The terms “contractor bond” and “construction bond” often refer to the same thing—surety bonds most commonly used in the construction industry. These bonds guarantee the qualifications of contractors and ensure that investors don’t lose out financially if a contract is not completed or if the work fails to meet contract specifications. Learn more about the various types of construction surety bonds below, or fill out our convenient online application to get started today.
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Contractors bidding on construction projects are typically required to obtain a contractor surety bond as a condition for submitting a bid and being awarded a contract. The winning bidder may also be required to obtain other types of construction bonds. These bonds are almost always required for larger projects as well as public projects paid for with taxpayers’ money.
How Do They Work?
There are typically three parties involved in the bonding process:
- The obligee is the project owner or investor (often a government agency) that puts up the money for the project.
- The surety, usually an insurance company or bank, is the party guaranteeing the obligee that the contractor will complete the work according to the terms set forth in the bond.
- The principal is the construction company bidding on or awarded the contract.
The surety evaluates the principal’s qualifications, performance history, and financial condition based on thorough background and financial checks. Based on this evaluation, the surety determines whether or not to issue the bond and how much the construction company will have to pay for it. Some companies will be charged higher premiums than others, depending on the perceived risk.
If the contractor fails to meet all of the contract requirements, the surety compensates the project owner and/or investors for the resulting financial loss. The surety then has the right to sue the contractor to recover what was paid out unless the terms of the bond specify otherwise.
Benefits Of Contractor Bonds
The primary benefit of a contractor bond is to the obligee, who is protected against financial loss. The contractor benefits by being able to compete for projects that require bidders to be bonded. The surety benefits financially from the premiums paid by the contractor, though it also takes on the financial risk of potential contract default. When the obligee is a tax-funded government agency, the public also benefits indirectly.
How Much Do They Cost?
The premium cost for surety bonds is calculated as a specific percentage of the total bond amount (also known as the penal sum). That percentage is usually higher for construction bonds than for many other types of surety bonds because of the higher risk of default or nonperformance.
The exact cost will vary depending on the particular type of construction bond needed and the contractor’s financial strength. The total bond amount required in any given instance is established by the obligee and takes into account the estimated project cost as well as any statutory requirements.
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Types of Construction Surety Bonds
The following are the types of construction surety bonds project owners most commonly require companies to obtain in order to bid on, win, and begin work on construction projects. Learn more about each type below, and apply online today.
When bid bonds are required, only contractors who submit one with their bid will be considered for the job. A bid bond protects the project owner from financial loss if the winning bidder backs out after being awarded the contract or fails to obtain a performance bond that will allow work to begin. A bid bond expires once a contract has been awarded.
The winning bidder usually is not allowed to begin work until a performance bond has been submitted. The performance bond replaces the bid bond as the project owner’s protection against financial loss. As the name suggests, a performance bond provides protection against poor performance by the contractor. This may include substandard work, the use of defective, sub-par materials, or any deviation from the terms of the contract.
A performance bond also provides protection against potential financial loss due to the contractor’s insolvency. These bonds are mandated by the Miller Act for all public work contracts over $100,000.
A payment bond guarantees that the company awarded a contract has sufficient financial resources to pay its employees, subcontractors, and suppliers. This ensures that no liens can be filed against the project for nonpayment. If the contractor fails to make such payments, the surety is responsible for covering the financial loss to all parties.
ADVANCE PAYMENT BONDS
A contractor may need an advance payment from the project owner in order to finance the work. When this is the case, the contractor can obtain an advance payment bond to guarantee the return of the money advanced if the contractor fails to live up to the terms of the contract.
Sometimes, defects in materials or workmanship aren’t discovered until after a project is completed. A maintenance bond, also known as a warranty bond, provides financial protection for the project owner for a specified period of time (the maintenance term) after project completion. It guarantees that the contractor will do what is required to remedy any defects that surface during that time.
Construction projects typically involve the purchase of large amounts of supplies or materials. It is common for supply bonds to be required, especially for public works projects. As a general rule of thumb, federal projects over $100,000 typically require supply bonds.
In the case of a supply bond, the principal is not the construction company, but rather the supply company. This is a type of construction bond that guarantees that the supplier will deliver all of the supplies and materials specified in the contract, on time and in usable condition. The purchaser is the obligee and is protected against any financial loss due to late delivery or materials damaged in transit. Under the terms of most large construction projects, the construction company purchases the supplies and materials to be used and is therefore the obligee.
A reclamation bond is a type of contractor surety bond that is commonly required in the mining industry. Its purpose is to ensure that any company involved in extracting minerals restores the land and any water affected by its mining operations. The mining company is the principal and must obtain a reclamation bond to guarantee that it will fulfill its contractual obligation to clean up the mining site when its operations in the area cease.
Federal law requires a reclamation bond as a prerequisite for a company to obtain a coal mining permit, which includes a land reclamation plan. If the company fails to reclaim the land in accordance with that plan, the surety must provide the funds to carry out the reclamation.
Reclamation bonds may be in the form of corporate surety bonds, collateral bonds, and (in some states) self bonds. Collateral bonds may be backed by cash, certificates of deposit, letters of credit, investment grade securities, or other collateral.
Local governments may require subdivision developers to obtain a subdivision bond, also known as developer bonds, site improvement bonds, plat bonds, completion bonds, or performance bonds. The government entity requiring the bond is the obligee, or project owner. The principle is usually the developer, not the multiple contractors that may be hired by the developer to install sidewalks, electrical lines, and sewage systems, etc. The developer may, in turn, require individual contractors to obtain a performance bond.
Subdivision bonds guarantee that the surety will provide funding to finish any work a contractor fails to complete in accordance with local specifications by the deadline established in the contract. The surety can then attempt to recover the money from the developer.
SITE IMPROVEMENT BONDS
A site improvement bond is a specific type of subdivision bond required for projects involving upgrades or renovations to existing properties or public lands rather than new construction.
Sometimes construction work being done on private property can encroach on a highway, road, easement, or other government-owned land. When there is the possibility that such work could damage or alter public property, the municipality or county may require the contractor to obtain an encroachment bond before work begins.
The purpose is to ensure that funds will be available to restore the public property to its original condition if the contractor fails to do so. The municipality is the obligee and will receive funds from the surety to cover the cost of restoration if the contractor does not live up to its obligation. The surety that issued the bond has the right to then seek repayment from the contractor.
Get the construction bonds you need from Absolute Surety, and get on with business. We offer a comprehensive selection of the best bonds at the best prices to keep you in compliance with all your industry regulations.