Continuing the tradition of Guest Posts here at Construction Law Carolinas, I am pleased to welcome Danielle Rodabaugh, the chief editor at SuretyBonds.com, a leading surety provider. As a part of the company’s educational outreach program, Danielle writes to help construction professionals better understand the legal intricacies of contractor bonding. Danielle has also written a number of articles about green building practices and how environmental regulations affect the construction industry. (Note: The link to Danielle’s employer is for biographical purposes only and is not an endorsement or referral of same.)
A Basic Guide to Contractor Bonding
By: Danielle Rodabaugh
As a surety professional, I know that contractors often have a limited understanding of how contractor bonding works. Oftentimes this is through no fault of their own; the process is complicated, and rarely do underwriters take the time to explain the process in full. Even experienced contractors who have worked in the industry for decades have questions about surety bonds. Furthermore, a great deal of contractor bonding information available online is inaccurate, hard to find or just plain boring. As such, this guide will answer common questions contractors have about the bonding process.
How do surety bonds work, anyway?
Before we get into the specifics of contractor bonding, you’re probably wondering what surety bonds are and how they work. A basic definition explains that a surety bond brings together three parties in a legally binding agreement. The agreement that’s made varies depending on the bond type. Generally speaking, though, bonds keep project owners from losing money on projects.
They do so by forming a contract that involves a contractor, a project owner and a surety provider. If the contractor breaks the bond’s terms, the project owner can make a claim on the bond to gain financial reparation. If the claim is proven to be valid, the surety will be required to either resolve the problem or pay retribution. The bond’s indemnification clause will then require the contractor to reimburse the surety for any claims paid out, which is the key difference between surety insurance and traditional insurance policies.
How do I know if I need a surety bond?
Most states require contractors to purchase a license and permit bond before they can apply for their contractors license. This is a basic surety bond type that’s required of contractors in almost every state. Depending on your county, city and subdivision’s laws for contractors, you might have to maintain additional license bonds as well. At the bare minimum you’ll have to comply with your state’s contractor license bond requirements.
When it comes to surety bonds that are issued for specific projects, however, the story is different. Dozens of individual contractor bond types exist; some of the most common ones are bid bonds, payment bonds, performance bonds, supply bonds and maintenance bonds. The federal Miller Act requires contractors to file payment and performance bonds before they can work on any publicly funded project that will cost $100,000 or more. However, the project owner will tell you if you need to get a contractor bond in other situations. For example, some cities even require bonds on public projects that cost $10,000 or less, and private project owners might also choose to require bonds.
How often do I need to get bonded?
The answer here primarily depends on how many projects you work on, the nature of those projects and the type of owners that fund them. Because public projects are funded by government agencies, they almost always require that construction professionals file surety bonds to ensure projects will be completed. This is why it’s important to build a relationship with a surety provider you can trust. You’ll want somebody on your side when you have to provide multiple bonds for the many projects you work on each year.
What if I’m a small contractor?
In theory, small contractors shouldn’t have any more trouble getting the bonds they need than do larger firms. In reality, however, this isn’t always the case. When it comes to license bonds, every contractor can be easily approved for the bond they need. The catch is that the rate the underwriter charges depends on the applicant’s credit score. If a small contractor has a poor credit score, the rate will be higher than typical bond rates. Small contractors generally have a limited cash flow, so paying for the bad credit bonds they need could be more difficult than it would be for large contractors in the same situation.
When it comes to surety bonds issued for specific contracts, however, the problem gets trickier. Because so much risk is involved with construction contracts, surety underwriters are much more thorough when reviewing applications. This means applicants with poor credit can be flat out denied for the bonds they need, especially when it comes to expensive projects. Surety providers intend to avoid losses at all costs, so they assume applicants with bad credit are riskier than others. As such, they might choose not to issue bonds to those with bad credit.
Fortunately the Small Business Administration operates a program that helps small contractors get the bonds they need. Contractors can qualify for the program only if they’ve been denied bonding by commercial surety providers. The SBA can guarantee projects up to $2 million.
Although contractor bonding might seem like a hassle to experienced and emerging contractors alike, a greater understanding of how it works will help contractors prepare themselves for the application process. Hopefully this guide helps you along your way.