Generally, there are three types of contractor bonds associated with a construction project: a performance bond, a payment bond, and a license bond.
A contractor’s performance bond, simply defined, is a tool to provide financial assurance that a project will be completed to the satisfaction of the owner, regardless of the original contractor’s circumstances. For example, if a contractor does not complete a job as required by contract, the underwriter who issued the performance bond will provide a payment to a new contractor to complete the performance. Performance bonds are commonly used in the construction and development of real estate where a project owner or investor may require or wish the developer or contractor to ensure that contractors or project managers acquire such bonds to ensure that the value of the work does not be lost in the event of a contractor’s insolvency.
A payment bond is used in case a project runs out of money. Basically, the insurer will pay the contractor and subcontractors for the work completed. A payment bond ensures that a contractor pays the fees owed for labor and materials for the construction project. If a payment bond has not been obtained and if these subcontractor fees are not paid (i.e. insolvency, absconding, or contractor fraud), an owner who has paid the contractor could face the subcontractor’s or worker’s liens against the Finished project. If this happens, the owner could end up paying double or more for the value of the work done.
In many states, contractors must be bonded to obtain a contractor’s license, and consumers should always check the status of the contractor’s bond before hiring a contractor. These types of bonds typically pay for property damage caused by construction and materials lost or stolen from the project. In the event that these bonds are activated, the contractor is generally obligated to reimburse the surety company for the amount of the payment. It is not uncommon for a contractor to allow his bonds to lapse, which could have a detrimental effect on his license status.
Bonds are instruments to provide financial protection in the event that a construction project is not carried out as originally planned. If a contractor abandons a job, flees the state, or fails to meet its obligations, an adequate bond would cover this up to the amount of the bond.
Contractors can purchase a surety bond from a surety company that specializes in these products. The contractor or owner requesting the bond will be required to pay premiums to keep the bond current and active, and premium payments will vary based on the contractor’s work and licensing Performance Bonds history and the total amount of the bond. If a consumer makes a claim on a surety, they contact the surety company, in writing, and provide evidence to support each and every claim, usually through a timeline with photographs and exhibits, as proof that a contractor had abandoned a job. or materials ordered and used without paying, etc.
For contractors, a bond should be seen as a valuable tool (marketing and otherwise), because it can be seen as protection and peace of mind for clients. Sophisticated clients often prefer to work with contractors who have bonds as a form of financial security, and savvy subcontractors and vendors may demand to see proof of a contractor’s bond before agreeing to execute a subcontract. Construction can be extremely expensive, especially when things go wrong on a project, making a contractor’s surety an important tool. Contractors may also be required to have surety bonds for particular large public works projects.