Category:152 Contactor Bonding Responsibilities

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Bonds - What They Are and How They Work

MoDOT requires contractors to provide bonds during the bidding and construction phases of a project. A bid bond ensures that the contractor will honor its bid and take on the job. Bid bonds are required under 227.100 RSMo. Once a job has been awarded the contractor must furnish a payment and performance bond. A payment bond is required under 107.170 RSMo. Because MHTC is a state agency a subcontractor or material supplier is not legally allowed to place a lien on state property, so the payment bond ensures that subcontractors or material suppliers will be paid for their work. The performance bond ensures that, in the event the prime contractor is unable to complete the job, the surety will ensure that the job is completed and is required by 227.100, RSMo. MoDOT’s required bond form combines the payment and performance bond into a single document to reduce paperwork. Bid and payment and performance bonds provide MoDOT a financial safety net and are also required by Sections 102.8 and 103.4.1 of the Missouri Standard Specifications for Highway Construction. Bonds have a cost and contractors include the cost of providing bonds in their bidding costs.

A surety company is the entity that provides the bond. While the surety is almost always an insurance company, the surety bond is not an insurance policy. The surety provides financial assurance of the contractor’s performance. The contractor is primarily liable for performance of its contract with MoDOT and the surety is secondarily liable in the event of a default by the contractor. A default occurs when the contractor is unable, by its own admission, to complete the job or when MoDOT has determined that the contractor cannot complete the job.

The prime contractor is responsible to the surety for any loss the surety may suffer as a result of a default by the contractor. The prime contractor and a surety have a financial agreement that MoDOT is not a party to. So, if a prime contractor causes a surety financial loss, the surety will expect the prime contractor to cover this cost. MoDOT is protected by the bond against financial loss as a result of a contractor defaulting on a road or bridge improvement contract. The bond does not cover disputes that arise between MoDOT and the contractor.

A bond is a contract between the surety and the prime contractor for the benefit of subcontractors and MoDOT. For subcontractors and material suppliers, the bond ensures payment when the prime refuses to pay for completed work. For MoDOT it ensures that, in the event of a default by the prime contractor, the job will be completed.

In the event of a dispute between MoDOT and the contractor over construction, time table, quality of work, etc., the surety is not involved unless the risk of default by the contractor is significant.

For payment claims by subcontractors and suppliers, the surety will usually investigate such claims and request documentation from the subcontractor or supplier. Subcontractors and suppliers may request MoDOT’s involvement in disputes regarding payment from the prime contractor to a subcontractor or supplier. MoDOT has an obligation under 7 CSR 10-8.111 to assist in resolving such disputes. MoDOT staff should respond to requests for information from subcontractors, suppliers and sureties to assist these entities in resolving their disputes. At a certain point, however, the subcontractor or supplier may exercise their legal rights and sue on the bond in court.

In some circumstances it is obvious when a prime defaults or is declared in default such as when the contractor is in bankruptcy and has admitted that it cannot fulfill its contract. In this instance, the surety should act relatively quickly. When the default is less clear, the surety may perform an investigation and determine its options. In all instances, MoDOT should expect a prompt response from the surety to the notice of declaration of default, communication while the investigation takes place, and a surety decision within a reasonable period of time. When default becomes a real possibility, please alert the Chief Counsel’s Office as soon as possible.

When MoDOT decides to declare that a prime contractor has defaulted on a job, the following consequences may occur:

(1) The surety takes over the job and finds a new contractor to complete the work or the surety could hire the original prime contractor to complete the job and the surety and the prime contractor resolve their issues,
(2) The surety may decide not to be involved in finding a replacement contractor and allow MoDOT to find such contractor. In this case the surety is left with a bill for the work left on the bond and the surety has little control of the situation; or
(3) The surety may find a new contractor that is acceptable to MoDOT to complete the job. The surety takes over the job only to hand it over to the new contractor.

The surety remits the appropriate funds left on the bond to MoDOT and the surety is effectively out of the contract. A new surety bond is issued with the new contractor. The first option is most preferable to MoDOT, the second is less preferable and the third option is the least preferable.

For MoDOT road and bridge projects, there is little history of contractors defaulting or MoDOT declaring a contractor in default. MoDOT contractors have a history of complete contracts on schedule 95% of the time and within 1% of the contract award amount.