When it comes to ensuring the completion of a Project, Owners are well advised to look beyond traditional (Commercial General Liability, Professional Liability, and Excess/Umbrella Liability) insurance policies. While such policies will cover the Owner in the event of defective design and/or construction of the Project, they do not offer recourse should a defaulting contractor or subcontractor need to be replaced in order to complete the Project.
So what options are available to an Owner to protect itself from such an eventuality?
While the first line of defense should always be to start with a reputable Contractor known for finishing out jobs in a proper and timely manner, Owners can further protect their interests by obtaining Payment and Performance Bonds or Subcontractor Default Insurance (SDI).
Payment and Performance Bonds typically come in a matched set. The Payment Bond, as the name implies, guarantees payment to all subcontractors/sub-subcontractors/suppliers and down the chain, and serves to protect the Owner from liens being filed resulting from non-payment. Performance Bonds however, ensure should the Contractor be terminated for cause, the bonding company will take steps to replace the Contractor and cover any increased costs resulting from such a replacement. While bonding is most common at the General Contractor level, bonds can also be purchased at the subcontractor level.
Subcontractor Default Insurance operates similarly to a Performance Bond, but rather than replacing the Contractor, the insurer will take action to replace any subcontractor that has been enrolled in the policy should such a subcontractor default.
While the products may seem similar, there are pros and cons to each.
For instance, Payment and Performance Bonds cover not just the risk of default, but also of non-payment, which SDI will not cover. Additionally, Payment and Performance Bonds generally do not carry a deductible as would an insurance policy.
However, while bonding companies typically take a long time to investigate claims, SDI policies are known to act more quickly to replace the defaulting subcontractor and minimize losses to the Project. SDI also offers the flexibility of being able to enroll whichever subcontractors the Owner and Contractor choose, and thus offer more flexibility in pricing and risk assessment than Bonding would which, if done at the GC level, typically covers the entire cost of the Project.
