In the last posting, and in light of the explosion of new construction in the South Florida real estate market, we began to explore certain issues that owners and developers should consider before beginning a project and signing a construction contract with a general contractor. The first tip was regarding change orders. Our second tip relates to construction bonds.
When a developer or owner enters into a contract for a new construction project, it is a good idea for him or her to seriously consider requiring the general contractor to obtain both payment and performance bonds from a surety. A performance bond guarantees that the contractor will perform the contract and usually provides that the surety may complete the contract or pay monies up to the limit of the bond upon the contractor’s default and failure to complete the contract. A payment bond guarantees the owner that all bills for labor and materials contracted for and used by the contractor and its sub-contractors will be paid by the surety if the contractor defaults, thus avoiding liens on the property and title from being clouded.
Conditional/Unconditional Payment Bonds
Payment bonds may either be conditional or unconditional. An unconditional payment bond exempts real property being developed from liens filed under the Construction Lien Law, by an owner simply filing a notice of payment bond in the public records where the property is located. A conditional payment bond does not automatically exempt the owner’s property from all liens filed under the Construction Lien Law, but allows the owner to transfer the lien to the bond to the extent of the payments made to the contractor. Thus, if a conditional bond is in place, an owner’s property may be liened for claims in which the owner has failed to pay the general contractor.
Contractual Arrangement Between Owner, Contractor and Surety
Whether guaranteeing performance or payment, a construction bond is a contract between three parties: the owner, the contractor, and the surety. Under this contractual arrangement, if the contractor fails to perform its duties owed to the developer or owner, the developer or owner may assert a claim either against the contractor, the surety, or both. In most cases, upon a default by the contractor, a developer or owner looks immediately to the surety bond. Once a default is declared, the surety must investigate, and then either perform on the bond or deny the owner’s claim. If accepted, an owner’s claim against a surety bond will be limited to the face amount of the bond, which in almost all cases will equal the contract sum of the project being developed.
Payment & Performance Bonds: An Owner’s Best Friend
In sum, payment and performance bonds protect the owner of real property from two specific potential defaults by the contractor: (i) they guarantee that all subcontractors and materialmen will be paid, thus avoiding potential liens on the property; and (ii) they guarantee that the construction contract will be fully performed according to the construction contract. As such, it is always a good idea for an owner to require a general contractor to purchase both payment and performance bonds prior to the commencement of construction. In particular, unconditional payment bonds should be required as opposed to conditional payment bonds. With the explosion of new construction in South Florida, payment and performance bonds can quickly become an owner’s best friend.