How does a construction bond work? | Allianz Trade (2023)

Though they may have new applications, construction bonds themselves are not new: they’ve been around since 2,750 BC. The Romans then updated the laws of surety in trade around 150 AD, and those principles survive today.

As with all bonds, the construction bond guarantees the principal will act in accordance with certain laws or to the contract between the principal (the construction company) and the obligee (the beneficiary of the surety bond). If the principal fails to perform the contract in this manner, the bond will cover any sums stipulated up to the maximum amount mentioned in the surety bond.

In this article, Robbert Langhorst, our Group Head of Global Surety Distribution, explains what a construction bond is, tells us how a construction bond works, and how this tried-and-true solution is an important bulwark against unforeseen events in a changing world.

What is a construction bond?

A construction bond is a type ofsurety bond (aka a guarantee) used by investors in large infrastructure or constructionprojects. To complete this construction bond definition, we can say the construction bond provides protection against disruptions or financial loss due to a contractor's failure to complete a project or failure to meet project specifications.

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A construction bond can also be defined in its simplest form as an agreement or document to guarantee compliance, payment or performance of a contractual or legal obligation as part of a construction project.

Guarantees and sureties are terms often used interchangeably. However, they are two different legal entities, each with their own rights and obligations for the parties involved.

A guarantee isan independent commitmentof the insurer or bank, separate from the main obligation. It means that the guarantor cannot invoke the exceptions of the principal debtor based on the underlying contract. Even if the underlying obligation is nil, the guarantor has to fulfil its obligation – the only exception being a “manifest abuse of rights.” This is a big difference with a surety bond.

A surety bondisan accessory security, which means it follows the main obligation. The guarantor insurer or bank promises the same performance as the principal debtor for the main obligation. The object is to ensure the performance of the obligation towards the principal within the limits of the main obligation.

Concretely, a construction surety bond – like any other surety – can only exist for a valid agreement. When it is used, the guarantor can oppose payment in case of disagreement until a final judicial decision has been reached in favour of the beneficiary, or when the principal has failed and is no longer able to perform its obligations.

Robbert explains: “In the case of construction projects, the construction bond definition includes a three-party agreement that legally binds together a principal (the contractor, who needs the bond), an obligee (the project owner, who requires the bond), and an obligor (the surety provider or guarantor, that sells the bond). Construction surety bonds are based on this contractual triangular relationship, in which the obligator uses its good name to vouch to third parties for the contractor’s obligation.”

The main purpose of a construction bond is to provide the security, or guarantee, to the owner that the project he instructs the contractor to build will be completed in the case of failure or bankruptcy of the contractor’s company,” says Robbert.

The owner transfers the risk of an expected loss due to the delay or incompletion of the works to the bond provider – a bank or an insurance company. “The better the creditworthiness of the guarantor, the better the guarantor,” Robbert continues. “And the more solid the construction surety bond.”

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A contractor is required to have construction bonds for nearly all government and public works projects and infrastructure developments such as ports, bridges, hydroelectric plants, grids, pipelines, and tunnels. All entail substantial completion and performance risks, and construction contractors are often required to provide construction surety bonds to be considered for a contract.

“Although the protection or benefit with the issuance of a construction bond is with the owner, the need to have a bond facility in place lies with the construction companies,” explains Robbert. “The owner stipulates in the tendering process that the construction company needs to present a bond from a guarantor as a condition to be chosen to build the project.”

In other words, the protected party – the owner – is not the one who needs to buy a bond. It’s the contractor who must purchase the construction bond.

“Wedo not have any contractual relationship with the beneficiary(the owner) – only a contingent liability, on behalf of our client (the contractor),” adds Robbert.

Before choosing the right contractor, the project owner requests that a set of specific surety bonds be issued. Choosing the right contractor and the contractors’ surety goes hand in hand.

The surety provider evaluates the contractor. The risk evaluation process typically involves the assessment of the contractor’s financial strength, their ability to perform the contract and their character – that is, the integrity, reliability, and commitment to meet obligations.

After this process, both parties agree on the final surety bond facility structure. Then, this is how a construction bond works:

  • If the contractor fulfils its obligations, no action is necessaryand the bond will eventually expire.
  • If the contractor is unable to perform their duties as agreed and fails to complete the project, the surety company will pay the full penalty amount and other damages incurred.

Construction bonds tend to be relatively long-term: two years on average; four to six years for larger infrastructure projects.

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“What is covered under the bond depends on the wording, which is based upon the owner’s need for protection,” says Robbert. “The bond to be issued normally follows the milestones of the project in order to cover the specific risks in each phase.”

