Why should rural and regional water systems insist on their contractors being bonded? The answer is easy: protection. Bonding can raise the level of confidence an owner has in their contractor. A contracting firm’s ability to get bonds and the cost of his bonding is based on its past performance. The owners of most public works projects require contractors to purchase specific bonds as a form of protection or insurance against any number of actions which could delay or prevent completion of construction, or which could result in claims against the owner. These systems think of bonding as insurance to protect them from some very unpleasant consequences. A bond is a financial instrument, but unlike other forms of insurance, it has no deductibles.

The expense of the bond is, of course, included in the contractors bid price. Therefore, the owner ultimately pays for this protection. Some may wonder why they want to pay for bonding. In many instances, projects in excess of a certain size are required by the state to be bonded. It is part of the owner’s responsibility to the system’s constituents to have this level of protection. Of course, it is important when considering bonding that the system keep its legal counsel involved.

Three distinct bonds are typical for rural water system construction: a bid bond, a performance bond, and a payment bond.

The bid bond binds contractors to accepting a contract for the bid amount they stated in the bid form. If they fail to execute the agreement for the stated amount, they forfeit the bond.  The bid bond amount is typically as much as five to ten percent of the bid amount.  This amount is then paid to the owner. This money offsets the cost to rebid the project or award to the second low bidder. Essentially the bid bond holds the contractor to their word.  There are limited instances in which the obligation to the owner can be negated depending on the documents used.  In almost all cases the bid bond is not forfeited if the contractor can demonstrate that a substantial error was made in preparation of the bid.  Something that rarely happens.

Performance and payment bonds are part of the actual construction agreement with the contractor. The performance bond guarantees the contractor will perform the work to completion. This protects the system from any inability by the contractor to finish the job. This is obviously important. A partially completed pipeline or treatment plant is of little value to an owner. If the contractor fails to finish the work and the owner files a claim against the bond, the system will receive funds to complete the job or the bonding company will step in and finish the job with another contractor.

The payment bond guarantees the contractor will make all payments to suppliers for labor, materials and equipment. This protects the system from liens filed by subcontractors or suppliers of material or equipment.  For example, if the contractor fails to pay a supplier, that supplier can file against the bond and receive payment provided the claim is justifiable. This also is an avenue of protection should the supplier file a claim against the owner.  In those instances the supplier would be referred to the bonding company.

There are many examples of where bonding has saved a system time and expense. On a large pipeline project the contractor building the project encountered financial difficulties due to work on other projects and was in the process of becoming financially unstable and unable to complete the work.  The bonding company stepped in and provided the owner with a new contractor to finish the project.  While there was a slight delay in completion it was nothing in comparison to having the project incomplete and having to rebid due to the contractor going bankrupt.  The owner obtained the completed pipeline project for the bid amount and reasonably close to original completion time.

Bonding is just one more facet of system management and risk management—one that can save owners a lot of effort and money.