What is a Construction Bond?
A construction bond is a type of surety bond. Surety bonds are a type of legally binding contract between a surety company, a principle, and the obligee.
- The surety: The construction bonding company that backs the surety bonds.
- The principle: This typically refers to the general contractor in question (or subcontractors on the project).
- The obligee: This is the company or entity requiring the surety bond (such as the owners of the construction project or a developer).
So what is bonding? Construction bonds are usually issued at a specific price—or maximum compensation—that the surety company provides if the contractor fails to complete the specified work (or otherwise damages the property in question).
The contract guarantees that the work being done is completed as specified by the surety bonds—and in the correct length of time. If a contractor fails to follow what's outlined in the bonds, they can be held liable. Bonding in construction is a common occurrence.
What is the Role of the Surety?
The ‘surety’ is the company that backs the bond you’re purchasing. Bonding companies step in if you are unable to complete a project or do not fulfill your obligations and reimburse the project owner when necessary. However, in most cases, the contractor is still liable for the payment of the bond. So performance bonds can be thought of as a line of credit for the bond amount outlined.
The Types of Construction Bonds
There are 4 common types of construction bonds that may be required to bid on a contracting job: Bid Bonds, Performance Bonds, Payment Bonds, and Maintenance Bonds.
- Bid Bond: A bid bond is usually required to bid on a construction project. It protects the owner/developer in the case of a bid not being honored. It also proves that you can supply both a performance bond and a payment bond if necessary.
- Performance Bond: A performance bond is a contract in which the constraints of the construction project are laid out. If the contractor breaks the requirements of the performance bond, the project owner can claim restitution for the cost of hiring another contractor to complete the project.
- Payment Bond: This bond signifies that you’ll pay everyone under your employ—subcontractors, vendors, laborers, supplies, and so forth. If your construction company were to file bankruptcy, this surety bond can be used to reimburse those completing the construction projects.
- Maintenance Bond: This bond acts as a type of warranty for your work. If something completed is faulty or defective for a specified length of time after the completion of a project, this can help reimburse costs incurred to fix the defect and/or damage.
Other types of construction bonds may be required to bid on a federal project, such as Public Works Bonds and Site Improvements Bonds.:
- Public Works Bonds: This is the equivalent of a performance bond, but usually required on the state level.
- Site Improvement Bonds: When a construction company is obtained for a project where they're updating a building, this ensures that they follow all current building codes and standards.
Why Does a Contractor Need Construction Bonds?
If you're wondering why you should consider a construction bond, here are some examples of the necessity:
Example #1: If your bid is accepted and you retract your bid or bow out of the project for whatever reason, the developer can make a claim against your bid bond to cover the difference between your bid and the next highest bidder. If you haven't obtained a bid bond, you and your business may be held personally liable for any losses sustained.
Example #2: A project owner lets you know they'd prefer you to obtain a site improvement bond, and you opt not to since it's not a requirement. After you complete the work, the project owner has the work inspected before moving on to the next step of the project. Unfortunately, your work isn't up to code. The project manager is upset, and hires another contractor to redo your work—and you are on the hook for the cost.
You may be wondering—why go through the work to obtain the bond if you're held liable for payment either way? While it's true that a construction bond primarily protects the project owner, because a bond is usually for a fixed payment amount, it protects you as well. If the cost of damages, repair, or replacement to a construction project is higher than the bonding rate obtained from the surety company, you are still only liable to provide payment for that amount. So in some ways, the bond protects both parties in question.
Secondly, obtain constructions bonds are a way to foster trust between parties. If the contractor exceeds expectations and fulfills everything outlined in your performance bonds, a project owner or developer is more likely to use your business in the future.
Can I Get a Construction Bond for All of My Projects?
There are some construction projects where you will NOT be able to obtain construction bonds from a surety company:
- Projects on Indian Reservations: Indian reservations are excluded because they do not have to adhere to certain federal laws and regulations where a construction bond would normally be required.
- Anything being constructed outside of the United States: Because anything outside of the U.S. doesn’t fall under federal law, a payment bond is not required for large projects.
- Construction jobs completed over a timeframe of 3+ years: Surety companies are hesitant to back construction bonds for contracts that are long-term—especially if the construction company that won the bid is engaged in multiple projects, increasing the chance they default on the bond.
- Home remodeling projects:Unless this is paid for by the federal government, it is considered a private project and does not qualify for a payment bond.
How Does the Miller Act Apply?
According to the U.S. General Services Administration, “The Miller Act requires that prime contractors for the construction, alteration, or repair of Federal buildings furnish a payment bond for contracts in excess of $100,000”. The goal is to protect subcontractors and suppliers who are employed by a contractor to work on a federal project. So in this case, a contractor would obtain a payment bond. The bond protects anyone contracted by the contractor to complete work on a federal bid.
Is a Contractor License Bond the Same Thing?
The short answer is that a contractor license bond is not always the same. A contractor license bond—also referred to as a construction license surety bond—is required in some states (such as Florida) to become a licensed and bonded contractor. It is a binding agreement that you will adhere to the building codes and state laws of the municipality that you’re working in. It’s also a term that many use interchangeably with a contractor’s bond or construction bond—so make sure you know exactly what is being required of you for the project you’re bidding on.
Where Can I Obtain a Construction Bond?
There are multiple companies that provide construction bonds for projects. If you are looking to bid on a federal project, connect with your agent—or reach out to one of ours—to ascertain exactly what bonds will be required. You want to be sure that your business and all subcontractors under your employ are protected.
Connect with an Agent to Learn More
If you'd like to connect with one of our agents to talk about the different surety bonds that may be required for a contractor, complete the form at the top of the page or give us a call at 1-877-907-5267.
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