Most people have heard a cautionary tale about contracted work. Websites like Angie’s List became popular to help people safely identify contractors with a proven track record of completing work in agreement with contracted terms.
These apprehensions toward contracted work exist in both the personal and business worlds. Contract bonds are used to offer financial protection to shareholders, taxpayers, investors, and even the public.
What Is a Contract Bond?
A contract bond is a surety bond, an agreement between three parties. The person requiring the bond is often the person who needs work done, the person providing the work, and a company willing to provide a financial guarantee the work will be completed. The surety bond provides a guarantee to the performance, compliance, and payment of an act. Contract bonds are backed by financial institutions and are purchased by the party offering to make certain the work will be completed according to mutually agreed-upon terms.
Contract bonds are primarily used in the construction industry and are therefore also known as construction bonds. These terms are often used interchangeably.
Who Needs a Contract Bond?
The purpose of a contract bond is financial assurance a job will be completed in accordance with a competitive bid, or without financial disruption. Government or public jobs often require contract bonds as part of the bidding process. Private companies may also require contract bonds as part of a guarantee for their investors.
The Miller Act, enacted in 1935, requires contractors to furnish contract bonds when doing work for the federal government if the contracted work exceeds $100,000. This law was established to protect taxpayers and the federal government from financial interruptions associated with contracted work. The bonds help assure concerns such as the solvency of a contractor and the contractor’s ability to complete the contracted work.
State or municipality project contracts may also require bonds that are not subject to the Miller Act’s $100,000 minimal value, which means they can require bonds even if the jobs are less than $100,000.
Types of Contract Bonds
There are several instances when a contract bond is needed. These legal agreements can be used in various scenarios to assure the entity in need of contracted project work. The surety company backing the bond provides the financial guarantee of contracted work.
- Bid Bond – guarantees the project owner that a bidder will complete the work as outlined in the job proposal bid.
- Payment Bond – guarantees a contractor or subcontractor will pay their subcontractors, suppliers, and laborers.
- Performance Bond – guarantees a principal will fulfill their agreed-upon terms of contracted work for a specific project.
- Subdivision Bond – a type of performance bond that guarantees a subdivision’s site is developed according to contracted terms.
- Warranty or Maintenance Bond – guarantees against possible defects for a specific time after work has been completed.
- Supply Bond – typically guarantees the supply of contracted materials.
Contract Bond Requirements
Contractors are often required to pay a premium on the bond amount. A contractor’s ability to get a bond will depend on credit and work history. This information can also affect the cost of the bond. Underwriters for contract bonds will assess a contractor’s completed contract history, the contractor’s working capital, and the contractor’s skilled ability to complete the proposed project.
Underwriters for surety providers will request verification of the contractor’s ability to work. The required information can include financial statements, credit checks, personal financial statements from company owners, current projects and schedules, a list of current employees, current insurance certificate, or a bank reference letter.