Contractor surety bonds are important because they protect construction projects by ensuring that contractors adhere to the law and uphold their contractual duties. Before awarding many contracts, project owners, developers, and government agencies require contractors to be bonded. If contractors don’t have the necessary bonds in place, they might not be able to license their business or submit a proposal at all.
Working with Bowthorpe & Associates Insurance Producers, contractors can learn how surety bonds work. When used correctly, bonds can help contractors secure projects and maintain good standing while avoiding expensive legal issues.
Let’s review some questions contractors often have about surety bonds.
How Do Surety Bonds Work?
Performance and payment bonds create a contractual promise that the work will be performed per the contract’s requirements, including state and federal regulations. However, unlike traditional insurance, risk is not transferred. Instead, the bond guarantees the contractor’s obligations will be met. Should a claim be made against the bond, then the contractor is responsible for reimbursing the surety for the loss.
Because of this, surety will work with contractors to help ensure compliance and prevent claims from being filed. If a contractor fails to comply with contractual requirements, then the surety will pay the project owner for any financial losses. However, the contractor is still responsible for the cost.
The Three Parties Involved in Surety Bonds
The principal is the contractor who will perform the work per the contract requirements.
The obligee is the project owner or government entity who requests the bond.
The surety is the insurance company who issues the bond.
When the contractor doesn’t fulfill their contractual responsibilities, the project owner (obligee) can make a claim against the bond. In most cases, sureties will investigate claims, and determine if financial compensation or contract completion is in order.
Types of Contractor Surety Bonds
Contractors are commonly required to submit many types of bonds. These may vary by project type and location.
Bid bond – Ensures the contractor will sign a contract once awarded the project.
Performance bond – Guarantees the work will be completed.
Payment bond – Guarantees subcontractors and material suppliers are paid for work and services.
Maintenance bonds – Guarantees workmanship and repair defects within a specified period.
License and permit bonds – Some licensing agencies require contractors to purchase these bonds.
Bond Requirements by Federal and State Agencies
Contractors performing work on public projects may be required to be bonded by federal or state law.
Most construction projects at the federal level require payment and performance bonds. These bonds protect taxpayers and subcontractors working on the project.
State and local public works contracts often require contractors to meet specified bonding requirements.
Contractors may also be required to purchase and maintain license bonds if they work with certain licensing boards.
Helping Contractors Manage Bond Claims
Although each claim is different, most surety claims are resolved in a matter of months. The general rule when dealing with a surety claim is to act quickly and with a level head. Once a claim is filed the surety company will investigate to determine if the contract was not followed.
Documentation is key when dealing with surety claims. Make sure you keep detailed records of schedules, inspections, contracts, change orders, daily job reports, and payment records. Maintaining a strong relationship with your surety can help ensure the process goes smoothly and quickly.
If the surety determines the claim is valid, they may decide to have the project completed by another contractor, pay the project owner damages, or work with the contractor to complete the project.
Contractor Responsibility and Surety Bonds
When applying for a bond, most contractors sign an indemnity agreement with the surety company. This legally enforceable document states that the contractor and sometimes the owners of the business will repay the surety for any claim payments.
It’s important for contractors to understand that surety bonds are not insurance. Should a claim occur on a project the contractor is responsible for reimbursing the surety company for any loss. This is why it’s critical that contractors view surety bonds as a financial obligation.
To help minimize claims it’s important to track subcontractor payments, keep detailed records, and document all project progress.
Bond Capacity and Surety Approval
Bond capacity is determined during the underwriting process. After applying for a bond, most contractors work with an underwriter who reviews financials, credit, experience, and project size.
Strong financial statements and credit along with large projects equals lower surety risk which could result in more bond capacity.
Bond costs are typically a percentage of the total bond amount. Amounts can range from .5 percent to 3 percent or more based on the contractor’s financial strength and credit history.
It’s always a good idea to factor in bond costs when submitting a project bid. This will allow contractors to keep proper margins on projects.
Why Contractors Should Care About Surety Bonds
Many contractors don’t realize that surety bonds can help grow their businesses. Surety bonds not only provide assurance to project owners that work will be done, but they also allow contractors to qualify for larger and more complex projects.
Understanding the bonding process and staying compliant with surety requirements can help contractors limit their risks.
Frequently Asked Questions
Q1: What is a contractor surety bond?
A: Put simply, it’s a financial guarantee that contractors will perform work per contract requirements and follow regulations.
Q2: Why do contractors need surety bonds?
A: Surety bonds help project owners minimize risk by providing financial compensation for damages in the event that a contractor fails to complete work or abide by state and federal regulations.
Q3: What kind of bonds do contractors need?
A: Contractors typically need to purchase bid bonds, performance bonds, payment bonds, and maintenance bonds and may need licenses and permit bonds required by local governments.
Q4: How much do contractor surety bonds cost?
A: Bond costs vary by surety but typically range from .5 percent to 3 percent of the total bond amount.
Q5: What happens if you get a surety bond claim?
A: If a surety bond claim is submitted, your surety will investigate. If the surety believes the contractor is at fault, they will either complete the project, pay the project owner damages, or work with you to resolve the issue. You are responsible for reimbursing the surety for any loss incurred.