Note: This is Danielle Rodabaugh’s second post at AEC Quality .com. Her first post, Three ways surety bonds promote quality construction projects, discussed surety bonds. This post deals with contractor bonds. Both are important concepts in understanding risk management in the A/E/C industry.
Although the use of surety bonds in the U.S. construction industry has been around for hundreds of years, contractor bonding is still a confusing part of almost every construction project. This article will explore three of the most common myths surrounding the use of surety bonds in the construction industry and explain why they simply aren’t true.
1. Contractor license bonds are the same as contract bonds.
Although both are used for construction projects, contractor license bonds are a type of license and permit bond whereas contract bonds are not. Construction professionals must file contractor license bonds with government agencies before they can work in many states. If a state or local government agency requires a contractor license bond, construction professionals must file them before they can be licensed to work in a specific area. Contractor license bonds are typically valid for one year.
Contract bonds are specific to individual projects. There are a number of specific contract bonds out there, but the three most common are bid bonds, performance bonds and payment bonds.
- Bid bonds guarantee that a contractor won’t increase its bid if it’s selected by the developer.
- Performance bonds guarantee that a contractor will perform all tasks for the project as outlined in the contract.
- Payment bonds guarantee that the contractor will pay all subcontractors and material providers appropriately.
Contract bonds are valid for whatever time period is appropriate given the specific project.
2. Surety companies are responsible for paying claims against bonds.
Surety providers do not function as do insurance companies. Bonds typically require contractors to sign an indemnity agreement, which basically explains that the contractor understands that they are financially responsible for paying claims made against a bond. A surety will only pay for losses if the bonded contractor or construction firm does not have the funds to do so. If the obligee or another harmed party wants to collect on a bond but the principal does not have the funds to pay the reparation, they typically have to take the surety to court.
3. Contractors with bad credit can’t get surety bonds.
It’s true that surety providers are typically more hesitant to work with contractors who have low credit scores. However, this doesn’t necessarily mean they’ll refuse to issue them a bond. What they will do is charge a higher premium because backing a contractor with a low credit score is much riskier for a surety provider. If a contractor’s credit score is really bad, the surety provider might require 100% collateral to be posted before issuing the bond.
So when contractors says they weren’t able to get bonded, it’s usually not because they couldn’t qualify for the bond; instead it’s probably that the bond was far too expensive for the contractor to afford. Fortunately, the Small Business Administration’s Office of Surety Guarantees offers bonding services for small construction firms who are having trouble getting the bid, performance and payment bonds they need on projects that cost $2 million or less.
Surety bonds can be confusing, but construction professionals shouldn’t perpetuate myths about them simply because they’re complex products. A basic understanding of the contractor bonding process can relieve a significant amount of stress when when it’s time for construction professionals to get bonded.
Danielle Rodabaugh is the editor of the Surety Bonds Insider, a publication that provides in-depth analyses of developments within the surety industry. The publication explains contract bond changes to help contractors understand the surety bond regulations that apply to them whether they work in New York or California.
Thanks again, Danielle! If you are interested in writing a guest post for AEC Quality .com, I welcome your contribution.