A contractor bond (also known as construction or surety bond) is a bond that must be paid by the contractor before the undertaking of a construction project to the project owners or investors in the case of contractor default, incompletion or failure to meet specification requirements.
Who’s involved in contractor bonds?
There are generally three parties involved in contractor bonds: the project investors (known as obligees), contractors who will complete the project and the surety company that ‘administers’ the bond.
The obligee is usually a government or public organization that hires a contractor to carry out large scale construction projections. Contractor bonds are put in place to hold the contractors liable so that they complete the project on time. Here is a closer look at contractor bonds.
The difficulty in getting a contractor bond starts when the contractor must purchase a bond from a surety company. The surety company runs extensive background checks on a contractor’s financial history before the bond can be approved. A surety company acts as a financial guarantor for the bond, reassuring the oblige that the contractor will meet the terms of the agreement of the bond.
If a contractor files for bankruptcy, for example, the surety company will be responsible for compensating for the obligee’s financial losses.
Why is securing a contractor bond difficult?
The surety company will calculate a premium based on a contractor’s performance and financial history, and how likely they are to default on the project. So, if you have good performance and financial records, the premiums charged will likely be lower. Just like loans, this method is more beneficial for larger and more established contractors. For new contractors who don’t have an extensive project history, the premiums could be more costly and probably more paperwork will be involved.
However, once approved, surety bonds could add to the credibility of contractors as being reliable and trustworthy.
For larger projects, there are three types of contractor bonds:
- Bid Bonds- Contractors pay this during bidding to reduce the risk of them backing out of the project
- Performance Bonds – This bond protects the obligee if the contractor fails to meet the specification and quality requirements of the project.
- Payment Bonds- These are paid by the contractor to reassure that they have the financial resources available to pay for workers and materials.
As the case in most insurance markets, new and small contractors may find it difficult or even impossible to secure a bond for the first time.
An option for new or small contractors might be safety programs like the SBA’s Surety Bond Guarantee Program. They assure up to a 90 percent guarantee to the surety. The program is suitable for any small business meeting the SBA’s eligibility criteria. $ 6.5 million worth of single bonds are offered by this scheme.