Construction Bonds are a type of surety bond written specifically for contractors. Contractors are often need many different bonds that are divided into two major categories. These include Contract Bonds and Commercial Bonds. Â
Contract Bonds are normally what people think about when they talk about construction bonds. These bonds include Performance Bonds, Payment Bonds, Bid Bonds, Maintenance Bonds and Supply Bonds. Construction Bonds are a three-party agreement. The contractor is referred to as the principal. The contractor’s obligation is guaranteed by a third-party which is the surety bond company, or Surety. The party that is requesting the bond and benefiting from its guarantee is the obligee. For Construction Bonds, this is the Project Owner and/or Lender, the Developer or an Upstream Contractor.
Bid Bonds guarantee that if a contractor is the low bidder and awarded a project, that contractor will enter into a contract with the owner and if asked, provide other construction bonds such as performance bonds, payment bonds and maintenance bonds.Â
Bid Bonds protect owners from the cost of having to rebid projects if the contractor will not honor their bid price. If a contractor is the low bidder and will not honor their bid amount, the owner can submit a claim on the bid bond. Without bid bonds, contractors would be able to withdraw their bids with little or no consequences.Â
Bid bonds provide the owner with a secondary benefit by acting as a prequalification process. By requiring a bid bond from a corporate surety, an owner can be sure that a professional surety underwriter has looked at the contractor's qualifications to perform the work and believes they can successfully complete the project. You can read more about these bonds on our bid bond page.
Performance Bonds guarantee that a contractor will complete a project according to the contract terms and at the contract price. A performance bond benefits the owner because they can be sure they will get their project completed for the at the agreed upon price. If the contractor cannot build the project for the price, the owner can make a Performance Bond Claim against the bond. Without a performance bond, an owner would be responsible for the cost overages if a contractor cannot complete the work.Â
Performance Bonds also benefit contractors. First, they act as a prequalification and help to set themselves apart from competition that may not be able to provide a bond and complete such work.
Secondly, contractors can ask for a performance bond from their subcontractors and suppliers to manage their own risk. Performance bonds can be a valuable tool against Subcontractor Default and price escalations. You can read more about Performance Bonds here.
Payment Bonds provide a guarantee that the Contractor is going to pay their subcontractors, material suppliers and bills on a project. If the contractor does not or cannot, a claim can be submitted to the bond company. This is a valuable tool for owners, lenders and the general public. It ensures that the project will be free of Mechanic’s Liens.Â
Likewise, Payments Bonds benefit subcontractors and suppliers. On a project with a payment bond in place, the parties can be sure they will receive payment for the work they have done under a construction contract. You can read more about payment bonds here.Â
A Maintenance Bond guarantees that the project will be free from defects for a specified period. These bonds can also be referred to as Warranty Bonds. Maintenance Bonds protect the owner’s investment by ensuring that the contractor will come back to correct work during the maintenance period. Generally, maintenance periods should not exceed 24 months. Everything breaks down over time and the contractor and surety bond company do not want to be making repairs forever. You can read more about Maintenance Bonds here.
A supply bond guarantees that material or equipment will be provided at an agreed upon price. Supply Bonds protect contractors against price escalation from material suppliers. Supply bonds can be a useful tool when future prices are uncertain such as when a product may not be needed for a while, prices are constantly influx or when there are a limited number of suppliers providing material or equipment. Some Surety Bond companies classify Supply Bonds as a type of Commercial Surety Bond instead of a Construction Bond. You can read all about Supply Bonds here.
The Principal pays the Surety Bond Company a premium. In return, the Surety provides a bond to give to the Obligee that promises that the Principal will complete contractual commitment. If the Principal does not, the Surety will step in and provide financial recourse to the Obligee.
Construction Bonds are required on most public projects. In fact, The Federal Miller Act requires that any project with $150,000 or more of Federal money, must be protected by Construction Bonds. This ensures that Public’s funds are protected by keeping projects completed at the contract price. It also ensures that Subcontractors and Suppliers are paid because they cannot file liens on public buildings and improvements.
Most states and municipalities have similar requirements. The dollar amounts to require construction bonds may vary by location though. These are referred to as "Little Miller Acts".
