A contract bond, also known as a construction bond, is a kind of surety bond that will guarantee the contractor will fulfill the terms of the contract. If the contractor fails to meet the agreed-upon terms, the contract owner can file a claim to be compensated for the losses they suffer.
This bond is common when you’re working with governmental bodies as they need to make sure you can complete the project efficiently and in time. If you want to get a contract bond for your next project, there are 4 essential details you need to know about before getting one.
1- Pre-Qualification
In order to get a contract bond, you contact a surety company or an insurance company to acquire one. The surety company must make sure you can fulfill the contract before issuing you a contract bond. This process can take a long time as you need to gather many documents the surety company requires, answer any questions they may have, and they may also take time to verify all the information you have presented. The size and the type of contract determine the information needed to qualify for a contract bond. As a rule of thumb, the contractor should have good or excellent personal credit with no prior bankruptcies, tax liens, or past due accounts to qualify for contract bonds. Keep in mind that every jurisdiction has its underwriting guidelines; however, many of the requirements are the same or similar which may include:
- Business and personal financial statements
- Work in progress schedule (WIP)
- References and details about your previous completed projects
- Forecasting and inventory reports
Once you have been approved for a contract bond, you should select one based on the proposals, and then it will be issued to the obligee.
2- Types of Contract Bonds
There are different kinds of contract bonds, however, surety companies usually provide three main options. The first is a bid bond which is suitable for the bidding process as it increases the chances of winning the bid. The bid bond protects the owner if they and the contractor weren’t able to agree on the terms. If the owner has to find another contractor, the bond will cover the cost if it costs more than the previous one. The second type is the performance bond that ensures the contractor will deliver the project according to the quality, timeframe, standards, specifications, and any agreements in the contract. This is the most commonly used kind of contract bond, as it covers any losses, damages, or repairs the owner may suffer due to the contractor’s performance. The payment bond, which is the third type, is usually used with the performance bond, and it is also called a labor and material payment bond. This bond guarantees that the contractor has the financial capabilities to pay their workers, subcontractors, and suppliers for their services and materials to avoid any complaints or lawsuits from them that may disrupt the delivery of services.
3- Cost
The cost may vary depending on the contractor’s credit, past bonded work completed, type of work, and the owner’s requirements. As a rule of thumb, a contract bond costs from 1% to 3% of the contract’s value. The financial standings of a company will affect the cost; the stronger the company is, the lower the rate.
Naturally, if you’ve worked with a surety company multiple times and you achieve a high success rate, the surety company will offer you better deals. The amount of the contract value that some owners may request will determine the cost of the bond. In most cases, the performance bond is usually paired with the payment bond under one coverage.
4- Indemnity Agreement
The indemnity agreement is the main difference between a bond and insurance, as the surety company ensures that the contractor will reimburse them in the case of a paid claim. Additionally, the indemnity agreement ensures that the contractor will reimburse the surety company for any additional expenses incurred from the default. The surety company indemnifies corporate shareholders, and in some rare cases, the spouses of the shareholders to make sure that indemnity will be executed reasonably.
Contract bonds are essential for numerous projects, especially construction projects. It gives guarantees to the owner that the work will be executed properly and in time while giving the contractor a higher chance to win the bid. It also ensures the quality of work done will be up to standards. Contract bonds are an efficient risk management tool that should be utilized regularly to avoid any losses for both sides.
