Senate Bill 392 requires any contractors who want to start a LLC to obtain a $100,000 surety bond in addition to the $12,500 contractor bond that’s already required. The new bond is for the benefit of any employee affected by an LLC’s failure to pay wages or fringe benefits.

In the past, contractors starting LLC’s were not able to get a contractor license in the state of California. Now the only way to do so is to obtain the $100,000 bond on top of the $12,500 contractor license bond that is already required of California contractors. If all goes as planned, the CSLB (Contractors State License Board) should be accepting applications from LLC applicants by the January 2012 deadline.

Any contractors aspiring to start an LLC will not be taking this new $100,000 bond requirement lightly simply because it will be costly. Surety bond pricing is based off a percentage of the bond amount (roughly 2-20%) which is calculated by the contractor’s credit history and financial strength. Even if a contractor is financially sound and qualifies for a low rate e.g. 2%, they will still have to pay $2,000 for the bond!

Although it’s unclear why California contractors have been unable to open an LLC in the past, they will be able to in the near future; but it could very well end up being costly which may drive contractors from even considering the option of an LLC at all.

Surety bond definition

A question often asked regarding construction bonds is, “What is a surety bond?” In simplest terms, surety bonds are legally binding contracts. For contractors, the agreement involves three parties: an obligee, a principal and a surety.

Obligee: the agency or government entity requiring the bond

Surety: the agency selling the bond that will be responsible for repayment of damages should the contracting company be found to be in noncompliance with the protections the surety bond guarantees

Principal: the individual or company purchasing the bond

Each bond affirms the principal will adhere to the laws specific to the surety bond. In construction, the most commonly acquired bonds are performance, payment and bid bonds. Performance bonds guarantee the contractor will complete the work per the specifications of the contract. Payment bonds ensure laborers and suppliers will be compensated for their work; and bid bonds certify the price the contractor offered to bid upon a project will be offered should the firm win contract award.

 California surety bond requirements

The Miller Act requires construction projects exceeding $100,000 to hold both payment and performance bonds regardless of the state the work is being conducted is in. Specific to California, contractors must also hold a CA contractor’s bond to be written for $12,500 by a surety company licensed through the California Department of Insurance. For those looking to find a surety agency that is licensed in California, the National Association of Surety Bond Producers includes information on finding agencies able to produce bonds by geographical location as well as an education center to obtain answers for the most commonly asked surety bonding questions.

Cost of a surety bond

One of the biggest misconceptions of surety bonds is how they are calculated. Surety bonds are not based on one flat fee; rather their costs are determined by a number of factors including the financial history of the principal, the industry in which the bond is needed and how much the bond is protecting. Surety bond costs for those with standard credit can range between 1 to 5 percent of the bond amount. Those with less than average credit histories can also apply for a bond as many nationwide surety agencies offer bad credit programs for applicants. These bonds, however, are more costly and can range between 5 and 20 percent of the bond amount.

Consequences of not obtaining a bond

As with any legal requirement, there are severe outcomes for those who perform work without a surety bond. Fines, legal retribution and, in some instances, one’s license can be revoked. Should an agency be found to be working without the protection of a surety bond, it will ultimately destroy their chances of obtaining a surety bond in the future.

The project not going as planned is how Scott’s fraudulent ways were revealed. City officials who were monitoring the job noticed issues with the work so in order to be prepared for an unsuccessful job and potential claims on the bonds; they looked closer at the contract bonds he provided. After all, the bonds that were required for the jobs guaranteed that the work would be completed. In the event of an incomplete project, the surety company who wrote the bonds would step in and fund the rest of the job. Then the surety company would then go to the contractor who originally purchased the bonds for reimbursement. In this case, there were no authentic bonds to protect against an unfinished project which may cost millions of taxpayer dollars. Scott’s court hearing is scheduled for Dec. 13 and faces a maximum of five years in prison for each violation.

This story demonstrates how important surety bonds can be. Now the city of Sacramento risks either having an unfinished project on their hands or the loss of public money, both of which are bad outcomes. Should there have been legitimate surety bonds in place, this job would have been completed the way the city intended.