Contractor’s FAQs for Surety Bonding
The amount of paperwork required to bid on a construction project can, at times, be overwhelming. A common prerequisite for many public construction projects is to acquire a surety bond. Although their presence is common within the construction industry, many contractors know little about the services and benefits surety bonds provide. To help dispel myths and misunderstandings, the following is an insider’s look into contractor’s most frequently asked questions regarding surety bonding.
In simple terms, surety bonds are a form of financial guarantee. They help ensure stakeholders that contractors will complete work and play suppliers and laborers per the specifications of the contract. Surety bonds are an agreement between three parties:
• An obligee – the project owner
• A principal – the bond purchaser or bond owner
• A surety – the company who sells the bond and ensures the contract is followed
Where did surety bonds originate?
The origin of surety bonds dates back to 1935 with the passage of the Miller Act. This required performance and payment bonds on federal construction projects which exceed $100,000. With the Miller Act’s passage, several state legislatures also adopted similar regulations for smaller projects. These rulings are known as Little Miller Acts.
What is the difference between contract bonds and contractor bonds?
In short the answer is “nothing.” These terms are used interchangeably to refer to various types of construction surety bonds. The most common types of contract surety bonds are bid bonds, performance bonds and payment bonds.
• Bid Bonds : guarantees the contractor will enter into a project for the amount he/she bid upon
• Performance Bonds: these bonds protect project owners from contractor default or if work is not performed as outlined in the contract
• Payment Bonds: these ensure that all parties involved in the project will be paid appropriately. Often, performance and payment bonds are issued jointly as a single surety bond.
How much do surety bonds cost?
Surety bond costs range depending upon the geographic region the bond is required, the financial history of the applicant and the surety’s policy. Those with strong credit ratings will receive the most competitive rates, however those with weaker financial histories are eligible to purchase a bond through a surety company’s bad credit program. Rates range between 1 to 3 percent of the contract amount while high-risk applicants may spend as much as 20 percent of the bond cost.
One of the most commonly asked questions for surety bonding is how it differs from insurance policies. The main variant between the two is how risk is assessed. For insurance, individuals pay a premium to their insurance company which transfers most risk to the agency that is overseeing the policy. Should a claim be filed, it is the insurance company’s responsibility to ensure all parties are financially compensated. With surety bonds, the element of risk continues to lie with the individual who owns the bond, or the principal. If a claim is filed against the contractor who owns the bond, the principal will be expected to repay damages.
Vic Lance (firstname.lastname@example.org) is the owner of Lance Surety Bonds a nationwide surety agency. He helps advise contractors and small businesses on the bonding process.