Alex Levin is a writer for JW Surety Bonds, the largest surety bond agency in the country. When he’s not helping clear up the mystery of the surety bonding process, he writes on a variety of topics from eco-friendly building tips to developments in construction law. (Note: The link to Alex’s employer is for biographical purposes only and is not an endorsement or referral of same.)
Surety Bonding 101 for Contractors
By: Alex Levin, JW Surety Bonds
Starting a construction project involves not only hiring and
training your crew, but it also requires paperwork. From obtaining licenses, permits and other legal documents, the amount of red tape necessary to get a job started can seem like a project all in itself. To add to the amount of documentation, a surety bond is typically required for construction projects to begin. Yet, much is unknown about the purpose they serve, what bonds are required prior to starting a construction project and how much they’ll cost. The following will help sort through the mystery that is contractor bonds.
1) What’s the difference between construction bonds and contractor bonds?
The simple answer to this question is, “Nothing.” Construction bonds and contractor bonds are used interchangeably and refer to the surety bonds required for certain construction projects to begin. Often projects cannot even start until the contracting company obtains and displays their surety bonds.
Contractor license bonds, however, refer to the bonds required by local or state governments. These bonds can vary by area. Those interested in finding out if their state requires contractor license bonds should review the laws of the area they plan to work in.
2) So, what’s a surety bond?
Surety bonds are an agreement between three parties:
- A principal – the contracting company who is purchasing the bond;
- An obligee – the party requiring the bond (often a government entity); and
- A surety – the agency who issues the bond(s) to the contractor and will serve as an most intermediary between the client (principal) and the government agency
Should the contracting company be found to be at fault in regards to the specifications of the contract which is protected by the surety bond, a claim can be made on the bond. If it is found to be valid, damages must be paid, and most likely this is the responsibility of the surety company. If the surety company pays a claim under the bond, it may seek indemnification (reimbursement) from the principal.
3) What are the most commonly required surety bonds of construction projects?
In regards to construction projects, the most commonly required surety bond types are:
- Bid Bonds – these are submitted alongside a bid on a construction project and guarantee the contractor will hold to their original bid if they are awarded the contract
- Performance Bonds – these guarantee the faithful performance of the contract
- Payment Bonds– these ensure subcontractors, laborers and material expenses will be paid for in the event of contract default
The term “performance and payment bond” is also commonly used. Although combined into one phrase, they are two separate and unique bonds.
4) How much do they cost?
As pricing can change from one company to another, not one set premium stands for how much surety bonds cost. There are a several factors which influence the amount of a bond, such as: the financial strength of the contracting company applying for the bond, the industry in which the bond is required, the type of bond, and the amount of the contract.
In general, financially strong companies applying for bonds can expect to pay between 1 to 3 percent of the contract for their bond. Those with weaker credit may pay anywhere from 5 to 20 percent.
5) How do I get bonded?
As surety bond costs are largely determined due to an applicant’s financial strength, applying for a surety bond relies heavily on financial documentation. Many reputable surety agencies offer online
applications to their perspective clients, making the process much quicker and convenient. Those applying for a bond can expect to supply information on the following areas:
- Company background: the year the company was founded, previous bond claims and whether the organization has ever been denied a bond;
- Surety bond information: the type of bond required, the entity that is requiring the purchase of a bond; and
- Personal financial information: the monetary amount in bank accounts, salary information, amount of property owned and its value, insurance policies and amount invested, liability details such as loans, line of credit, etc.
Surety agencies also offer high risk programs for applicants with lesser than strong credit history. If applicants have enough assets to cover the bond should a claim be filed against them, typically bonds are approved within two days.