Construction Bonds and Contracts - Part 2

Construction Bond
 A construction bond is a type of surety bond used by

investors in construction projects. Construction bonds are
a type of surety bond that protects against disruptions or
financial loss due to a contractor's failure to complete a
project or failure to meet contract specifications. These
bonds ensure a construction project’s bills will get paid.
 Surety bonds for contractors are legally binding
agreements between three entities:
project owners, known as the bond oblige;
contractors, known as the bond principal; and
the surety company that issues and backs the bond.
 Depending on the specific type of bond, these agreements
have different conditions, though they all serve the same
purpose of securing protections and guarantees for bond
obligees.
Construction Contracts
 A construction contract can be explained as the
warranty that ensures that the executed job gets
the specific amount of compensation or the
way compensation will be distributed.
Moreover, a construction contract is negotiated
specifically for the construction of an asset or a
group of interrelated assets.
 Construction Contracts provides requirements on
the allocation of contract revenue and contract
costs to accounting periods in which
construction work is performed. Contract
revenues and expenses are recognized by
reference to the stage of completion of contract
activity where the outcome of the construction
contract can be estimated reliably, otherwise
revenue is recognized only to the extent of
recoverable contract costs incurred.
Construction Bonds and Contracts
 Under Article 1713 of the Philippine Civil Code, a construction contract falls within the general
classification of a contract for a piece of work whereby the contractor “binds himself to execute a
piece of work for the employer, in consideration of a certain price or compensation. The
contractor may either employ only his labor or skill, or also furnish the material.”
 The term construction can include the erection, repair and demolition of things as diverse as houses,
offices, shops, dams, bridges, expressways, home extensions, factories and airports. Different firms
may carry out specialist work relating to particular technologies, but few firms are confined to only
one building type or technology. Thus, the industry—and issues that affect construction projects—is
sometimes be difficult to comprehend fully because:
The relationship between the parts are not always clear.
The boundary of the industry is unclear.
 A construction contract encompasses a building contract related to the construction of a building, as
distinguished from the construction of infrastructure or engineering projects. Engineering contracts
refer to the engineering and construction of an industrial facility designed by engineers, such as an
offshore oil and gas platform or a mineral processing facility (Ibid.).
 Lump sum or fixed price contracts. Lump sum
contracts involve the buyer agreeing to pay a set price
and the contractor or builder agreeing to complete the
project for that set price. With this type of contract, the
buyer has certainty because he knows what his final
costs will be unless changes are made.
Types of
 Cost plus contracts involve the buyer paying the actual
costs of construction and purchases plus an additional set
percentage or amount for the contractor or builder. The
Construction owner takes on the risk here, because if it turns out the
project is much more expensive, the buyer will be the
one to pay for the cost of construction plus the profit
Contracts 
margin.
A Labor contract means the Owner pays for the labor
spent by the builder
 A Material Contract means the Owner pays for the
material spent by the Contractor
 Progress Billing a contract which pays the contractor
per accomplishment
History of Construction Bonds
Contracts
Early History
 Early construction documents in pre-industrialized America were drawn to a small scale, and
contained little detail about dimensions and materials, according to an analysis by Brigham
Young University construction management professors Kevin L. Burr and Kevin R. Miller. Most
project decisions, such as choice of materials, remained up to the builder. Industrialization
brought major changes by the early 1900s, however. The architect's and builder's roles grew
increasingly separate, requiring more complex contracts to manage those relationships.
The Miller Act
 Congress tightened expectations for contractors by enacting the Heard Act in 1894, according to a
history posted by the Surety Information Office. The law required federally funded projects to
carry a surety bond, which is a contractual means of guaranteeing a project's completion. The
Miller Act's passage in 1935 stipulated performance bonds for public works contracts over
$100,000, and payment protection for contracts worth $25,000 or more. A performance bond
protects against the contractor's inability to finish the job. Payment bonds hold contractors liable
for paying labors, subcontractors and suppliers.
Prevailing Wages
 The Davis-Bacon Act's passage in 1931 marked another major change in U.S. construction
contracts. The law aimed to stop contractors from bypassing union labor by hiring lower-paid
workers, who were often African Americans imported from the South, according to a U.S. Federal
Highway Administration overview. Davis-Bacon required contractors to pay an area's prevailing
wages on federally awarded projects. However, the law did not apply to interstate projects until
1956, when the Federal-Aid Highway Act took effect.
Recent Trends
 Interest in environmentally friendly "green construction" practices has increased the complexity of
contracts in recent years. Contractors must balance their skills against the uncertainty of a
building's performance on completion, or failure to achieve third-party green certification. Failure
to satisfy such requirements and manage these expectations can result in litigation, "The Green
Economy Post" reported in February 2010. The American Institute of Architects and Association
of General Contractors publish form contracts to guide contractors in assessing these risks
properly.
Value Engineering
 Within the last 15 years, preconstruction contracts have become increasingly essential for
commercial project owners looking to control costs, according to an analysis posted by designer
Ben Shook. Using this method, known as value engineering, the owner gets involved with a
construction manager early in the process. Both sides determine the most cost-effective aspects of
a project's design, which helps generate several estimates. The design can then be tailored more
closely to the owner's budget.
Advantages
Prequalification Process Personal or Corporate Indemnity

 Prior to obtaining a bond, the contractor  Sureties require the contractor to indemnify
must participate in the surety’s vigorous the surety for all costs incurred by the surety
prequalification process which analyzes the in the event the bond company is called
contractor’s financial strength and upon by the owner to cure a contractor
construction expertise, among other things. default
advantages
Surety’s Performance
 The most important advantage of a bond is
that in the event of a contractor default or
inability to perform, the surety will fulfill
the contract and complete the remaining
contract work.
disadvantages
Bond Performance May Result in
cost Litigation
 Although the contractor is required to  Even though the surety guarantees the
obtain the bond, the contractor will include contractor’s performance in the event of a
the cost of the bond in the price charged to default, the burden is on the owner to prove
the owner. to the surety that the contractor defaulted.
This conflict between the surety and owner
often ends up in litigation.
disadvantages
Surety’s Reluctance to Perform Owner Loses Control of Quality

 Performing under the bond and stepping  In order to minimize costs, the surety, in
into the shoes of the contractor to complete responding to the bond, may implement the
the work is typically a costly endeavor for cheapest and least expensive remedy for the
the surety. As a result, the surety will contractor default, which will likely
attempt to find technicalities in the bond that compromise quality for the owner.
the owner has not complied with in order to
avoid responding under the bond.
disadvantages
Owner’s Burden to Calculate Losses

 If the owner fails to adequately calculate its
losses and the costs to complete for the
surety, the owner will be unable to recoup
the deficit from the surety.
V. Actual Example
Based on Research, Case
Study, Publications.

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Construction Bond

 A construction bond is a type of surety bond used by

Prequalification Process Personal or Corporate Indemnity

Surety’s Reluctance to Perform Owner Loses Control of Quality

Owner’s Burden to Calculate Losses

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