An Introduction To Contractor Bonds For Contractors In The US
/Why Contractor Bonds Are Important
Contractors are required to purchase different types of contractor bonds to work on many construction projects. The federal, local, or state government might require you to purchase a contractor bond before you can bid on public projects, and you may also need to be bonded to obtain a contractor license. Contractor bonds protect the project owner and the government against a contractor's failure to perform, failure to pay, default, warranty problems, and other issues. Here is some information about why contractor bonds are important for contractors, subcontractors, and project owners.
How Contractor Bonds Work
Some people confuse contractor surety bonds with insurance, but there are some key differences. Contractors are required to purchase a contractor license bond to get licensed by the states in which they will perform work on projects valued above a threshold amount. They might also be required to purchase other types of bonds before they can bid on public projects or to guarantee that they will perform their contractual duties and pay their suppliers and subcontractors.
Contractor bonds protect the project owner against mechanic's liens if the contractor fails to pay its suppliers and subcontractors. They also protect project owners from financial losses caused by delays and failures to perform. If a problem occurs, the project owner can file a claim against the surety bond. The surety company will then investigate the claim. If the claim is validated by the surety company, it will pay the project owner the additional expenses the owner incurred because of the contractor's default or breach. The contractor holding the bond will then be required to pay the surety company for the amounts the surety had to pay for the claim or face legal action.
Contractor bonds serve as guarantees that the contractors will fulfill their duties under their contractual terms. There are three parties involved in contractor bonds, including the following:
• Obligee - The party requiring the contractor bond, which can include the project owner, the government, a supplier, or a subcontractor
• Principal - The individual contractor or company that purchases the bond
• Surety - The company that provides the bond and guarantees the principal's performance, payment, and legal compliance
When you purchase a contractor bond, you will be required to sign an indemnification agreement with the surety company. This agreement legally obligates you to pay the surety company for any valid claims that might be filed against your bond.
Why Contractors Need Bonds
Contractor license bonds might be required by the state for contractors to secure licenses to perform work on projects worth more than a threshold amount. They may also need to purchase other bonds to work on specific types of projects. A bond helps to protect the project owners by providing an assurance that the contractors will fulfill their contractual obligations and pay their subcontractors and suppliers what they are owed.
Contractor bonds serve as a prequalification of the contractors. Surety companiesconduct underwriting to determine the degree of risk they face by agreeing to issue surety bonds to contractors. If a contractor's finances are in poor shape and the contractor has had issues with its performance on past projects, the surety company might deny the contractor's bond application. If a contractor has strong credit and experience handling large projects, the contractor may have to only pay a small percentage of the maximum bond amount to secure the bond.
Federal projects worth more than $100,000 require contractor bonds under the Miller Act. Each state also has similar laws that require contractors to be bonded to perform work on state or local projects worth more than a threshold amount. Many private project owners also will only contract with contractors who are licensed and bonded.
State and federal projects valued over the relevant thresholds require at least payment and performance bonds. Contractors that want to bid on public projects may also be required to purchase bid bonds, and a few other types of bonds could be required as well.
Private project owners might ask contractors and suppliers to purchase surety bonds for a proposed project. When a private project owner requires a bond, the contractor could add the cost of the bond to the contracted price since it is an additional item the owner has requested.
Why Surety Bonds Are Used on Construction Projects
Surety bonds are required on construction projects to provide the owner with some financial protection. While contracts generally contain provisions for what will happen if a contractor fails to perform, the owner can still face financial exposure and additional costs needed to complete the project if the contractor defaults.
Types of Contractor Bonds
There are many different types of contractor bonds. However, there are three types of bonds that are typically required, including performance bonds, payment bonds, and bid bonds.
Performance bonds are required for work on public projects and are frequently required by private project owners. They guarantee that the contractor will comply with the provisions of the contract in how it performs work on the project. Performance bonds protect the government or private project owner from the contractor's potential default mid-project, from substandard work, and from work that fails to meet the requirements of the contract. The project owner or government can file a claim against a contractor's performance bond to recoup losses caused by the contractor's failure to perform.
Payment bonds are also typically required by the government for public projects and by private project owners. A payment bond protects project owners when the contractor fails to pay its suppliers or subcontractors. Without a payment bond, the subcontractors or suppliers could file mechanic's lien claims against the property's title when the contractor fails to pay for their work or supplies. Payment bonds also help to ensure that the subcontractors and suppliers will be paid for the work they perform.
Bid bonds guarantee that the contractors will sign contracts for the amounts they bid if their bids are accepted. Bid bonds help to prevent contractors from backing out of a project when they learn how much the other bids were. When a contractor has a bid bond and bids on a project, the contractor will be obligated to contract for the accepted bid amount.
Contractor bonds are a cost of doing business for most contractors that want to perform work on large projects or on public projects. Many private owners also will not contract with contractors that are not bonded. To get the lowest bond rates, contractors must have excellent credit and a strong track record of performing as promised on past projects. Once a contractor obtains the bonds that it needs, the contractor should operate its business ethically to avoid bond claims.
If you want to delve deeper into the subject of contractor bonds for contractors in the US, read more about performance bonds from Axcess Surety.
