
Why two bonds are better than one:  A public agency's strongest position is to have performance protections from a surety for 100% of the contract amount that does not get reduced by payment claims against a combined bond.  Sureties do not charge contractors more to obtain separate performance and payment bonds, and the separate bonds ensure that the public is better protected.

Separate bonds on FHWA funded projects:  Washington State's Department of Transportation (WSDOT), through their Highways and Local Programs Department, recently approved the use of separate payment and performance bonds for local agencies on FHWA funded projects.  APWA's Division 1 Committee has developed separate sample bond forms that may be used on FHWA funded projects, or projects with other funding.  The separate bond forms will be available on the APWA Division 1 Committee's website soon (http://www.apwa-wa.org/committee.aspx?id=5).
Mike Purdy's Public Contracting Blog 
© 2012 by Michael E. Purdy Associates, LLC 

1 comment:

Performance Bonds said...

Performance bonds and surety bonds are the same type of instrument, used to help define business contracts when an owner wants to hire a contractor to do specific work. In general, "surety bond" is a term used to describe all such bonds, while "performance bond" is used to describe a specific type of surety bond. Other types of surety bonds includes payment and bid bonds. None of these bonds should be confused with insurance or investment bonds.