The construction industry is a risky business. Governments and owners of construction projects need financial security in place and the assurance their projects will be successfully completed.
Going green as a construction contractor is easier and more profitable than you think. Far more than a simple buzzword, green construction is fast becoming a critical sector brimming with opportunities. So sure, you already have a surety bond to protect your clients by ensuring you comply with all contracts and regulations, but protecting the environment and your bottom line further starts with green construction.
What is a Surety Bond?
Surety bonds are a valuable tool in mitigating and managing the risk inherent in construction projects. They play a vital role in the success of a construction project by providing valuable prequalification of the contractors, along with financial security and construction assurance to owners of construction projects.
Surety bonds are a three-way agreement between the contractor, or principal, the company providing the bond, or surety, and the government or private entity requiring the bond, or obligee. The principal uses the bond provided by the surety as a guarantee to the obligee that their regulations and best practices will be followed at every phase of construction. Opponents of green building regulations cite these bonds as an unnecessary financial burden on contractors and their employees.
How Surety Bonds Work in the Construction Business
In effect, the burden of the construction risk is shifted from the owner to the surety company. When 50 per cent performance and 50 per cent payment bonds are required on a project, the bonds ensure the contractor will complete the project and pay the subcontractors and suppliers. Surety bonds guarantee the owner that the contractor will successfully perform the contract. The surety company is willing to accept this risk based on the results of a professional and rigorous prequalification of the contractor.
The prequalification process is one of the most valuable benefits of a surety bond. Contractors that do not meet the high qualifying standards of competence are disqualified from the process.
A surety will often request more capital be allocated or retained in the construction company, especially if the contractor is looking at a larger or longer duration contract. In addition, the surety will evaluate the team and key personnel, prior experience in this type of work, quality of trades and the total work program the contractor currently has in place.
Since the surety takes indemnities as security from the contractor, these indemnities also serve as an incentive for the contractor to complete the contract, thereby providing a further mitigation of risk for project owners. If the contractor defaults and is unable to complete the work, then the surety steps in and uses its resources and expertise to arrange for completion of the project.
Subtrades are also often severely affected by the default of a general contractor. An often underestimated value of surety is the labor and material payment bond. In the event a general contractor defaults and there are unpaid trades, the labor and material payment bonds provide protection to the local trades by ensuring they will be paid for the work they have performed. This prevents subtrades from defaulting or abandoning the project and, instead, allows the subtrades to continue to perform the work to project completion.
While the benefits of owning and operating green certified buildings are often discussed, the legal implications of their design and construction can be overlooked. Clear-eyed owners should weigh some practical considerations before entering into design or construction agreements aimed at green certification.
Green building adds a new dimension to the economic loss rule. It remains to be seen whether courts will consider failure to obtain LEED certification, or failure to reach anticipated operation and design cost savings, a construction defect. To avoid disputes and maximize the ability to recover in a state with the economic loss rule, owners should negotiate text in the prime contract addressing the extent to which the contractor will be responsible under its warranties, and those given by the subcontractors, if the building isn’t as green as anticipated.