What is a Construction Bond?
A construction bond is a type of surety bond, also sometimes referred to as a contract bond. Surety bonds are a type of legally binding contract between a surety company, a principle, and the obligee.
- The surety: The surety bond company that backs the surety bonds.
- The principle: This typically refers to the general contractor in charge of the construction projects (or subcontractors on the project).
- The obligee: This is the company or entity requiring the surety bond (such as the owners of the construction project or a developer).
So why do you need construction surety bonds? Construction bonds guarantee financial protection for the parties involved. A bond is usually issued at a specific price—or maximum compensation—that the surety company provides if the general contractor fails to complete the specified work (or otherwise damages the property in question).
The contract between the parties guarantees that the work being done is completed as specified by the surety bonds—and in the correct length of time. If a contractor fails to follow what's outlined in the bonds, they can be held liable for any incurred costs. Bonding in the construction industry is a common occurrence.
What is the Role of the Surety?
The ‘surety’ is the bond company that backs the bond you’re purchasing. Bonding companies step in if you are unable to complete a project or do not fulfill your obligations. They will reimburse the project owner when necessary. However, in most cases, you as the contractor will still be held liable for the payment of the bond. So performance bonds can be thought of as a line of credit for the bond amount outlined.
The Types of Surety Bonds
3 common types of construction bonds that may be required to bid on a contracting job: bid performance, and payment bonds.
A bid bond is a surety bond that is usually required to bid on a construction project. Bid bonds protect the owner/developer in the case of a bid not being honored. It also proves that you can supply both a performance bond and a payment bond if necessary.
A performance bond is a contract in which the constraints of the construction project are laid out. If the contractor fails to meet the requirements of the performance bond, the project owner can claim restitution for the cost of hiring another contractor to complete the project. Performance bonds are quite common with large construction projects or government projects.
A payment bond guarantees that you’ll pay everyone you employ—subcontractors, vendors, laborers, suppliers, and so forth. If your construction company were to file bankruptcy, this surety bond can be used to reimburse those completing the construction projects.
Maintenance bonds act as a type of warranty for your work. If something completed is faulty or defective for a specified length of time after the completion of a project, this can help reimburse costs incurred to fix the defect and/or damage.
Less Common Contract Bonds
Other types of construction bonds may be required to bid on a federal project, such as public works bonds and site improvements bonds.
Public Works Bond
A public works bond is the equivalent of a performance bond but is usually required on the state level for public construction jobs. This may be required for state projects, federal projects, or other public projects. Again, if you as the contractor default on the requirements of the project, this bond serves to protect the project owner from financial loss.
Site Improvement Bonds
A site improvement bond ensures that when a construction company is obtained for a project where they're updating a building, that they follow all current building codes and standards.
Why Does a Contractor Need Construction Bonds?
If you're wondering why you should consider a construction bond, here are some examples of the necessity:
- Example #1: If your performance bid is accepted and you retract your bid or bow out of the project for any reason, the developer can make a claim against your bid bond to cover the difference between your bid and the next highest bidder. If you haven't obtained a bid bond, you and your business may be held personally liable for any financial loss sustained.
- Example #2: A project owner lets you know they'd prefer you to obtain a site improvement bond, and you opt not to since it's not a requirement. After the project's completion, the project owner has the work inspected. Unfortunately, your completed work isn't up to code. The project manager is upset, and hires another contractor to redo your work—and you are on the hook for the cost.
How a Construction Bond Protects Both Parties
You may be wondering—why go through the work to obtain the bond if you're held liable for payment either way? It's true that a construction bond primarily protects the project owner. However, because a bond is usually for a fixed payment amount, it protects you as well.
If the cost of damages, repair, or replacement to a construction project is higher than the bonding rate obtained from the surety company, you are still only liable to provide payment for the bond amount. So in some ways, the bond protects both parties in question.
Secondly, obtaining constructions bonds is a way to foster trust between parties. If the contractor exceeds expectations and fulfills everything according to the contract, a project owner or developer is more likely to use your business in the future.
Can I Get a Construction Bond for All of My Projects?
There are some construction projects where you will not be able to obtain construction bonds from a surety company:
- Projects on Indian Reservations: Indian reservations are excluded because they do not have to adhere to certain federal laws and regulations where a construction bond would normally be required.
- Anything being constructed outside of the United States: Because anything outside of the U.S. doesn’t fall under federal law, a construction bond is not required for large projects.
- A construction job completed over a timeframe of 3+ years: Surety companies are hesitant to back construction bonds for long-term contracts—especially if the construction company that won the bid is engaged in multiple projects, increasing the chance they default on the contract bond.
- Home remodeling projects: Unless this is paid for by the federal government, it is considered a private project and does not qualify for bond claims.
How the Miller Act Applies
According to the U.S. General Services Administration, “The Miller Act requires that prime contractors for the construction, alteration, or repair of Federal buildings furnish a payment bond for contracts in excess of $100,000.”
The goal is to protect subcontractors and suppliers who are employed by a contractor to work on a federal project. So in this case, a contractor would obtain a payment bond. The construction bonds guarantee that anyone contracted by the contractor to complete work on a federal bid is paid in full.
Is a Contractor License Bond the Same Thing?
The short answer is that a contractor license bond is not always the same. Contractor license bonds—also referred to as construction license surety bonds—are required in some states (such as Florida) to become a licensed and bonded contractor.
It is a binding agreement that you will adhere to the building codes and state laws of the municipality that you’re working in. It’s also a term that many use interchangeably with a contractor’s bond or construction bond—so make sure you know exactly what is being required of you for the project you’re bidding on.
Where Can I Obtain a Surety Bond?
Multiple construction bond companies that provide bonds for projects. If you are looking to bid on a federal project, connect with your agent—or reach out to one of ours—to ascertain exactly what bonds will be required. You want to be sure that your business and all subcontractors you employ are protected.
Connect with an Agent to Learn More
If you'd like to connect with one of our agents to talk about the different surety bonds (payment bonds, performance bonds, bid bonds, etc.) that may be required for a contractor, complete the form at the top of the page or give us a call at 1-877-907-5267.
Related Articles: Construction Insurance, Insurance for General Contractors, Independent Contractor Insurance
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