Additionally, many private projects require construction bonds as well. This is a way for general contractors to protect themselves from subcontractor risk and price escalations. Additionally, many lenders require construction bonds when lending money to owners and developers. This provides protection so that mechanic’s liens are not filed against their collateral and that borrowers will not need to return for additional capital to address cost overages.Â
Both General Contractors and Subcontractors could need construction bonds. A project owner may require a general contractor to bid on a project with a bid bond. If they are awarded the project, the owner may ask the general to provide a performance bond and payment bond to ensure that the project gets built for the contract price and that the project is lien free.
Similarly, the General Contractor may want the subcontractor to provide construction bonds to the General Contractor. Instead of protecting the owner, these bonds protect the General Contractor by preventing default or liens from the subcontractor. These are often referred to as Subcontract Bonds.
The cost of construction bonds depends on the strength of the contractor. Contractors with strong financial conditions, good experience and systems can usually get construction bonds for less than 1% of the contract amount. Contractors with less experience or weaker financial conditions may pay rates as high as 3% of the contract amount. Most contractors can expect to pay 0.5% - 3% of the total contract amount. Long term warranties, long completion times, and Design Build projects can increase the cost of Construction Bonds. You can read more about Construction Bond Costs by clicking the image to the right.
Bid bonds on the other hand are free from most brokers. Axcess Surety Bonds does not charge for bid bonds. We provide these as a service to our construction bond customers. You can read more about why bid bonds are free.
The underwriting of construction bonds depends on the size of the contract being bonded. For projects of $1,00,000 or less, contractors can get a bond with a simple credit check. Most of these construction bonds can be purchased instantly and in minutes. Just click on one of the buttons below.Â
For larger projects, contractors need to submit full underwriting documents. Construction Bond underwriting is referred to as the 3Cs which stand for Credit, Character, and Capacity. You can read more about these and how underwriters look at each here. The most basic information needed for larger construction bonds include:Â
For Performance Bonds, Payment Bonds and Maintenance Bonds, we will also need a copy of the contract. For Bid Bonds, we usually need a copy of the bid specifications.Â
Once we receive all the underwriting information, we can have construction bonds for most contractors within 24 hours. It may take longer for contractors with credit challenges.Â
Generally, no. Construction Bond companies generally do not take collateral unless a claim is filed. Construction Bonds are considered a form of unsecured credit. However, if the contractor has financial challenges, collateral may be a way to gain approval of the bond.
Contractors with bad credit and bankruptcy can also obtain construction bonds. Contractors should be ready to explain the circumstances behind the credit issues. Contractors with strong balance sheets should find obtaining construction bonds easy, even with credit challenges.Â
In tougher circumstances, the SBA Surety Bond Guarantee Program, Funds Control, or Collateral can be used to help contractors get construction bonds.
Construction Bonds require that the contractor indemnify the surety bond company providing the guarantee. This means that if a loss occurs and the bond company pays out, they will come back to the contractor for reimbursement. Contractors often misunderstand indemnity and view construction bonds as insurance. Construction Bonds more closely resemble a credit product, however. They are not insurance. To get construction bonds, contractors will be required to sign a General Indemnity Agreement. Contractors should review this document carefully and understand what they are signing before requesting construction bonds. You can read more about indemnity and General Indemnity Agreements.
Construction insurance covers things like liability from operations, property damage, employee injuries, etc. Â Contractors can learn more about the differences between construction bonds and construction insurance by clicking on the image to the right.
The second type of Construction Bonds are commercial bonds. These include contractor license bonds, right of way bonds, out of state tax bonds, wage and welfare bonds, demolition bonds, release of lien bonds, permit bonds and many others. Many of these bonds can be purchased online instantly visiting your state surety bond page.
Some owners may accept Irrevocable Letters of Credit as an alternative to construction bonds. Contractors should be skeptical of doing so. A contractor has very little defense to a claim against an irrevocable letter of credit. Additionally, using a letter of credit will tie up the contractor's borrowing ability and that liquidity may be needed for the project or business. Contractors can learn more about the differences of using a Contract Bond compared to a letter of credit here.
Understanding Construction Bonds does not have to be difficult. Axcess Surety is an expert in the field of construction bonding. We unlock the door to making bonding easy. Contact our construction bond experts anytime.
Axcess Surety is the premier provider of surety bonds nationally. We work individuals and businesses across the country to provide the best surety bond programs at the best price.
