Many contractors are new start up companies with owners that know little about surety bonds. Often, a contractor states they “need to be bonded”. Many that make the assertion do not know what it means to be “bonded”. Below, we will review what a surety bond is and the most common bond types required of contractors.
The first thing that a contractor must understand is that a bond is three-party agreement. Therefore, a bonding company will only write a bond when it is required by another party. In other words, a contractor can not obtain a bond just to claim he/she is “bonded”. Often, people make the mistake that anyone can be bonded for any reason. This of course is not true, as surety bonds require three parties and not everyone qualifies. Surety bonds are a form of credit, not insurance. Therefore, the underwriting used in surety bonding is often similar to underwriting for issuing other forms of credit such as a loan.
Contractors usually require either a contractor license bond (a specific bond type) or a contract bond (a general bond category). Both bond types guarantee precisely what their name suggests. A contractor license bond guarantees the contractor will operate per the rules and regulations of the state and is to be filed with their license. This type of bond can be required by the local or state government. A contract bond guarantees a specific contract. Contract bonds are a category of different bond types. Some examples of contract bonds are bid bonds, which guarantee a contractor will provide a performance bond if awarded the job. Performance bonds are a type of contract bond that guarantee the performance of the contractor on the job cited in the contract. There are many other types of contract bonds, but bid and performance are the most common.
At times, a contractor will be required to obtain a letter of bonding capacity from their bond producer/agent. Bonding capacity refers to a contract bond line, which consists of a single and aggregate limit the contractor is held to. For example, a contract may have a $200,000 single and $400,000 aggregate bond line. In this case, the contractor is only approved for jobs under $200,000 and may not have more than $400,000 of bonded work at any given time. Bond limits make it vital for the contractor to have a good line of communication with their bond agent/producer. This will allow the contractor to make the best use of his/her surety credit at all times.
Regardless of the surety bond type, it does not protect the contractor. In fact, in the event of a claim the surety will look to the contractor for payment of the claim and any attorney fees associated with it. A bond is form of credit and should not be viewed as property and casualty insurance. The bond is required in order to protect the obligee (usually the government), or in other words, the party requiring the bond.
With thousands of bond types available, stating “I need to be bonded” is very vague. If you need to obtain a bond, you will need to inform the bond producer what type of business you operate and who is requiring the bond of you. The answers to these two questions should be enough for your bond producer to know what type of bond you are in need of.