How Different Contract Bonds Work

As any contractor knows, contract bonds are used to guarantee that they will abide by the specifications in a construction contract. A contract surety bond, once issued, assures a project owner that a contractor will perform the work and pay specified subcontractors, laborors and material suppliers. Not doing so would result in a breach of the contract and, what generally happens is that if the principal (contractor) reneges on his promise, the surety company will come and seize his assets.

There are many companies that specialize in serving the needs of small to medium-sized contractors, such as electricians, carpenters, masons, plumbers, painters and landscapers. They issue different types of bonds for different aspects of the services provided.

Different bond types available

There are several types of contract bonds:

  1. Bid bonds guarantee that a contractor will enter into a contract, if awarded, and furnish such contract bonds as required by the terms of the contract. The Bid Bond is intended to keep frivolous bidders out of the bidding process by assuring that the successful bidder will enter into the contract and provide the required performance and payment bonds.
  2. Performance bonds guarantee faithful performance of the terms of a contract of construction or furnishing of supplies, at the agreed upon price, and within the time allowed.
  3. Payment bonds guarantee payment for labor and materials used in the work the contractor is obligated to perform under the terms of a contract. Since mechanic's liens can not be placed against public property, the payment bond may be the only protection these claimants have if they are not paid for the goods and services they provide to the project.
  4. Maintenance bonds guarantee against loss because of defective workmanship or materials used in the completion of a construction project.

Understanding the bonding process

Before any surety bond can be issued, the contractor must be evaluated and qualified to secure the project owner that the contractor possesses the resources and capacity to perform the contract according to its terms and conditions. This process is known as contract bonding.

Certain financial statements required with a contract bond

Because of the risks involved, many surety companies have very stringent financial reporting requirements for contractors , such as requiring contractors to provide CPA-prepared financial statements. The bottom line is that, with a contract bond , the client is financially guaranteed a positive exit in a business arrangement. Whether it comes from the principal or the surety, they will be paid.