Common Types of Construction Bonds

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When you enter into a project as a developer, you need all the assurances you can get. In the construction and real estate industry, you have to hire and bring in a lot of different contractors to get the job done. But often, if the contractors fail to meet the terms of the agreement, you may end up facing significant losses and delays.

So, to protect the financial interests, a project owner asks for construction bonds to make the contractors liable in case of any error from their end. Suppose the contractors cannot complete the job in the stipulated time, if their workmanship is inferior or not satisfactory, or if they go bankrupt, a construction bond can help the client cover their losses.

There are different types of bonds issued in the construction industry; in particular, contractors may be asked to provide performance, bid, and payment bonds.

Moreover, if you are a contractor, you might not need to present these bonds when undertaking a project for a private company. On the other hand, if you’re undertaking a government project, then issuing bonds is mandatory to proceed with the project. So, here are some of the different types of construction bonds you will need.

Types of construction bonds

1) Bid Bonds

Bid bonds are a guarantee given to the developer by the contractor when they place their bid for the tender. It is a guarantee that safeguards the developer, and in case the contractor is given the job, they have to accept it without backing out. A lot of time and resources go into choosing the best contractor, so once a developer has chosen the contractor, they have to accept the job as per the bid bond.

If the winning bidder refuses to proceed with the job, the project owner can file a claim to cover the bid’s evaluation costs. Moreover, the claim will also cover the cost for further evaluation of contractors.

2) Performance bonds

It is a bond that assures the client or the project owner that the project will be conducted as per the agreement and that the project will be delivered at the agreed-upon time.

Also, a performance bond mandates the contractor completes the job abiding by the contract. The project owner can file a claim if the contractor fails to comply with any conditions. They can also seek a claim for the work to be redone or for the rest of the work to be completed by another contractor. The remedy is usually chosen by the surety.

Additionally, if the contractor goes bankrupt and cannot complete the project, the surety will be held responsible for paying the client.

3) Payment bonds

There are times when the contractors might fail to pay their suppliers and laborers. It could cause delays in your project if the contractor is not making timely payments to the suppliers, laborers, and other subcontractors.

So, a payment bond guarantees the contractor will pay all the hiring parties. If the contractor fails to pay them as per the agreement, any of these parties can raise a claim against them.

4) Contractor license bonds

Unlike other construction bonds mentioned in the list, a contractor license bond is not about one job. The other types of bonds are useful only for one project, as with every new project, the contracting company wins; they have to get new bonds.

So, a contractor needs a license bond as it guarantees the project owners that their work would be conducted as per all the local laws and regulations.

How do the bonds work?

In case of any claim, the project owner receives the funds from the surety. But, the contractor is not relieved from their obligation to pay to the surety as the contract has an indemnification clause that holds the contractor liable for reimbursing the claims.

After the surety has given payments to the project owner, they will seek the funds back from the contractor. Commonly, the surety even offers the contractor a repayment scheme in these cases.

How much does a construction bond cost?

To get a construction bond, the contractor has to pay a fee to the surety. A surety will not simply hand out bonds to any contractor. They consider a plethora of factors before issuing a bond to a contractor.

The personal credit score, the company’s financial history, and past experiences are all analyzed to estimate the fee percentage. If an applicant has a good financial standing, they can get a bond by paying a minimum of one to three percent of the total contract amount as their yearly premium to the surety.

So, these are some of the different types of construction bonds that you may need to enter into a contract with any government or private institution.

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