Used heavily by contractors, particularly general contractors, contract surety bonds, are a guarantee from a surety to a project owner that a contractor will adhere to the provisions of an agreed-upon contract. In other words, the contractor will get the job done as specified in the contract. A contract bond provides the project owner financial protection and assurance that a contractor will complete the project, and pay laborers, subcontractors, and suppliers. The use of contract surety bonds is common for medium and large sized contractors like carpenters, electricians, painters, plumbers and landscapers.
Called contract bonding, a contractor must be qualified prior to contract surety bond issuance to provide assurance to the project owner that the contractor possesses the capability and resources to carry out the project according to the contract specifications. Financial strength, ability to perform, and reputation with project owners, subcontractors, suppliers and lenders are all examined by surety professionals in pre-qualifying a contractor for a surety bond.
Contract Surety Types
There are four main types of contract bonds: payment bond, bid bond, performance bond and maintenance bond.
1. Payment Bonds – guarantees the project owner that contractors and supplies will be paid for materials and labor.
2. Bid Bonds – if a contractor is awarded a contract, bid bonds guarantee that the contractor will enter into a contract.
3. Performance Bonds – an owner is guaranteed that the contractor will complete the contract terms, such as price and time, as specified in the contract.
4. Maintenance Bonds – guarantees an owner against loss because of faulty repair or defective workmanship of materials used in completing the project.
Contract Bond Financial Requirements
Many surety companies have strict financial requirements for contractors. Some companies require contractors to provide financial statements prepared by a CPA. However, in many cases, tax returns and in-house financial statement will suffice, with current and prior years (often three years) statements required.
Contract Surety Bond Underwriting
Contract surety bond underwriting takes into account both business and personal assets. What this means is that the underwriting is based on the contractor’s overall financial soundness of his business and owners. The underwriting process typically includes contacting a contractor’s references, suppliers, and banker to learn more about his business practices. Generally, contact surety bonds are supported by good customer references, bank lines of credits, and good bill paying records.
If the contractor defaults on the project or contract, the Surety must step in and complete the project. The Surety then has the right under the terms of the Bond to go after assets of the contractor in default to recoup any amounts paid under the bond.