Here are several examples of construction bonds:

  • A bid bond protects the owner against the losses he occurs if the construction company withdraws after being greenlighted to build the project, leaving the owner to restart the whole process of choosing a new construction company. The construction bond covers the cost of the delay as well as any new costs to be made.
  • A performance construction bond protects the owner against any loss occurring due to late or incomplete delivery of the project, or against the failure of the other party to meet obligations specified in the contract.
  • A maintenance bond protects the owner against failure of the project after completion, which can lead to losses due to repair costs. Sometimes referred to as a construction retention bond, it provides a guarantee that the contractor will fix any issues after the job has been completed, including after full payment has been made.

Performance construction bonds and construction retention bonds cover most eventualities, but they do not cover the losses that are not stipulated in the bond wording. “Certain parts of a project cannot be secured via a construction bond, says Robbert. “For example, financing a loan guarantee by a bank to the construction company, with the obligation to repay that loan, is something we can’t secure with a bond.”

One of the biggest changes in coverage stems from the global Covid-19 pandemic, which is affecting the exposure that contractors face and will continue to face for years to come. Threatened supply chains, worker safety, and ESG concerns, may not be covered by the general force majeure clause that appears in most contracts and are already influencing construction surety bond underwriting.

The most obvious benefit for the owner of a construction bond, whether bid bond, performance completion bond or construction retention bond, is the assurance of project completion as the owner is protected in the event the contractor defaults on the contract.

In addition, consider these benefits of construction bonds:

  • They reassure owners they’re working with capable and qualified contractors who have gone through a meticulous qualification process to determine their ability to handle a contract and avoid default.
  • They enable companies to tender for a contract knowing that credit lines with their bank won’t be affected and offer financial security as the additional financial resources provided by construction bonds protect cash flow.
  • They provide technical, managerial or financial assistance as needed. They reduce risk of liens filed by subcontractors, labourers and suppliers.

“The applicable tariff depends on the credit quality of the construction company (our client), the volume of the construction bond offered or proposed, the complexity of the project, the duration of the bond to be issued, the competition, market conditions, and local or international issuance of the bond,” explains Robbert. “With small bond amounts there can be a fixed premium.”

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The cost of a construction surety bond normally is calculated with the formula: x% (tariff) * bond amount = premium amount.

For example: 1% (tariff) * EUR.100,000 (bond amount) = EUR.1,000 (premium amount).

With aStandard & Poor’s global rating of AA,Allianz Trade is accepted by corporations and banks around the world, a guarantor with one of the best ratings worldwide and a reliable reference for your beneficiaries.

More than 40% of our surety clients operate in the construction segment. Every year, we provide bonding facilities worth around € 50 billion to approximately 14,800 clients. We evaluate each client on an individual basis and tailor solutions to unique needs.

We have global insights and surety teams around the world and can support companies in their global activities and international bond requirements, by providing centrally managed surety programs to companies operating in several countries.

“We have a strong local presence, with a mighty international network of teams in all regions, in 24 countries,” explains Robbert. “So, we have the ability to follow our clients all over the globe. We have expert teams that understand the local markets, the distribution partners and agents.”

To see how construction bonds and othersurety products can support your business, visit our local websitesand contact our local teams.

(Video) What are Surety Bonds? Explained with Examples


What are the 3 main bonds for a construction project? ›

The three main types of construction bonds are bid, performance, and payment.

What is the purpose of a construction bond? ›

Construction bonds are a type of surety bond that guarantees that a party (typically a contractor) will comply with its contractual and legal obligations, failing which, the bond will protect and compensate the party to whom the defaulting party owed the contractual and legal duties.

How do you calculate bond construction? ›

The cost of a construction surety bond normally is calculated with the formula: x% (tariff) * bond amount = premium amount.

What are the four types of bonds in construction? ›

The 4 Main Types of Construction Bonds Explained
  • Bid Bond. ...
  • Agreement to Bond (a.k.a. Surety's Consent or Consent of Surety) ...
  • Performance Bond. ...
  • Labour and Material Payment Bond.

What are the three major types of construction bonds Why are they required? ›

3 Types of Construction Bonds
  • Bid Bonds. In the construction industry, contractors bid for construction contracts. ...
  • Performance Bonds. These type of construction bonds guarantee that the contractor will complete the project according to the terms of the construction contract. ...
  • Payment Bonds.
Jul 15, 2017

Which bond is mostly used for construction work? ›

English bond

This is the most common and popular bond and is used in most of the structures. The English bond consists of alternate layers of headers and stretchers.

What does payment bond mean in construction? ›

A payment bond is a type of surety bond issued to contractors which guarantee that all entities involved with the project will be paid. A payment surety bond is a legal contract, a type of bond, that guarantees certain employees, subcontractors, and suppliers are protected against non-payment.

