(This article was provided by SuretyBonds.com, a nationwide surety bond producer. For the most recent updates in contract bond regulations, check in with the agency’s Surety Bonds Insider Blog.)
Regulations that affect the construction industry seem to change on a daily basis, and laws regarding the use of surety bonds are some of the most variable ones out there. From contractor license bonds to green performance bonds, here is the latest insight into how and why contract bonds are used in the current construction market.
Why are surety bonds important?
Government agencies in most states require the use of surety bonds to protect consumers and regulate industries. When it comes to construction, contractors typically have to secure all necessary bonds before they can begin work on large-scale public construction projects. Failing to secure these bonds could result in legal recourse, heavy financial penalties and license revocation for negligent contractors, which is reason enough to recognize that bonds are considered extremely important to the industry.
How do surety bonds work in the construction industry?
Although there are thousands of unique surety bond types available, they all function in the same basic way. Each bond works as a legally binding contract between three entities to guarantee a certain level of professional performance. In construction, surety bonds are also known as “contract bonds.”
When it comes to contract bonds, the contractor who purchases the bond acts as principal. The government agency or other project owner that requires the bond acts as the obligee. The insurance company or special surety agency that sells the bond fulfills the role of surety. With each contract bond that’s issued, the surety backs a promise to ensure that contractors fulfill their duties as outlined by law.
What are the major contract bond types?
Three major contract bonds are used on almost every major construction project. Bid bonds guarantee that a contractor won’t increase the initial bid submitted to the project owner. Payment bonds guarantee that a contractor will pay for all materials and subcontractors as necessary. Performance bonds guarantee the final product for a certain period of time to protect against any inherent structural flaws.
A number of other contract bonds are used under the discretion of local governments. As environmental regulations continue to develop, so has the interest in using “green” performance bonds. Additionally, many states use contractor license bonds. For example, California contractor license bonds are highly sought after since the state has such rigid bonding regulations for its construction professionals.
How do surety bonds add value to contractors’ bids?
First off, since so many states require the use of bid bonds for projects that will cost $100,000 or more, contractors should know that it’s pretty much impossible to get any major job without first supplying a bid bond. Bid bonds are typically written as a financial guarantee for 5 percent of the bid amount. So, if a contracting firm bids $100,000 on a project, it will need to submit a $5,000 bid bond along with the bid to the project owner. Project owners value bid bonds because they know that the projected cost cannot be increased once they choose a contractor for a project. This gives them the ability to manage the project’s finances much more easily.
Can new surety bond regulations change the construction industry?
Yes. As legal rules and regulations surrounding contract bonds continue to change, contractors will have to make adjustments to continue working in local construction markets. For example, the Virginia legislature just passed a bill that will raise minimum contract bond amounts from $100,000 to $500,000. Once the law goes into effect, small contracting firms might find themselves struggling to secure such expensive bonds. Contractors must be able to adapt any time contract bond regulations change, otherwise they won’t be able to continue work.