The second type of bond is the performance and payment bond. These can be a single instrument, or two separate bonds, but either way they are typically used in unison.

The word performance speaks to the owner receiving assurance that there will be sufficient funds available to complete the project should the contractor encounter financial problems.

If you sign an agreement with a contractor that does not require a performance bond, and half way through the job the contractor ceases operating, you will be left with the responsibility of figuring out how to finish the project. Not only will you have to deal with the headaches, but you will also likely incur extra cost in completing the work. You can seek redress from the contractor, but you will likely be at the end of a long list of entities looking for money, and your chances of succeeding are slim. It will take attorney fees to recover any funds that you have lost.

If, however, you have required the contractor to supply a performance bond, the surety will step in and assume the responsibility of finishing the project. They will also ensure that no additional costs are incurred. It is then the surety’s problem to collect any extra costs from the contractor. For him this is a much easier prospect, as he likely has an agreement with the contractor that gives him leverage you do not have.

The word payment speaks to the owner receiving assurance that the contractor will pay all labor, material, and subcontractor costs for the project.

When a contractor starts to have financial problems, the first thing that is likely to happen is he will start stretching out payments to his suppliers. In doing this, he is often using money from one project to pay bills from an older project. It is definitely possible for a contractor to be paid for a project fully by an owner, but for him to still owe money to subs and suppliers. Waivers of lien can help alleviate this situation, but they do not provide fullproof guarantees.

If this happens, the laws in most states allow those subs and suppliers to go back to the owner for payment, causing the owner to pay twice for the same work. At the very least, those subs and suppliers will place liens on the real estate, which can cause an owner considerable grief, especially if there is long term financing that must be closed after the construction is complete.

The payment bond allows employees, subcontractors, and material suppliers to pursue payment from a surety instead of the owner. The owner often will hear about these issues first, and he has an obligation to turn them over to the surety in timely fashion, but if he follows the stipulations of the bond correctly, he should be able to insulate himself from extra costs, and any issue with liens should be quickly resolved. The surety will persuade the contractor to make the payments, or if he makes the payments himself, he is in the same good position to use his leverage with the contractor to recover the funds.

The most typical face value of the bond is 100% of the contract amount, although some owners will require 150%. 100% is generally sufficient because it is unlikely that a struggling contractor will be able to obtain a bond to start with. If he can supply the bond, any issues he has will take time to develop, and a portion of the project will already be complete.

As noted in the last post, performance and payment bonds have premiums associated with them. Those premiums can start as high as 2.5% for very small contract amounts, and they have a sliding scale with a percentage that decreases as the size of the contract increases, so that a $15M project might have an aggregate premium of not much more than 0.5%. The financial strength, size, and history of the contractor will effect his bonding rates, so different contractors may very well have different rates for the same project.

The contractor pays the premium to the surety, but he includes it in the price of the project. So ultimately, the owner is paying for these assurances.

That statement marks a good place to leave off. The next post will address the question:

Should you require a bond for your project?

I will use the next couple posts to cover bonding basics for those new to the world of construction.

Not all projects use bonds. For those that do, two types of bonds are typically required.

The first is a bid bond. As the name implies, this bond is submitted with the bid. It theoretically ensures that the contractor will enter into a contract for the amount of his bid, and that he will supply the required performance bond when the contract is executed. The value of this bond is typically 5% of the bid amount. If, after submitting the bid, the contractor refuses to sign a contract, the owner can require the surety company to reimburse it for the difference between the bid amount and the next lowest bid, up to the value of the bid bond.

Sometimes the bid documents allow the contractor to provide a certified check in lieu of the bond, although contractors almost never take this route. If the contract is not executed, the certified check is then available to the owner to make up the difference between the low and second bids.

Practically speaking, I am unaware of any instance where an owner has actually enforced the terms of the bid bond. This happens so rarely that sureties do not even charge premiums for bid bonds. The only premiums paid by contractors are on performance bonds after a successful bid has been converted into a contract.

This is because, unless a bid is wildly low (say by 20% or more), the contractor will not hesitate to sign the contract. The reason he bid the project is because he wants to do it. He needs to do it. This is how he makes his living. Getting work is difficult enough without turning down contracts on bids where the pricing is reasonably close. There is no incentive to expend the energy and money to prepare a bid if you do not intend to take the work afterward.