What is bond interest rate? ›

The coupon rate is the rate of interest the bond issuer will pay on the face value of the bond, expressed as a percentage.1 For example, a 5% coupon rate means that bondholders will receive 5% x $1,000 face value = $50 every year. Coupon dates are the dates on which the bond issuer will make interest payments.

What is a bond line in construction? ›

A bondline can be defined as the structure including—but not limited to—the adhesive between two structurally bonded parts.

How is bond value calculated? ›

Bond valuation, in effect, is calculating the present value of a bond's expected future coupon payments. The theoretical fair value of a bond is calculated by discounting the future value of its coupon payments by an appropriate discount rate.

How many bonds are there in construction? ›

The 3 most common types of construction bonds are Bid Bonds, Performance Bonds, and Payment Bonds.

How are bond rates calculated? ›

The price of a bond is determined by discounting the expected cash flows to the present using a discount rate. The three primary influences on bond pricing on the open market are term to maturity, credit quality, and supply and demand.

What are the 6 bonds and guarantees required of the contractor? ›

6 Types of Contract Surety Bonds
  • #1: Bid Bond. ...
  • #2: Performance Bond. ...
  • #3: Payment Bond. ...
  • #4: Supply Bond. ...
  • #5: Maintenance Bond. ...
  • #6: Subdivision Bond.
Apr 11, 2017

What are the 3 different types of bonds? ›

There are many types of chemical bonds that can form, however the 3 main types are: ionic, covalent, and metallic bonds.

What is the most important type of bond? ›

Covalent bonds are the most important means of bonding in organic chemistry. The formation of a covalent bond is the result of atoms sharing some electrons. The bond is created by the overlapping of two atomic orbitals [1].

What are were the two main types of bonds and how do they work? ›

The two main types of bonds formed between atoms are ionic bonds and covalent bonds. An ionic bond is formed when one atom accepts or donates one or more of its valence electrons to another atom. A covalent bond is formed when atoms share valence electrons.

What are the different types of bonds in building construction? ›

Types of brick bonding
  • 3.1 Stretcher bond.
  • 3.2 English bond.
  • 3.3 English garden wall.
  • 3.4 English cross bond.
  • 3.5 Flemish bond.
  • 3.6 Flemish garden wall (also called Sussex bond)
  • 3.7 Monk bond.
  • 3.8 Header bond.
Dec 21, 2022

What is the strongest bond in the work? ›

In chemistry, a covalent bond is the strongest bond, In such bonding, each of two atoms shares electrons that bind them together. For example - water molecules are bonded together where both hydrogen atoms and oxygen atoms share electrons to form a covalent bond.

What is the strongest bond in building? ›

English bond is considered as the strongest and most widely used brick bond in construction work. It consists of an alternate course of headers and stretchers. In this arrangement, vertical joints in the header and stretcher courses come over each other.

What is the most common bond used within brickwork the construction industry? ›

The running bond is the most used bond and is composed of stretchers offset by 1/2 brick per course. It is often used in cavity wall construction reinforced with metal ties back to the main structural wall.

What is an example of a performance bond in construction? ›

For example, a client issues a contractor a performance bond. If the contractor is not able to follow the agreed specifications in constructing the building, the client is given monetary compensation for the losses and damages the contractor may have caused.

Is a bond a one time payment? ›

Surety bonds are generally quoted and must be paid for on an annual basis. Most surety companies will allow for multi-year terms with premium paid up front for the duration of the bond term. Some bonds, such as performance and payment bonds, will only require a one time premium payment for the duration of the project.

Do you make payments on a bond? ›

Bonds are issued by governments and corporations when they want to raise money. By buying a bond, you're giving the issuer a loan, and they agree to pay you back the face value of the loan on a specific date, and to pay you periodic interest payments along the way, usually twice a year.

How much is a 1000 bond worth? ›

Total PriceTotal ValueYTD Interest

What rate are bonds paying now? ›

Current I Bond interest rate now

The current bond composite rate is 4.3%. That rate applies for the first six months for bonds issued from May 2023 to October 2023. For example, if you purchased I bonds on May 1, 2023, the 4.3% rate would be in effect until Oct. 31, 2023.

What is a bond in simple words? ›

A bond is simply a loan taken out by a company. Instead of going to a bank, the company gets the money from investors who buy its bonds. In exchange for the capital, the company pays an interest coupon, which is the annual interest rate paid on a bond expressed as a percentage of the face value.

How do construction lines work? ›

Construction lines do not change the extents of the drawing, so their infinite dimensions have no effect on zooming or viewpoints. You can move, rotate, and copy construction lines the same way you move, rotate, and copy other objects. You can use construction lines as references for creating other objects.

