Understanding the world of surety bonds can be overwhelming at first glance. Not only is it a unique type of insurance, but there are also many nuances to consider.
Essentially, a surety bond guarantees that the person, business, or agency that hired you will get what they paid for. It is a three-party contract that provides financial security and a promise that a project will be completed on time and within scope.
While surety bonds can be used for a number of reasons, they are especially common in the construction industry since construction involves an agreement between a contractor and their client. Read on to learn more about construction surety bonds and their importance for contractors.
Purpose of Surety Bonds in Construction
For the purpose of this article, we will be focusing solely on construction surety bonds. Investopedia explains that this is a type of surety bond that protects against disruptions or financial loss due to a contractor's failure to complete a project or failure to meet contract specifications. In other words, a construction surety bond gives the client reassurance that a contractor will uphold these agreements.
A construction surety bond is often required for contractors before beginning a construction project. For larger projects, Investopedia shares that these bonds are often split into two parts. One is to protect against overall job incompletion, and the second is to protect against nonpayment of materials and labor. Construction surety bonds may be more like lines of credit than traditional insurance policies.
Since surety bonds for construction are still a three-party contract, they include:
- The investor (also known as the obligee, typically a government agency)
- The contractor
- The surety company
The investor, also known as the project owner, wants assurance that their project will be completed on time and within scope. The contractor needs this insurance to give the investor this assurance. And, finally, the surety bond company is who backs the bond amount.
If a contractor fails to abide by the conditions of the contract, they and the surety are both held liable.
Types of Construction Surety Bonds
There are three main types of surety bonds in construction that are often required for a contractor. They include:
- Bid Bond: guarantees you can and will meet bid requirements if the contractor wins the bid. Every contractor is required to submit a bid bond along with their bid to protect the investor in case the contractor backs out or is unable to perform their promised duties.
- Performance Bond: guarantees work will be completed as promised and within regulations. This protects the owner from financial losses. For instance, if the contractor's work is poor quality or defective, the project owner can make a claim.
- Payment Bond: guarantees workers and suppliers will be paid timely and legally. This is also sometimes called a labor and material payment bond. It guarantees that a contractor has the funds to pay for all labor and materials.
There are also a couple of other surety bonds in construction to consider:
- Maintenance Bond: guarantees materials and workmanship for up to two years after completion.
- Completion Bond: guarantees a specific performance obligation.
There are also contract bonds, warranty bonds, subdivision bonds, supply bonds, and more. These all cover unique aspects of construction work.
The Three C’s of Surety For Contractors
Contractor bonds are frequently required by law for any contractors or businesses working on public projects. However, they are not guaranteed.
Surety bond companies take a few factors into consideration before underwriting a bond. In the construction industry, there are widely known as the “three C’s of surety.”
BigRentz provides a comprehensive breakdown of what the three C’s include:
- Character: The qualities and business morals of the contractor. It’s perhaps the most important of the three. Contractors need to demonstrate that they are honest and make every effort to carry out their business dealings. The surety bond company may look at a contractor’s past performance to determine character.
- Capacity: The contractor’s ability to complete a project. They will need to show the surety company that they have the skills and resources to fulfill the job’s needs. They can show past projects they have completed and inventory numbers.
- Capital: The contractor’s financial ability to take on the project. The surety bond company typically reviews a contractor’s financial statements to understand their net worth, the profitability of past projects, and the amount of working capital they have.
Benefits of Surety Bonds in Construction
Construction bonds not only provide peace of mind for the project owner but are also beneficial for contractors. Besides being a requirement to work, construction surety bonds help contractors with:
Providing Confidence to Clients
A surety bond for construction proves that a contractor is trustworthy, reliable, and financially stable enough to complete a project within scope. Unlike traditional insurance, which protects the policy owner, a surety bond protects the project owner.
This assurance can open new doors for contractors and help them win bids.
Ensuring Compliance
Contractors who want to work on a public project must be bonded. And without the proper construction surety bonds, they may be prohibited from certain types of work and limit their business opportunities.
Surety bonds help ensure compliance with state and local jurisdictions. Contractors can expand their work opportunities while avoiding costly fines and penalties that could also damage their brand.
Financial Protection and Risk Management
Though this type of insurance is meant to protect the finances of the owner first, it can also help contractors improve their risk management. If a contractor can’t complete a project due to unforeseen circumstances, the surety company is able to step in and ensure the project is completed to the benefit of both parties.
This assurance helps mitigate financial losses overall. Though the contractor will still be held liable, the surety bond is still beneficial to help reduce risks.
Find A Surety Bond for Construction Today
If you need a surety bond or fidelity bond for your business, World Insurance can help.
We offer a wide range of options and have the ability to execute bonds from $1,000 to $500 million from A.M. Best “A” rated, U.S. Treasury-listed sureties that are licensed in all 50 states. Plus, we have a Contractor's Express Program, where we can obtain up to $1,000,000 in bonding support for you within 24 to 48 hours with only minimal information required.
Learn more about your options for surety bond insurance today.