Greg Rynerson, CEO of a California-based surety company, Surety Bond Authority Inc, answers in detail on what you need to know about construction bonds.
Today, many small, emerging, and even large-scale contractors looking to secure surety bonds and expand their businesses have many questions about construction bonds as required by state laws.
Greg Rynerson, CEO, and founder of Surety Bond Authority Inc. specializes in providing surety bonds and surety bond consulting services. He has more than 25 years of experience in the surety bond and insurance industries.
To deliver you clear-cut answers, we have put together a lineup of 10 frequently questions where Greg can provide insight and expertise on construction surety bonds and why they matter.
Q1: What is a surety bond?
A: In the construction industry, a construction bond is frequently referred to as a “contract bond.”
A contract bond guarantees that the contractor will perform as agreed in the underlying construction contract. A contract surety bond consists of 3 parties.
1) Contractor (the party performing the work);
2) Customer (the party that expects the Contractors work to be duly completed);
3) Surety / Insurance Company (the party guaranteeing that the Contractor properly conducts the work as agreed).
In surety bond terminology, the contractor is known as the Principal, and the customer is called the Obligee. In short, the contractor is expected to perform as stated in the contract. If the contractor fails to show quality performance, the Surety Company must step in and indemnify the Obligee.
Q2: Are surety bonds similar to insurance policies?
A: No. Surety bonds are unlike traditional insurance policies. Surety bonds include three-party agreements, whereas traditional insurance policies have only two-way contracts. In the case of a surety bond, the surety company does not expect to cover the primary obligation but is secondary responsible if the principal (contractor) fails to perform its bonded obligations. In fact, a surety company does not expect to suffer losses or damage; if a surety pays out as a result of a claim, the bonded contractor must repay the surety.
Q3: Are construction bonds required only on government projects or is it also required for private projects or both?
A: Construction surety bonds are required by the federal, state or local governments, regulation departments, and general contractors.
According to the federal Miller Act and state regulations, any federal construction contract that amounts to $150,000 or more requires a performance bond and a payment bond. In fact, each state establishes a “Little Miller Act,” similar to the federal Miller Act. Each local jurisdiction has its public works performance and payment bond requirements.
There is no requirement for the use of bonds on construction projects in the private sector.
However, many private owners understand the value of surety bonds, and they choose to secure them on their projects to minimize risk and ensure that the contractor hired is qualified to perform the job. This bond also promises that subcontractors and suppliers will get paid.
Q4: Are there different types of construction bonds?
A: Yes. Some of the most common types of construction bonds include:
- Bid Bond – For project developers who bid on construction projects.
- Performance Bond – For government agencies and private project developers that guarantee quality performance for the completion of a project.
- Payment Bond – For lead/general contractors hiring subcontractors and suppliers to provide financial protection to the subcontractors and suppliers.
- Maintenance Bond – For developers seeking insurance for contractor work against defective materials and weak performance for a set duration after project completion.
Usually, the bid, performance, payment and maintenance bonds are included in a single surety bond package. This way, the obligee (customer) can be comfortable that the contractor can complete all phases of the project (from bidding to completion).
Q5: If I already secured a license bond for my contractor business, why do I still need construction bonds?
A: License and permit bonds are required by most states to guarantee that a contractor will comply with the rules and regulations to operate its business.
But a license bond does not exactly guarantee a particular contract. License bonds are not the same as construction bonds. Construction bonds assure adherence to state laws that a contractor will do the specific duties as indicated in the contract and guarantees that any certain subcontractors or suppliers hired will be compensated for their services.
Q6: How much do I need to pay for construction bonds? When are bond premiums typically paid?
A: Bond premiums become payable on the implementation of the bonds and the initial contract. The minute the bonds are issued, they are already binding and in effect.]
Sometimes the surety will allow the contractor to pay installments over the course of the project.
The premium (cost) of contract bonds will vary depending on the circumstances. As a rule of thumb, contract bonds usually cost from 0.5% to 3% of the contract amount. Usually, the greater the risk of default, the higher the premium.
Q7: Do I need to provide collateral for construction surety bonds?
A: Most contract surety bonds are issued without the necessity of collateral. Collateral may be required in situations where the surety is uncomfortable with the risk.
Q8: What factors does a surety company consider for me to qualify for a surety bond?
A: Contractors go through a thorough pre-qualification process. Surety underwriters review and assess factors that include, but not limited to:
- Financial capacity
- Credit score
- Work portfolio (history/experience)
- Work in progress
- Net worth
- Bank sheets/statements
- Operational efficiency
- Reputation and integrity
- Nature of the project
Q9: Do I need an attorney in construction and surety matters?
A: An attorney is not required for most contract surety bonds. However, depending on the complexity of the surety bond, parties may determine that attorney services are advisable.
Q10: Let’s say, for whatever reason, the contractor defaults and can’t finish the project. What options does the surety company have to indemnify the obligee?
A: In the case of default, the surety company has many options to compensate the obligee. For example, the surety company could provide financial assistance to the original contractor to complete the project. Or, the surety company could locate and pay another construction company to carry out the project. Alternatively, the surety company could only write a check to the obligee for the damages. In short, it is the responsibility of the surety company to find the most efficient way to indemnify the obligee. Keep in mind that the contractor is not “off the hook” for its failure to perform. The surety company will likely attempt to collect from the contractor for their inability to perform.