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Contract Bonds

What Are Contract Bonds?

Contract Bonds are a class of Surety bonds that include Performance Bonds, Payment Bonds, Bid Bonds, and Maintenance Bonds. They are aptly named Contract Bonds because they guarantee an obligation and follow contract documents. The majority of Contract Bonds are written for construction contracts. However, many different types of companies may need Contract Bonds. Some examples include School Bus Operators, Security Companies, Food Service Suppliers, and Commercial Mowers. These are referred to as service contracts.

 

 

Chart Shows the type of contract bonds on the left and the relationship between the surety, contractor and obligee on the right. Red boxes with construction cranes in the background.

Parties to Contract Bonds

The Principal on Contract Bonds is the company who is responsible for fulfilling the contract obligation. This is the Contractor. The Obligee is the party receiving the benefit of the contract. This can be a Project Owner, or it could be a General Contractor if the contract bond is written for a Subcontractor. The Surety is the third party Bond company who is guaranteeing the Principal's obligation.

 

Types of Contract Bonds

 

Contract Bond Types and Guarantees - This charts shows 4 types of contract surety bonds including Performance Bonds, Payment Bonds, Maintenance Bonds and Supply Bonds. Next to each bond is a definition of what they guarantee. The background is three construction excavators.

 

Performance Bonds

Performance Bonds guarantee that a contractor will complete a project according to the price and terms of the contract. Performance Bond protect the Obligee by guaranteeing that their project gets built for the agreed upon price. Because the contractor is locked into the contract price, performance bonds are required on most public projects to protect taxpayers against contract cost overruns. Performance Bonds are Commonly written together with Payment Bonds.

Payment Bonds

Payment Bonds guarantee that the Principal Contractor will pay subcontractors and material suppliers on the bonded project. This helps keep the project free of Mechanic's Liens. This is important on Public projects as subcontractors and suppliers typically cannot file liens on these projects. Payment Bonds are commonly written together with Performance Bonds.

Maintenance Bonds

Maintenance Bonds guarantee that a project will be maintained for a specified period after the completion of a project. For example, a contract may require the contractor to correct any deficiencies for up to twelve months after the project is completed. The Maintenance Bond guarantees that the contractor will come back and make these corrections. If they do not, a claim can be made against the Maintenance Bonds.

Surety Bond Companies normally include twelve months of maintenance at no additional costs. However, longer maintenance periods generally carry an additional cost.

Surety Bond Companies are reluctant to write long term maintenance bonds. Everythings breaks down over time and bond company and contractor do not want to be responsible for long term deterioration.

 

Supply Bonds

Supply Bonds guarantee the delivery of the products or equipment at the agreed upon price. Supply bonds may be required when a product is very specialized, has a lot of price fluctuation, or a long lead time. Supply Bonds are low cost compared to Performance Bonds. They generally run less than 0.5% of the contract amount. However, if the supplier is responsible for installing any of the equipment, the risk most likely fall under that of a Performance Bond.

 

What Do Contract Bonds Costs?

 

Contract Bond Costs - Green box showing that Contract Bonds Cost between 0.5% - 3% of the contract. The background is a construction hardhat, blueprints and two hands drawing on the blueprints.

 

Contract Bonds such as performance bonds and payment bonds generally cost between 0.5% - 3% of the contract amount. You can read in depth on how these bonds are priced and ways to reduce those costs here. Other factors could increase the cost of contract bonds such as design build projects and long completion times. Additionally, contractors that have to use specialty tools such as the SBA Bond Guarantee Program, Funds Control, or Collateral could also add to this cost. Bid Bonds are free from most bond brokers.

Other contract bonds such as Supply Bonds and Maintenance Bonds are usually less than 0.5% of the contract amount. However, all contract bonds depend on the financial strength, credit and experience of the Principal being bonded, the type of work being bonded, as well and the Surety Bond Company's filed rates. Contractors with more financial strength and experience can expect lower rates while contractors with financial challenges can expect to pay higher rates.

How to Get Contract Bonds

Contract Bonds $1,000,000 and less are very easy to obtain. Most contractors can obtain those bonds quickly with just a simple credit check of the owner(s).

Larger contract bonds and Bond programs require more underwriting. Contract Bonds are underwritten using the 3Cs which are Character, Credit, and Capacity. That means a contractor must provide company and personal financial statements, job schedules, an application and sometimes bank information to qualify. You can read more about the 3Cs here.

 

When Are Contract Bonds Required?

Any party can require a Contract Bond as a condition of a contract. However, Contract Bonds are generally required on any project where there is $150,000 or more in Federal funds involved. These are required by The Miller Act. Most states and municipalities have adopted similar requirements referred to as "Little Miller Acts". Many owners and contractors on private projects also require contract bonds as a way to manage risk.

Contract Bond Companies

Contract Bonds can be written by both Corporate Surety Bond Companies and Individual Surety Bond Companies.

Corporate Surety Bond Companies

Corporate Surety Bond Companies are heavily regulated corporations. They are frequently rated by third parties for their financial strength and ability to meet their obligations. Principals should always get a Contract Bond from a Corporate Surety Company. Most contracts require an "A" rating by A.M. Best or similar rating agency. All Federal contracts and most other contracts require that the Corporate Surety be listed on The U.S. Treasury's Circular 570 list of approved Surety companies found here. This is referred to as a T-Listing.

Individual Surety Bond Companies

Individual Sureties are non Corporate Sureties that are often backed by personal assets. Individual Sureties have history of fraud and questionable practices. They should be avoided.

Not Insurance

Although many companies that write Contract Bonds also write insurance, they are two very different products. Contract Bonds more closely resemble a credit product. Contract Bonds require Indemnity meaning the Principal will have to reimburse the Surety if they suffer a loss. You can read more about indemnity here.

Contract Bonds can be confusing but they do not have to be. Contact Axcess Surety anytime for all your Contract Bond questions. You may also visit our Surety Bond FAQ page anytime for a list of common questions.