If the bid is wildly low, the contractor will immediately review his pricing, looking for major mistakes. If he can not find a mistake, he will still likely take the project, because he generally believes in himself enough to think he is that much better than his competitors in this particular instance. To not take the bid without any explanation would also damage his reputation.

If he does find a major mistake, every owner I know will allow him to withdraw his bid without penalty once the details of the mistake are demonstrated.

Owners are usually reasonable people with businesses of their own and they empathize with such a mistake. They have probably been in similar circumstances. They recognize it does no good to force a contract on someone that will only hurt that person. They also recognize that forcing such a contract will likely damage their own interest. They have their own reputations in the community to be concerned with. They also understand that a contract that guarantees a loss from the outset can do very real harm to the project. There is no surer way to jeopardize quality than to start the process with low morale and too little money.

Experienced owners who wish to avoid problems will go so far as to throw out extra low prices if they are confident in their budgeting process and the next price is within the budget. This would be especially true if the low bidder is inexperienced or does not have an established relationship with the owner.

The practical purpose of the bid bond actually lies in the assurance that the contractor will be able to supply the performance bond when the contract is executed. I will cover the performance bond in more detail in the next post, but one of its main purposes is to ensure that bidders have enough financial strength to complete the work. Bonding companies will not provide bid bonds unless they will also supply the performance bond. The one instance I can imagine where an owner would be well justified in enforcing the terms of the bid bond would be if a contractor is willing to sign a contract, but the surety is unwilling to follow through with the performance bond.

I will end this series with a discussion on how to decide whether or not to require bonds at all.

For now, simply understand that the main use of the bid bond is to ensure that only financially qualified contractors will make the effort to bid the work.

It should be posted sometime in the next few days. I am later than I expected to be with this, but I will be getting Ed something once a month from now on. Some of that will be things already posted here, or it may be that new information will be posted here and there at the same.

Either way, we are now off and running.

Conference Resources for Construction Projects

Until now, if I am not mistaken, every article for this Church Development Blog has been written by Ed Fenstermacher.

That gives me the honor of being the first “expert” contributor to this new blog format that Ed is hoping will spark some extra energy in the church growth movement for the conference. Hopefully I can live up to that moniker.

My area of expertise is construction, and I serve as the main contact for what used to be known as the Construction Connection ministry. That ministry has been reconstituted and is now geared toward providing referrals to industry professionals who are willing to help (at no initial compensation) churches with specific needs in the area of finance, vision casting, and the nuts and bolts of designing, building, and/or renovating church facilities.

It is, I think, logical, hopeful, and faithful to believe that the “Sending of the Saints” initiative recently launched by the conference will require new infrastructure in some churches. Not everyone may choose a plan so bold as to envision new structures, or even renovated worship, gathering, gym and/or classroom spaces. But some will, and by the Grace of the Spirit they will succeed and be blessed with the need to serve more people than their current facilities allow.

Nothing would give me greater pleasure than to have a chance to help those churches meet those needs. The UMC (in the form of Granger Community Church, where I have been involved in every building project since the first) significantly impacted my faith life when I was a young man and I am anxious to give back where I can.

By way of background, I have a civil engineering degree from the University of Notre Dame. I have 25 years of hands on experience in the construction industry. I started by working summers as a laborer when I was in college. I have since been a project engineer, project manager, estimator, chief estimator and, for the last ten years, a Vice President for two different commercial contractors in the South Bend area.

I am often involved in projects from conception to completion. I pride myself on serving owners well, helping them to maximize the money they have to spend while ensuring that program is met and that design is not sacrificed to the detriment of the final product.

There is a place on every project where budget, need, and the aesthetic can meet to everyone’s satisfaction. Helping architects and owners find that place is the particular need I hope to fill.

I now run my own construction consulting business while also serving as Vice President of Henry CAP Construction in Mishawaka IN. The details of my business and that relationship can be found on my website, www.narrowtheroad.com.

I am available for consultation with Methodist Churches throughout the conference at no initial cost and am happy to make a visit with no promises of anything further. If you have any questions at all, or would like me to visit your church, I can be reached at (574) 298-8981, or via email at timshort@narrowtheroad.com.

In the meantime, I expect to be a regular contributor to Ed’s blog. Please look for another post from me next month. Any suggestions about what that article might address would be happily received !!