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What Are Contract Bonds?
A “Contract Bond”, also commonly referred to as a “Construction Bond”, is a name given to a broad group of surety bonds that function to guarantee a given contract is fulfilled. Some of the more common types of Contract Bonds in the construction industry are Bid Bonds, Performance Bonds, Payment Bonds, Sub Division Bonds and Maintenance Bonds. Contract Bonds are most commonly required when working on government projects, though they can be required by private entities as well.
How Do Construction Contract Bonds Work?
Contract Bonds are a three party contract between the Surety (The insurance company issuing the bond), the obligee (the entity requiring the bond, which is often a government agency) and the principle (you, the contractor). The bond guarantees the obligee that the principle will abide by the terms of the contract. If the principle fails to abide by the terms of the contract, the surety will pay the obligee according to the financial damages incurred and the principle is then responsible for repaying the surety the amount of the bond payout, plus legal expenses. With this in mind, surety bonds are a form of credit, unlike insurance. As such, surety’s will generally require solid financials on behalf of the principle as well as a personal guarantee in the form of an indemnity agreement before they will consider issuing a contract bond.
How Much Do Contract Bonds Cost?
The cost of a given contract bond will vary based on many factors, but is generally a few percent of the bond amount, assuming the principle is financially strong. Many factors can affect the premium of contract bonds including the specific type of bond being requested and the financial strength/experience of the applicant. Not all contractors will qualify for a contract bond as the requirements for bonding are more stringent than other types of surety bonds, such as a contractors license bond. As part of the application process, contractors will generally be required to submit full financials and other supporting documentation in order to satisfy the surety that if a bond were issued and a claim did occur, the principle is financially sound enough to repay the surety the amount of the claim plus legal expenses.
Common Types of Contract Bonds:
A bid bond is typically required when the owner of a construction project wants some type of assurance from a contractor that if awarded a job, the contractor will enter a contract with the owner under the terms negotiated in the bidding process. After being awarded a job, the owner will likely require the contractor to post a Performance and Payment bond as part of the contract terms.
A Performance Bond guarantees that a contractor will complete an awarded job according to the terms of the contract negotiated with the owner. The bond becomes payable if an unfortunate event, such as the contractor becoming insolvent, prevents the completion of a job according to the agreed upon terms.
A Payment Bond guarantees a project owner that a contractor will pay certain bills including labor and materials for itself, sub-contractors and suppliers, which protects an owner from claims or project delays as a result of a contractors financial actions. Payment bonds are often required in conjunction with bid and performance bonds, especially on medium to large federally funded projects.