What is a Contractor Bond?
What is the key element that sets your business apart from the rest? Is it speed, quality workmanship, the ability to stick to the contract, or something else? At the core of all this, your success as a contracting business depends on the trust amongst key stakeholders. This is where a contractor bond (also known as construction bond or surety bond) comes in.
So what is a contractor bond? Essentially, a contractor bond is a legally binding agreement that contractors can set up to help build trust with clients and other stakeholders in their projects. These bonds could either be required or voluntary, as we will discuss later on.
This guide answers the question “what is a contractor bond?” and goes into the nitty-gritty of the main types of contractor bonds that construction and other contracting businesses can benefit from.
Let’s get started!
An Overview of Contractor Bonds
As we’ve mentioned earlier, a contractor bond is a legally binding agreement. It’s essentially a type of surety bond that’s tailored to the needs of the contractor and their stakeholders.
As a type of surety bond, a contractor bond mainly involves three parties:
- The principal – the entity that makes the promise, via the legally binding agreement, to the obligee
- The obligee – the entity that is protected by the surety bond
- The surety – the company that provides the surety bond
Contractor bonds are there to guarantee (1) the completion of work according to the contract, (2) proper payments towards subcontractors and suppliers, and/or (3) the completion of work adhering to set regulations.
How Does a Contractor Bond Work?
Because a contractor bond is essentially a surety bond, it works the same way that other surety bonds do.
The principal (who is the entity that makes the guarantee or promise) purchases the surety bond from a surety company. This could be voluntary (to win the trust of an obligee) or it could be required by the obligee themselves. In some cases, such as with license and permit bonds, these can be required by the government for businesses that potentially pose a risk to the public when regulations aren’t adhered to.
So what happens when the principal fails to fulfill their task, promise, or guarantee? In this scenario, the obligee can make a claim. When the claim is approved, the surety will reimburse the losses up to the bond amount. This is why obligees feel safer working with a contracting business that has the right type of contractor bond.
How Does Commercial Insurance Differ From a Surety Bond?
A contractor bond, which is an industry-specific kind of surety bond, is set up to protect and/or establish trust with obligees. We mentioned earlier that if an obligee is subjected to loss because of a contract breach by the contractor, a contractor’s failure to pay, and so on, the surety company will pay out for losses up to the bond amount. This can sound a lot like what commercial insurance does—but there’s a big difference.
What sets contractor bonds apart from insurance policies is that the principal (i.e. the purchaser of the bond and the entity making the guarantee to the obligee) will need to pay the surety company back if claims arise.
Types of Bonds in Construction (and Related Fields)
Different types of contractor bonds can guarantee various things. A business can have one or more contractor bonds depending on its needs.
The following are the main types that are relevant to construction and other related fields:
1. Performance Bond
A performance bond is a subtype of what’s known as “contract surety bonds.” Performance bonds guarantee that a project will be completed according to what’s agreed upon in the contract.
The usual principal: any type of contractor
The usual obligee: the investor/owner of the project or the municipality
2. Payment Bond
A payment bond is a contractor bond that also falls under the category of “contract surety bonds.” This type guarantees the proper payment for (1) materials from suppliers or (2) labour from subcontractors.
The usual principal: any type of contractor
The usual obligee: the suppliers or subcontractors
3. License and Permit Bond
Unlike the first two types of contractor bonds, license and permit bonds fall under the category of “commercial surety bonds.” License and permit bonds are there to guarantee compliance with regulations. Typically, this type of bond is required by the government for businesses that pose a risk to the public when regulations aren’t followed.
The usual principal: contractors that work on government/public works or contractors that pose a risk to the public (i.e. roofers, electricians)
The usual obligee: The clients, as well as the general public
Who Sets Up a Contractor Bond?
Typically, the principal is also the entity that sets up the needed contractor bond. This could either be voluntary or required (by the obligee or the government), depending on the scenario.
How to Set Up a Contractor Bond
The first thing you need to do is find a trusted surety. The surety is the company that will set up the contractor bond that you need. In some cases, you can get insurance and surety bonds from the same company. For instance, here at Contractors Insurance, we specialize in both insurance policies for contractors and contractor bonds.
Get the Best Contractor Bond for Your Business Today
Whether you need a performance bond, payment bond, or any other type of contractor bond, Contractors Insurance has got you covered. If you’re not sure about what kind of contractor bond your business will benefit from, our experts can also help you choose.
Contact us today to get started!
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