The Basics of Construction Bonding

When new clients contact us, they frequently have questions regarding bonds used on construction projects; they want to know their rights and obligations under payment bonds and performance bonds.  Sometimes performance or payment bonds are required by law; other times, they are are the option of the project owner or general contract.  Today, we have invited Eric Weisbrot is the Chief Marketing Officer of JW Surety Bonds to be a guest blogger to address some of these threshold bond question.  Eric has years of experience in the surety industry under several different roles within the company, and he is a contributing author to the surety bond blog.  Let’s see what Eric has to offer to our readers:

When Does a Company Need a Surety Bond, and Why?

In the world of business ownership, regardless of the industry or size of the company, understanding the requirements for operating legally can be a challenge. Not only are there guidelines for business structures, accounting, and human resources management, there are also stipulations for business licensing and bonding in some instances. Understanding when a company needs a surety bond, and the reason behind it is helpful in ensuring a construction professional operates in-line with state laws. First, let us take a the basic definition of a “surety bond”.

In the simplest terms, a surety bond is a contract between three parties – the oblige (the person or entity requiring the bond which is often the owner or the general contractor), the principal (the business or contractor required to have a bond which is often a general contractor or a subcontractor), and a surety (the company offering the bond). Through this contract, the contractor or business owner secures a bond through a surety, and the surety promises to pay the oblige up to the limits of the bond should the work contracted not be completed correctly or in full. The purpose of a surety bond in business is protecting the person, entity, or municipality from financial loss should a business or contractor fail to perform as promised.

When Surety Bonds are Required

In nearly all states, individuals and businesses are required to put a bond in place as part of pre-licensing requirements for specific work. For instance, a construction contractor must have a bond before getting a license to do work in a city, county, or state. Without the bond in place, a contractor license is not approved. Similarly, other businesses may be required to have a bond in order to receive or renew their business license. This mostly applies to companies operating in the public space on contracts that are federally financed or requested by a state or city.

However, private investigators, mortgage brokers, motor vehicle dealers, and notaries may all be required to carry a bond at a minimum amount before being approved for a license to do business. Individuals and companies can check with their state or municipal licensing board to determine when a bond is required.

What Surety Bonds Cover

There are several different types of bonds which businesses and individuals may be required to have in place in order to operate. The most common bond types include:

• Performance bonds – these are surety bonds required for projects valued at more than $100,000 for contractors. After a project is won, this type of bond needs to be in place to ensure the work is completed in line with the conditions of the contract.
• Payment bonds – with a payment bond, suppliers, subcontractors, and laborers working on the main project are protected against not receiving payment. In many cases, a payment bond goes hand in hand with a performance bond.
• Bid bonds – contractors may also be required to have a bid bond in place before a contract is awarded. This type of bond ensures that if a contract wins a project, the work will be completed in line with the initial proposal or bid.

One or more of these bonds are required, especially in construction contract work, to help mitigate the risk of financial loss should the contractor not perform the way he or she should. Owners of the job, such as a state or municipality, want to know that they have recourse if a project goes awry. If that does take place, the surety company steps in to cover the sunk costs up to the bond amount. However, the contractor business is then obligated to repay the claim against the bond over time.

Even though getting a bond seems like an extra step in the process of operating a legitimate business, the cost burden to contractors and other business owners needing a bond is not as steep as many think. Securing a bond only requires a percentage of the total bond amount, not a full payment, and those who have strong business financials, solid personal credit, and little to no bond claims history receive the best pricing. Fortunately, there are bonds available for those without the perfect track record in the business, but the cost is often higher initially.

Having the right bond in place is crucial to a company or contractor’s success. In most cases, a business license or the ability to bid on new projects is not offered to those without a bond. Each state or municipality has its own requirements for bond minimums, so it is necessary for contractors and business owners to check with the licensing board before seeking out a bond.