A Contract bond is a project-specific surety bond, usually included as a stated condition of an agreed upon contract. Contract bonds have multiple approval phases depending on what part of the contract process the contractor is in.
Contract bonds must be issued by insurance carriers admitted in the state where the Obligee (owner of a project) requiring the bond resides.
What are the different contract bond stages?
LETTER OF BONDABILITY - A contractor submitting to be placed on an approved vendor list usually for state or federal work will need a letter of bondability, or a letter stating their current bonding capacity.
BID BOND - If the contractor is in the bidding process of the project there may be a listed requirement to include a bid bond with their bid, along with other insurance requirements. The bid bond provides financial assurance that the contractor submitting a bid, if awarded the contract, will enter into a formal contract with the owner and post the required performance and payment bonds (if required).
PERFORMANCE BOND - Once the project has been approved and awarded to the contactor, the project owner may then require to file a performance and/or payment bond. The performance bond is a surety line that guarantees performance of the work as specified by the contract. A payment bond guarantees payment of all labor suppliers and material providers.
MISC CONTRACT BONDS
Maintenance Bond - a bond guaranteeing the contractor will repair defective work at no cost to the owner within a specified period of time, typically between 1-2 years.
Supply Bond - a bond intended to guarantee the delivery of goods, such as raw materials, food, clothing, and fuel, and contain provisions that specify the quantity and price of items required.
Subdivision Bond - a bond guaranteeing that the developer will complete the required improvements within a certain period, with extensions usually available, in accordance with the governing body’s requirements.
Why is a contract bond required?
Contract bonds protect the project owner by transferring to a surety company the cost of damages resulting from a contractor failing to perform the duties of the contract (“Performance Bond”) and failing to pay laborers and material suppliers (“Payment Bond”). This unique line of surety bond is most often required by government agencies for construction projects on public property.
How much does a performance bond cost?
Contract bonds cost between 1% and 3% of the contract amount. Contract bond rates are determined by the size of the bond and the financial stability, as well as experience and reputation of the contractor. For contractors that qualify for bond amounts up to $500,000, contract bonds cost 3% of the bond amount. For contractors needing larger bonds, the rates will be tiered based on the size of the bond. The tiered rate is essentially a volume discount for larger bond amounts. The most typical tiered rate is known as a 25/15/10 rate; translated to mean 2.5% of the first $100,000 of the bond amount, 1.5% for the next $400,000, and 1.0% for the rest.
What information is needed to qualify for a performance bond?
To qualify for a contract surety bond, contractors will be asked to provide information to the surety company to demonstrate their ability to complete the contract as expected. The information requested will vary depending on the type of work to be performed and the size of the contract.
Qualifying for contracts up to $450,000
Several surety companies offer bonds up to $450,000 in size based primarily on the contractor's personal credit. To qualify for these programs, the contractor must have good or excellent credit and must not have any tax liens, judgements, bankruptcies or past due accounts. If a contractor’s credit score is bad, but does not contain tax liens, judgements, or bankruptcies, the contractor may still qualify for a surety bond with help from the Small Business Administration (“SBA”), collateral, or fund control.
Qualifying for contracts over $450,000
Contractors must demonstrate credibility, capability and capacity to complete the contract. Surety companies will review the business owner's credit along with the following information to determine eligibility:
- Business financial statement
- Personal financial statement for each owner
- Bank references
- Work in progress schedule (“WIP”)
- Accounts receivable aging schedule
- Proof of insurance (General Liability)
- Customer and supplier references
What is the SBA surety bond program?
The U.S. Small Business Administration (“SBA”) surety bond guarantee program helps contractors whose small business would otherwise not be approved by a surety company. The program provides a guarantee to surety companies for up to 90% of the liability on a contract to encourage approval for contractors needing bonds on projects up to $6.5 million. The SBA is an independent agency of the federal government.
What is fund control?
Fund Control is a tool utilized by surety companies to ensure the proceeds of a contract will be used first to pay all employees, subcontractors, and suppliers of the contractor before the contractor has access to the funds. This protects the surety company from potential payment issues related to the contract. Payments are made directly from the project owner to a trust account controlled by a 3rd party fund control company, and all disbursements to the contractor and their vendors must be approved by the fund control company.
What other types of surety bonds are required of contractors in California?
While all licensed California contractors are required to carry a $15,000 contractor license bond, certain contractor licenses may require a $12,500 Bond of Qualifying Individual, a $100,000 LLC Employee/Worker Bond, or a Disciplinary Bond depending on their license status.