What is a broken bond in construction? ›

Bricklayers achieve irregular lengths by introducing “Broken Bond.” This involves cut bricks, and/or header bricks in stretcher courses, to achieve the desired length. On long walls it may be possible to simply tighten up the mortar joints, or perhaps widen them slightly.

What is bond contract? ›

A contract bond is a guarantee the terms of a contract are fulfilled. If the contracted party fails to fulfill its duties according to the agreed upon terms, the contract “owner” can claim against the bond to recover financial losses or a stated default provision.

What is an example of a bond price? ›

For example, say a bond has a face value of $20,000. You buy it at 90, meaning that you pay 90% of the face value, or $18,000. It is 5 years from maturity. The bond's current yield is 6.7% ($1,200 annual interest / $18,000 x 100).

What is retention in construction? ›

What is retention in construction? Retention in the Construction sector is a sum of money withheld from a payment to a contractor / subcontractor until the contracted project is completed to a satisfactory standard within an agreed time period.

What is construction guarantee? ›

Construction Guarantee. A guarantee is a written undertaking by an insurance company (Lombard) or a bank in favour of a Beneficiary (Employer), whereby the insurance company or bank pledges to make certain payments on behalf of a Contractor, if the Contractor fails to perform in terms of a construction contract.

What are the five main types of bonds? ›

There are five main types of bonds: Treasury, savings, agency, municipal, and corporate. Each type of bond has its own sellers, purposes, buyers, and levels of risk vs. return. If you want to take advantage of bonds, you can also buy securities that are based on bonds, such as bond mutual funds.

How are bonds traded? ›

Unlike shares of a company that trade on stock exchanges, most corporate bonds trade over-the-counter (OTC). This is because bonds come from several different issuers, and each issuer will have several bonds offered - with different maturity, coupon, nominal value, and credit rating.

What are the 3 types of bond categories? ›

There are three main types of bonds:
  • Corporate bonds are debt securities issued by private and public corporations.
  • Investment-grade. ...
  • High-yield. ...
  • Municipal bonds, called “munis,” are debt securities issued by states, cities, counties and other government entities.

What are the 2 basic types of bonds? ›

Covalent and ionic bonds are both typically considered strong bonds. However, other kinds of more temporary bonds can also form between atoms or molecules.

What are the 3 strongest bonds? ›

The three types of chemical bonds in order of weakest to strongest are as follows: ionic bonds, polar covalent bonds, and covalent bonds.

What are the 2 main bond types? ›

What types of chemical bonds are there?
  • Covalent: occurs when non-metallic atoms share electrons. ...
  • Ionic: this occurs when metallic and non-metallic atoms bond and an electron charge is given from one to the other.

What is bond in simple words? ›

A bond is a fixed-income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental). A bond could be thought of as an I.O.U. between the lender and borrower that includes the details of the loan and its payments.

Which bond is the strongest? ›

So, in conclusion the ionic bonds are strongest among ionic, covalent and hydrogen bonds.

What are the most common types of bonds? ›

There are several different types of bonds, but the most common are:
  • Government bonds.
  • Municipal bonds.
  • Corporate bonds.
  • Treasury bonds.
Apr 26, 2023

What are the 5 common types of bonds? ›

Different Types of Bonds
  • Government Bonds. In general, fixed income securities are classified according to the length of time before maturity. ...
  • Municipal Bonds. Municipal bonds are the next progression in terms of risk. ...
  • Corporate Bonds. ...
  • Zero Coupon Bonds. ...
  • Bond Derivatives. ...
  • Diversify your portfolio with fixed income securities.

Do bonds pay monthly? ›

Both bonds and notes pay interest every six months.

Is A bond a debt or equity? ›

Bonds are debt instruments. They are a contract between a borrower and a lender in which the borrower commits to make payments of principal and interest to the lender, on specific dates. In return, the lender provides a loan to the borrower. The borrower is the issuer of the bond, and the lender is the bondholder.

What are the three types of bonding and what are their properties? ›

There are three types of strong chemical bonds: ionic, covalent and metallic. For ionic bonding the particles are oppositely charged ions. For covalent bonding the particles are atoms which share pairs of electrons. For metallic bonding the particles are atoms which share delocalised electrons.

How do you identify different types of bonds? ›

Identifying Types of Bonds
  1. Look at the chemical formula.
  2. Identify the elements in the compound.
  3. Determine if the elements are metals or nonmetals (using a periodic table)
  4. Metal – Metal = Metallic.
  5. Metal – Nonmetal = Ionic.
  6. Nonmetal -- Nonmetal = Covalent.


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