There are typically three types of contractor bonds associated with a construction project;a performance bond, a payment bond, and a licensing bond.
A contractor performance bond simply defined is a tool to provide financial assurance that a project will be completed to the owner’s satisfaction notwithstanding the original contractor’s circumstances. For example, if a contractor fails to complete a job as contractually obligated, the underwriter which issued the performance bond will provide payments to a new contractor to complete performance.
Performance bonds are mostly used in the construction and development of real property where an owner of property or project investor may require or desire the developer or contractor to ensure that contractors or project managers procure these bonds so as to guarantee that the value of the job will not be lost in the case of a contractor’s insolvency.
In many states, contractors are required to be bonded in order to obtain a contractor’s license, and consumers should always check the status of the contractor’s bond before hiring a contractor. These type bonds typically pay for damage to the property caused by the construction and lost or stolen materials from the project. In the event, these bonds are triggered the contractor is usually obligated to repay the bonding company for the amount of payout. It is not uncommon for a contractor to allow their bonds to lapse which could have a detrimental effect on their licensing status.
Bonds are instruments to provide financial protection in the event that a construction project is not performed as originally contemplated. If a contractor abandons a job, flees the state, or fails to complete their obligations, an appropriate bond would cover this up to the bonding amount.
Contractors can purchase a bond from a surety company who specializes in these products. The contractor or the owner requesting the bond will be required to pay premiums to keep the bond current and active, with the premium payments varying depending on the contractor’s work and licensing history and the total amount of the bond. If a consumer makes a claim on a bond, they contact the surety company, in writing, and provide evidence to back up any and all claims, usually by a chronology with photographs and exhibits, such as proof that a contractor had abandoned a job, or ordered and used materials without paying, etc.
For contractors, a bond should be considered a valuable tool (marketing and otherwise), because it can be viewed as protection and peace of mind for clients. Sophisticated clients more often than not prefer to work with contractors who have bonded as a form of financial assurance, and savvy subcontractors and suppliers may demand to see proof of a contractor’s bond before agreeing to execute a subcontract. Construction can get extremely costly, especially when things go wrong on a project, making a contractor’s bond an important tool to have in place. Contractors may also be required to have bonds secured for particular big public works projects.