A Performance Bond or Contract Bond is a project-specific surety bond between a principal and an obligee. The principal is the contractor and the obligee is the entity whom the contractor has a written contract with and is the party that would receive money in the case of a bond claim, typically a city, county, school district or a general contractor. A contract bond is a three-party contract involving (1.) the surety company financially guarantying the performance of (2.) the contractor to (3.) the obligee.
How much does a Contract Bond cost?
Contract bonds cost between 2.5% and 3% of the contract amount. Contract bond rates are based on the financial stability, experience, business reputation as well as bonded project details. For contractors needing larger bonds (above $400,000 single aggregate), the rates will be tiered based on the size of the bond.
Why are Contract Bonds required?
There are two primary functions of these type of bonds: First prequalifying a contractor and providing assurance that the considered contractor is properly vetted to perform the work they wish to undertake.
Second, providing financial protection to the obligee should the contractor default on its contractual obligation as well as ensure the contract will be performed properly and laborers/suppliers will be paid for work and materials provided.
The Contract Bond Process
Contract bonds have different approval phases depending on what part of the contract stage your business is in.
1.) 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. This contract requirement can occasionally be listed as needing a contractor’s bond rate.
2.) 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 submitted bid documents. 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 a performance and payment bond (if required).
3.) PERFORMANCE/PAYMENT BOND: Once the contract has been awarded to the contractor, the project owner (Obligee) will include requirements for a performance (contract) and/or payment bond. The performance bond is a surety provided credit line guarantying the performance of work as specified by the contract. A payment bond guarantees payment to labor suppliers and material providers.
4.) PROJECT COMPLETION: When the project and subsequent required maintenance period have reached completion a General Status Inquiry is issued by the obligee. This completion notice releases the project amount back into the contractor’s total bonding aggregate available, allowing them to bid and win other bonded projects.
What if there is a claim on the Bond?
While the contract bond is intended as a financial guarantee from the surety company to the obligee all parties involved should work diligently to avoid claims. Typical claims seen for performance bonds are extended delay of completion or abandonment by the contractor to a point that the obligee rescinds the project contract. Payment bond claims generally involve a contractor not paying a supply vendor in a timely manner or compensating subcontractors for work performed on the project. It should be noted that the principal must reimburse the surety for any claims paid out on the project by virtue of the indemnity agreement.
Who requires Contract Bonds?
Work performed for federal, state, and local governments have various requirements for contract bonds based on project size and a predetermined bond threshold. Under the established 1935 Miller Act any federally awarded project valued at $150,000 and over is required to have a performance (contract) and payment bond. Many states have adopted their own versions of the Miller Act requirements, known as “Little Miller Acts.”
Private sector businesses have increasingly included contract bonds requirements as an additional way to protect themselves by transferring the financial exposure to the surety. With the surety company properly reviewing the potential risk of a principal, the obligee can help mitigate project issues while the surety company assumes the cost of damages resulting from a contractor failing to perform the duties of the contract (“Performance Bond”) or failing to pay laborers and material suppliers (“Payment Bond”).
What information is needed to qualify for a Performance Bond?
To qualify for these types of bonds, 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 $400,000 SINGLE AGGREGATE
Several surety companies offer bonds up to $400,000 per bonded project based primarily on a contractor's personal credit. To qualify for these programs, the contractor will have their credit reviewed via a soft credit check. The surety companies are looking for good to excellent credit score, with an absence tax liens, judgements, bankruptcies or past due accounts.
If the credit does reveal these credit negative activities the contractor may still qualify for a surety bond with help from the Small Business Administration (“SBA”), providing collateral, or establishing fund control. These alternatives to traditional contract bond markets are not pursued by California Contractors Insurance Services.
QUALIFYING FOR SINGLE AGGREGATE CONTRACT BONDS OVER $400,000 OR TOTAL AGGREGATE LIMITS OVER $800,000
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 for bonds of this caliber:
• Business financial statement
• Personal financial statement for each owner
• Bank references
• Work in progress schedule (“WIP”)
• Accounts receivable aging schedule
What other types of Contract Bonds are there?
There are three other contract bonds that contractors need to be aware of; maintenance, supply and subdivision bonds.
Maintenance Bond: a bond guaranteeing the contractor will repair defective work at no cost to the owner within a specified period of time. It is not unusual for the contract to specify a maintenance period in the contract, typically 1 year which is a risk assumed as part of the performance bond form. There are instances when the obligee requires a separate bond indicating coverage for a maintenance and defects despite this usually being a redundancy. Obtaining a maintenance bond for more than a 1-year period can be difficult and require additional underwriting to be considered.
Supply Bond: a bond intended to ensure the delivery of goods, such as raw materials, food, clothing, and fuel, and contains provisions that specify the quantity and price of items required. A contractor will not typically be required to provide this type of bond, as it is a materials supplier requirement.
Subdivision or Site Improvement Bond: a bond providing guarantee to a government entity that the developer will complete the required improvements (roads, utilities, etc.) within a stated period, in accordance with the governing body’s requirements.
What Other Types of Coverages are Required of Contractors in California?
All licensed California contractors are required to carry a $25,000 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. Contractors may also be required by the owner of a project to provide a bid, performance and payment bond (often referred to as Contract Surety Bonds) on a job-by-job basis.