DEFINITION of Maintenance Bond
A maintenance bond is a type of surety bond purchased by a contractor that protects the owner of a completed construction project for a specified time period against defects and faults in materials, workmanship, and design that could arise later if the project was done incorrectly. Pricing a maintenance bond is very different from pricing regular coupon paying bonds.
BREAKING DOWN Maintenance Bond
A surety bond is a three-way contract where a third party called the surety guarantees the contractual obligations of one party (the principal) to another party (the obligee) by agreeing to pay a sum to the obligee as compensation if the principal does not fulfill its obligations. The surety assures the obligee that the principal will perform the required tasks. A maintenance bond is a type of surety bond used by contractors.
Under the terms of a maintenance bond, the contractor of a construction project is the principal who purchases the bond, and the client or owner of the project for which the contractor was hired to work on is the party that is protected by the bond. Maintenance bonds are often required on state and public construction projects and, less often, on private construction jobs.
The maintenance bond that is purchased remains active only for a certain period of time, after which, any financial loss from defects or issues found with the contractor’s work will not be covered by the bond. If after the completion of a construction project, say a building, the client finds that the structural framework was not satisfactory, it could file a claim against the bond during the maintenance term. If the surety company finds the claim to be valid, it will compensate the obligee for any losses and damages incurred. In turn, the contractor must indemnify the surety for any compensation it makes to the obligee.
A contractor that seeks to purchase a maintenance bond will have its credit check run by the surety before the bond purchase is approved. This is to protect the surety against an event in which the principal has insufficient funds to pay the surety after a claim has been approved and settled financially. In addition, maintenance bonds ensure that the owner of a construction project is fairly compensated for poor workmanship by the contractor.
A maintenance bond is not technically insurance, but basically functions as an insurance policy on a construction project that promises a contractor will either correct any defects that arise or that the owner is compensated for those defects.