What are Construction Bonds?
Construction bonds are a type of surety bond that guarantees that a party (typically a contractor) will comply with its contractual and legal obligations, failing which, the bond will protect and compensate the party to whom the defaulting party owed the contractual and legal duties. A construction bond is a three-way contract between the principal (the party that owes the contractual and legal obligations), the obligee (the party that is owed an obligation by the principal) and the surety (the party that issues the bond and financially guarantees to the obligee that the principal will perform its obligations).
There are five types of construction bonds:
- bid bonds;
- labour and material payment bonds;
- performance bonds;
- construction lien bonds; and
- holdback repayment bonds.
In a competitive bid process, bidding contractors are often required to submit bid bonds as part of their bid submission. In the event that the successful bidder refuses or fails to enter into a contract with the owner that sought the bid, the surety will compensate the owner for the difference in the bid price of the defaulting bidder and the bid price of the second choice bidder, up to the limit of the bid bond amount.
Labour and Material Payment Bonds
An owner may require a contractor to obtain a labour and material payment bond for a construction project. The labour and material payment bond guarantees that the subcontractors and suppliers that have supplied services or materials to the construction project will be paid for such services or materials. In the event that the contractor fails to pay the subcontractors and suppliers, they can seek payment from the surety that issued the labour and material payment bond.
An owner may also require a contractor to obtain a performance bond for a construction project. The performance bond guarantees that the contractor will perform its contractual obligations owed to an owner pursuant to a construction contract. If the contractor defaults with respect to its contractual obligations, the surety that issued the performance bond will first investigate the alleged default and, assuming that the default is confirmed, then proceed to remedy the default. The surety, at its option, may remedy the default in one of several different ways. The surety may: i) issue tenders for a replacement contractor on behalf of the owner and compensate the owner for any additional costs resulting from the new contract; ii) retain a replacement contractor itself to complete the project; iii) assist the defaulting contractor in remedying the default and completing the project; or iv) compensate the owner for the damages it has suffered as a result of the contractor's default.
Construction Lien Bonds
Construction lien bonds are typically posted at Court and guarantee that a lien claimant will be paid if it is ultimately able to successfully prove that it has a valid construction lien. Construction lien bonds replace the lands or the holdback funds as the security against which the construction lien was preserved, thereby allowing the construction lien to be removed as a charge against the title to the lands or the holdback funds.
Holdback Repayment Bonds
An amendment to section 22 of the Construction Act (Ontario) that took effect on July 1, 2018, now allows holdback funds to be retained in the form of a demand-worded holdback repayment bond in the form prescribed by the Act (Form 5).
Other Recent Amendments to the Construction Act (Ontario)
Some of the other amendments to the Construction Act (Ontario) that took effect on July 1, 2018, also relate to construction bonds. A new part, Part XI.1 – Surety Bonds, was added to the Act and addresses bonds. Section 85.1 of the Act (found under Part XI.1) now requires a contractor on entering a public contract with an owner (the Crown, a municipality or a broader public sector organization) to provide a labour and material payment bond and a performance bond, each of which must have a coverage limit of at least 50% of the contract price or such other percentage as prescribed by the contract.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.