When bidding on a construction project, you want to make sure that you have everything in your arsenal to win the project. This includes purchasing a surety bond so you can assure the project owner that you will perform all duties required to complete the project as specified in the contract.
So, what is a construction surety bond? A surety bond is a three-party contract between a surety company (usually an insurance company), the project owner and you (the contractor). The bond financially protects the project owner in the event that the contracting company fails to complete the project as promised in the agreement.
Types of Construction Bonds
It’s important to remember while a surety bond is purchased from an insurance company, bonds are not insurance. Instead, a surety bond is an agreement that the contractor will carry out their job duties and what will happen if the contractor cannot complete the job. These terms ultimately protect the project owner from any financial loss.
Depending on the work you’re performing, you have to choose the right bond for the project. For example, new construction companies require a different bond than a company that works on renovation projects. Some projects may even require more than one type of bond. Here’s a closer look at each type of bond and its purpose.
A contractor will submit a bid bond to the project owner during the bidding process. This type of bond guarantees that the information in the bid is accurate. It also guarantees that the contractor has the resources and financial credentials required to complete the job if they are awarded the project.
The bid bond is essentially a sign of good faith between the contractor and the project owner. Those who submit a bid bond are more likely to win contracts.
A performance bond is the contractor’s promise that they will carry out the project as stated in the contract. This bond protects the project owner in the case that the contractor can’t carry out their duties for any reason. The bond grants the project owner financial assistance so they can pay to move forward and complete the job if the contractor is unable to perform.
When a contractor works on a project, they are in charge of hiring and paying people who will work on the project, such as subcontractors and materials suppliers. A contractor obtains a payment bond to guarantee that those who contribute to the project will be paid for their services.
If the contractor runs out of funding or goes bankrupt during the project, the payment bond reimburses the subcontractors, suppliers and any other workers on the project.
A warranty bond, also known as a maintenance bond, protects the owner of a complete construction project. The bond guarantees a warranty on the quality and materials of the projects for a specified period of time. This means that the contractor will replace or repair anything theymay not have done correctly the first time around.
The bond grants the project owner additional funds to pay for a contractor to bring the project back to its completed condition.
Site Improvement Bond
A site improvement bond is a type of surety bond that is specifically for construction projects on an already existing structure. This type of bond is required for commercial renovation projects and guarantees that the job will reach substantial completion according to the contract’s terms. It also guarantees that the project will be in accordance with local building and renovation codes.
Contractor License Bond
A contractor license bond is necessary for a project whose project owner is a government agency. Whether it’s a federal, state, city or county-funded project, the contractor must obtain a contractor license bond. This bond guarantees that the work will be in accordance with the contract’s conditions and any codes and laws pertaining to the job.
The contractor on a project is responsible for finding, ordering and paying for materials from various suppliers. The supply bond is a guarantee to the project owner that the contractor’s supplier will produce all the necessary materials for the job. If the suppliers cannot follow through, the bond provides funding for other materials at no cost to the project owner.
Supply bonds aren’t a requirement for every project, but they are especially important for jobs that require a large number of materials. As a rule of thumb, the larger the project, the more important a supply bond becomes.
A subdivision bond is a type of surety bond that is required by a state, city or other government agency before a contractor can conduct work within a subdivision. This bond guarantees that the contractor will complete their work by abiding by codes and local standards without compromising anything within the subdivision.
Subdivision bonds apply to the building of new structures, which is the key difference between this bond and a site improvement bond.
A contractor doing a project that requires utilities such as electricity, water and other services is required to obtain a utility bond. This bond is a financial agreement that guarantees full and on-time payment of bills to the utility company.
Most bonds are agreements between a surety company, project owner and contractor. A utility bond is different in that it is an agreement between a surety company, utility company and contractor.
What Are the Benefits of a Surety Bond?
Surety bonds come with two main benefits. First and foremost, a surety bond guarantees that the contractor will complete the work according to the contract. This means that no matter what, the project owner gets a finished product when the project concludes.
The other main benefit of a surety bond is that the bond transfers the construction risk from the project owner. So, if the contractor cannot complete the work for any reason, the project owner does not have to pay more toward the project. Instead, the bond will cover the additional costs to complete the project.
What Is Covered Under a Surety Bond?
Although the contractor purchases the surety bond, it’s important to note that the bond protects the project owner. The contract ensures that the project owner receives financial compensation if the contractor cannot follow through. The bond does not offer any financial protection to the contractor.
Surety bonds protect the project owner in these situations:
- Contactor cannot complete the project
- Contractor fails to acquire the right permits and licenses
- Contractor fails to comply with codes and regulations
- Employee theft from the project
- Contractor fails to pay subcontractors and suppliers
Since the project owner is the one who benefits from the bond agreement, you may wonder why they aren’t the one who purchases it. The contractor secures the bond to demonstrate to the project owner that they have the resources and financial standings to take on and complete the project.
While a bid bond is not always required to submit with a project bid, a project owner will likely choose a contractor that can qualify and purchase a surety bond even before the project begins.
Construction Bonds FAQ
Construction bonds are complex contracts, so if you’re unfamiliar with them, you may have some questions about how they work and why they are necessary. Here are some of the most frequently asked questions about construction bonds.
What Is the Purpose of a Construction Surety Bond?
A surety bond provides the project owner with financial security when hiring a contractor. When a project owner hires a contractor, they need a guarantee that the contractor will complete the project and pay everyone who contributes to the project.
A surety bond creates that guarantee because it holds the contractor liable for any problems with the project. Most notably, the project owner can claim the surety to receive funds that they can use to move forward with the job if the contractor cannot complete the job for any reason.
What Are the 3 Cs of Surety?
When a contractor purchases a surety bond, they must first go through the qualification process before the insurance company will grant them their bond.
Similar to the way a car insurance company won’t grant someone with a bad driving record insurance, a surety company won’t grant a bond without doing a quick background check. For these checks, they look into the three C’s of surety — character, capacity and capital. Let’s take a closer look:
- Character: This refers to the qualities and business morals of the contractor. They will need to demonstrate that they are honest and make every effort to carry out their business dealings.
- Capacity: Capacity refers to the contractor’s ability to complete a project. They will have to explain to the surety company that they have the skills and resources to fulfill the needs of the job.
- Capital: Lastly, the surety company needs proof that the contractor is in good enough financial standing to take on the project. The surety company will review past financial statements to determine net worth, the profitability of past projects and the amount of working capital a contractor has.
How Long Does a Surety Bond Last?
The length of the bond’s terms is typically written into the bond. You might even think of it as a built-in expiration date. That date is typically when the project is set to conclude. However, a contractor can renew or extend the terms of the bond if they find that the job requires more time. A contractor could also purchase other types of bonds along with their original surety bond if they feel additional coverage is necessary.
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