Basics of Construction Bonding


Surya Narayan - May 21, 2022 -

Basics of Construction Bonding

Basics of Construction Bonding

All contractors are required to provide a bond when they apply for a contractor’s license. Contractors may also be required to furnish other bonds for specific projects, depending on the scope of work and the project type. To help you better understand construction bonding, we’re going to look at what construction bonds are, the types of bonds you may be required to provide, and what bonding capacity means.

What is a construction bond?

Think of a construction bond like an insurance policy. Contractors purchase bonds to protect themselves and/or the project owner from potential financial issues during a project. If a financial problem occurs, the owner files a claim with the insurer, the insurer pays the owner, protecting them from any financial harm. However, unlike insurance, once a bond claim is paid the contractor must pay the insurer back.

A bond involves three parties – the obligee, principal, and the surety company. The obligee is the person or company who gets paid if there’s a financial or performance issue on the job, usually the project owner or general contractor. The principal is the company who purchases the bond, usually the general contractor or a subcontractor. The surety company furnishes the bond and is the one who will pay any claims if they are filed.

Bonds are generally required on federal projects, especially those over $100,000. State and local public entities may require bonds on their projects. In addition, any project owner, whether public or private, can ask that bonds be provided for their project. Usually, the cost of the bonds is added to the contract price.

Types of bonds used in construction

Payment bonds

Payment bonds guarantee that a contractor or subcontractor will pay their lower tier subcontractors, laborers, and suppliers. The contractor’s subcontractors and suppliers are the obligees (when the bond is purchased by the GC). The contractor is the principal and is responsible for purchasing the bond. If a payment issue arises, the lower tier subcontractors and suppliers make a claim against the payment bond. Bond claims are filed in place of mechanics liens, which can’t be placed on public property.

Performance bonds

Performance bonds guarantee that the work spelled out in the contract will be performed according to the conditions and requirements of the contract. These bonds protect the owner from a contractor stopping work in the middle of a project, substandard work, and work that doesn’t meet the contract requirements. They are held by the project owner, with the GC or a subcontractor as the principal. The project owner makes a claim if there is a problem with the quality of the work or the work isn’t going to be finished according to the contract requirements.

Bid bonds

Bid bonds are turned in with a project proposal and provide reassurance to the owner that a contractor will sign a contract for the amount of their bid if they’re awarded the project. They keep a GC from backing out of a project at the last minute, and they obligate the contractor to sign a contract for the amount they listed, or the surety will have to pay the difference. Like performance and payment bonds, these bonds are held by the project owner and are provided by the general contractor as principal. If a claim needs to be made, the owner notifies the surety company.

License bonds

License bonds are issued to state licensing boards and protect a contractor’s clients, ensuring that the contractor follows state laws. These bonds protect customers from financial loss when they’ve got a claim against a contractor for substandard or incomplete work. They are different from other types of bonds because the obligee is the contractor’s board, and the board is responsible for making a claim against a license bond. So, if a customer has a complaint, they file a claim with the contractor’s board, who then files a claim against the contractor’s license bond.

Subdivision bonds

Subdivision bonds guarantee that a developer or contractor will make necessary improvements to a subdivision as per its agreement with the local jurisdiction. Bonded improvements may include things like sidewalk maintenance, electrical upgrades, or grading changes. The city or county determines the bond amount and how soon the work needs to be complete. If a claim needs to be made, the local jurisdiction files a claim.

Supply bonds

Supply bonds ensure that supplies or materials will be provided for a project. The supplier provides this bond to the GC or owner, protecting them from default by the supplier. They are often required on public projects.

Maintenance/Warranty bonds

Maintenance or warranty bonds guarantee the project owner or a local jurisdiction that a contractor will repair faults or defects in a certain improvement for a length of time. They are often required when doing work on public infrastructure, such as sewer lines, storm pipes, or water mains. If repair or replacement is needed within the warranty time frame and the contractor does not complete the work, then the jurisdiction files a claim with the surety for the expenses they incur to make the repair.

Completion bonds

Completion bonds ensure that the project will be completed on-time, on budget, and that all parties will be paid. They differ from performance bonds because they cover the completion of the entire project, not just a specific contract. Both completion and performance bonds may be required on the same project. The owner is the party that makes a claim if the project is not completed correctly or there are issues.

Public works bonds

Public works bonds are required for any work on state-funded projects. Each state has its own bond requirements for work on these projects. These bonds help guarantee that workers will be paid according to prevailing wage requirements, and the state uses the proceeds from these bonds to enforce those requirements. If a company is not paying the correct wages, the state files a claim and uses the bond funds to correct the wages.

Retention bonds

Retention bonds are purchased to replace the withholding of retention on a project. Instead of holding 5-10% of every payment, the contractor or subcontractor purchases a bond and it’s used to guarantee that all the work will be completed at the end of the project. Depending on the cost of the bond, it can be a significant savings for a contractor over the life of a project. The project owner or general contractor makes any claims for work that isn’t completed.

What is bonding capacity?

Bonding capacity is the maximum amount of bond coverage a surety will provide to a company. The surety decides a company’s bonding capacity through investigating the financial standing, experience, and business practices of the company and its owners.

There are two limits when it comes to bonding capacity – single-job and aggregate. The single job bonding limit is the maximum protection the surety will provide on one project. Aggregate is the total amount of bonded work, the total of all open bonded projects, that the surety will back at one time.

Bonds protect contractors

Bonds provide protection for contractors and project owners. They protect payments, guarantee work, and ensure that projects are completed on time and on budget. They are similar to an insurance policy, except when there’s a claim, the expenses have to be paid back.

If you’re being asked to provide a bond for a project, you should contact a bonding agent. After completing an application and providing financial information, they will collect proposals from several bonding companies. The agent will help you shop for the best one for your situation. Contractors often develop relationships with their bonding companies that last for several years.

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