Contract Surety Bonding
The three-party structure
A contract surety bond is a three-party instrument: the surety guarantees the principal's performance to the obligee. It is not insurance; the surety expects reimbursement from the principal under a general indemnity agreement and is subrogated to the obligee's rights. The main bonds are bid, performance, payment, and maintenance or warranty. A bid bond assures the owner that the low bidder will execute the contract and provide performance and payment bonds; if not, the surety pays the difference between that bid and the next responsive bid, capped by the penal sum-usually 10% of the bid. A performance bond responds to the principal's default, typically up to 100% of the contract price. A payment bond protects subcontractors and suppliers, commonly 50% to 100% of the contract price.
Underwriting and traps
Underwriters evaluate capital, capacity, character, and credit, plus continuity and experience. Traps: the surety has no general duty to defend; its obligations are defined by the bond. The surety's options on default include completing the contract, financing the principal, tendering a replacement contractor, or paying damages up to the penal sum. Change orders and time extensions may require the surety's consent. A performance bond is not a warranty of workmanship; it responds to default. Payment bond claimants must follow statutory notice and suit-limitation rules, especially on federal Miller Act projects.
Worked example
A contractor bids $1,000,000 with a 10% bid bond and refuses to sign. The next responsive bid is $1,050,000. The surety's liability is the lesser of the $50,000 difference and the $100,000 penal sum, so $50,000. If the next bid had been $1,200,000, the surety would still pay only $100,000.
Rule of thumb
Analyze a contract bond by asking: who is the obligee, what is the penal sum, what is the triggering default, and what notice or claim deadline applies?