What Is a Construction Bond Contract? A Guide for Contractors
If you're in the construction business, construction bonds are an unavoidable necessity.
With multiple types of construction bonds, it can be a mind-boggling process to determine which one is the best option for your project.
You’ve come to the right place.
In this guide, we’ll:
- Answer the question, “What is a construction bond?”
- Learn how construction bonds work; and
- Take a close-up look at the various types of construction bonds that are available
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Construction Bond Definition
A construction bond, or contract bond, can be described as an insurance policy purchased by a contractor to protect himself, and/or the project owner, from any potential financial issues that may occur during a job.
Purchased from a bank or insurance company, a construction bond guarantees the satisfactory completion of a job by a contractor.
Should a problem occur, the owner may file a claim with the insurer, and the bonding company will pay the owner any additional expenses they may have incurred due to the nonpayment.
In essence, a construction bond guarantees that the contractor or supplier who purchases the bond will fulfill the terms of the contract.
What Does it Mean to Be Bonded as a Contractor?
If a contractor is "bonded", it means that the property owner is financially protected in the event that:
- The contractor does not complete the job; or
- The job is poorly executed
How Does a Construction Bond Work?
A construction bond guarantees the project owner that the contractor will complete a project according to the contracted terms.
If a contractor fails to complete a project or meet the project’s specifications, the project owner can file a claim with the insurer to recoup any expenses incurred due to the default.
Construction Bonding Requirements
In general, the process for obtaining a construction bond is as follows:
- Review the requirements of the job to see if a contract or construction bond is needed.
- Secure a bid bond from your surety agent and submit it along with the proposal.
- If the contract bond is approved, contact the agent to obtain a performance bond.
- Complete the construction project.
- If necessary, obtain a maintenance bond when the job is completed, to cover any repairs.
3 Parties Involved in Construction Bonds
A construction bond involves three parties:
- Investor or property owner
- Surety company
- The contractor
#1: The Investor or Property Owner
Frequently referred to as the obligee, the investor is the individual who would receive payment were there to be a problem on the job.
This party will vary depending upon the type of construction bond.
For example:
- The obligee for a performance bond is usually the property owner; whereas
- The obligee for a payment bond will most likely be a supplier or subcontractor
#2: The Contractor
The contractor is usually the general contractor or subcontractor and is the person or company purchasing the bond.
#3: The Surety Company Backing the Bond
The surety company provides the bond for the project and will be responsible for paying any claims that may be filed.
What Is a Construction Bond Surety Company?
A construction bond surety company is the firm that buys or sells the bond and guarantees that the contractor will fulfill the obligation to the property owner.
What Do Construction Bonds Cost from a Surety?
In general, the construction bond cost will be approximately 1-15% of the total bond amount and is often based on the purchaser’s personal credit score.
6 Types of Construction Bonds
Depending on the specifics of the job, different types of construction bonds may be required.
Some of the most common types are:
- Bid bonds
- Performance bonds
- Payment bonds
- Maintenance bonds
- Public works bonds
- Site improvement bonds
#1: Bid Bond
The bid bond provides a guarantee to the project owner that a contractor will follow through with their bid by signing a contract for the bid amount if they are awarded the project.
Bid bonds keep general contractors from withdrawing from a deal after finding out how much other contractors bid.
Additionally, this bond protects the project owner in the instance that the general contractor forgets to include something in the bid since the contractor is required to sign a contract for the amount they recorded.
If the general contractor is not able to complete the contract as bid, the bond acts as insurance that the surety will pay the difference.
Bid bonds are made out to the project owner and are provided by the general contractor as principal.
In the instance a claim is needed, it is the owner's responsibility to notify the surety company.
Bid bonds are generally inexpensive, typically costing a few hundred dollars.
Occasionally, a surety will not charge for a bid bond since securing a bid bond often leads to the purchase of payment and performance bonds.
#2: Performance Bond
A performance bond guarantees that a contractor will complete the work according to the conditions and requirements of the project contract.
Performance bonds are to protect the owner in the event a contractor should default in the midst of a project. This means the owner would need to pay someone else a higher rate to complete the unfinished work.
In addition, performance bonds can also protect the owner from poor quality work or work that does not match the requirements set forth in the contract.
Performance bonds are generally required on public projects and may be requested on private jobs.
Performance bonds typically cost between 1-3% of the total contract price.
#3: Payment Bond
Payment bonds are designed to protect property owners from mechanic’s lien claims or other types of claims against the property title due to non-payment.
Additionally, they protect suppliers and subcontractors by guaranteeing they get paid for the work they do.
Payment bonds ensure general contractors will pay contractor suppliers and laborers and are required on most public projects. Owners of private projects may choose to require them, as well.
If the general contractor fails to provide prompt payment, the contractors and suppliers may register a claim against the payment bond.
Payment bond claims are filed instead of mechanic’s liens, which typically are not placed on public property.
Payment bonds generally cost around 3% of the contract value, depending upon the contractor’s credit history.
#4: Maintenance Bond
Also known as a warranty bond, maintenance bonds provide insurance to the project owner against defects in workmanship, design, or materials that could potentially cause issues down the road if work was done incorrectly.
Maintenance bonds are frequently required on public infrastructure projects such as water mains, sewer lines, or storm pipes.
The cost of a maintenance bond depends on the financial status of the contractor.
#5: Public Work Bond
As the name suggests, the public works bonds are required for work on any state public works project.
The bond amount required for work on these projects will vary from state to state.
Public works bonds guarantee that workers will be paid according to the state’s current wage requirements.
The state is considered to be the property owner on public works bonds and is responsible for filing any needed claims.
The cost of a public works bond is dependent on the financial status of the contractor.
#6: Site Improvement Bond
A site improvement bond is purchased with the intent of protecting the project owner from potential contract default and guarantees that improvements to a structure will be made in accordance with building codes and standards.
In the event that the contractor is found to be in breach of contract, the project owner may file a claim on the bond for reimbursement.
Most contact bonds cost approximately 2-3% of the bond amount.
The Future of Flexbase: We Can Share the Quality of Your Revenue and Cash Flow to Secure a Construction Bond
If you are needing to secure a construction bond, Flexbase can help.
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We can even offer to be your bond partner and can help refer you or act as an intermediary.
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