Contract Bonds

A surety bond is a contract between three parties: the surety company, the principal, and the obligee. When a surety provides the principal with a bond, it is guaranteeing that principal’s performance to the obligee. If the principal doesn’t meet the performance standards agreed upon, the obligee can file a claim against the bond to supplement any loss. In that sense a surety bond isn’t insurance for the principal, it’s a financial guarantee made to the obligee, and the principal remains responsible for repaying the surety on any claim it pays. For more on how the three parties work together, see our Surety Bond 101 guide.

The purpose of a surety bond is to provide financial security and make sure certain obligations are met. It protects the party requesting the bond (the obligee) against financial loss if the party performing the bonded obligation (the principal) fails to fulfill their contractual obligations. Surety bonds are typically required by government agencies, private entities, and other organizations as a condition of doing business. A contractor, for example, may be required to obtain a bond before beginning a construction project to guarantee the work is completed according to the contract. There are many types of surety bonds, including contract bonds, commercial bonds, court bonds, and license and permit bonds, each tailored to a specific obligation. In every case, the bond gives the obligee confidence they’ll be compensated for any loss if the principal doesn’t perform, and lets the principal demonstrate their financial stability and reliability.

A construction bond works on behalf of the obligee to protect a project from not being completed or not meeting specifications by the contractor awarded the job. It ties the contractor to the project and gives the obligee assurance their performance will meet the contract’s requirements. The bond works the same whether the obligee is a government entity for a public project, or an investor or building owner for a private project. You can learn more on our construction bond page.

A performance and payment bond is two guarantees issued together. The performance bond guarantees the project will be completed as promised in the contract’s specifications, and the payment bond guarantees that all subcontractors and material suppliers are paid in full, protecting the project owner. A project requiring performance and payment bonds typically requires a bid bond first, which qualifies the contractor to submit a bid.

Contract bonds are the family of surety bonds used on construction and commercial contracts. The most common are the bid bond, performance bond, payment bond, and maintenance bond (also called a warranty bond), along with supply and subdivision or improvement bonds. Each type is covered in more detail in the types section above.

The cost of a bond depends on a few factors, the two most important being the size of the contract and the contractor’s credit history. Rates are also filed by the surety with the state insurance department based on the contract amount. In most cases the premium ranges from as little as 0.5% to as high as 3% of the contract amount, and your rate will vary based on credit history, bond history, and whether you’re just starting out. We also have specialty programs for accounts that are harder to place.

Bonds are recommended on nearly any construction project since they help guarantee quality work, but they aren’t always required. Federal, state, and local governments often require surety bonds on public construction projects. Under federal law, any federal construction project over $150,000 must carry both a performance and payment bond. State and local thresholds vary, and private owners increasingly require them as well.

Contractors and subcontractors are responsible for obtaining the appropriate contract bonds before starting a construction project. If you’re a contractor or subcontractor, you can contact your surety to begin the underwriting and approval process. The producers at The Surety Place know exactly what each contract bond requires and will guide you through underwriting, and our specialty programs help place bonds for accounts that need them. Qualifying involves a thorough review of the contractor’s financial history, current and past financial statements showing both payables and receivables, copies of relevant contracts, information on the owners and key employees, current work on hand, proof of insurance, and any bank or loan information. That background protects the surety, the contractor, and the project owner alike.

Yes. Every surety runs its own pre-qualification through its underwriting team to gauge the risk of a given bond and principal. Underwriters review work-in-progress schedules, balance sheets, and financial statements, and check bond history, credit, work history, business model, and experience to determine whether the principal qualifies. It’s worth knowing that underwriting is continuous, so these evaluations are ongoing throughout the relationship.

Yes. A contractor’s bonding capacity is based on their financials. With proof of strong financials and adequate liquidity, a contractor can qualify for more bonding, which means bidding on more or larger projects. Capacity is usually expressed as a single limit (the largest individual project) and an aggregate limit (total work on hand). A common rule of thumb is showing 60 to 90 days of sufficient funds per project to cover the upfront costs of the bond, labor, materials, insurance, and other fees before the first owner payment arrives. As always, stronger credit, bond history, experience, and overall financials support a larger capacity.

GIA stands for general indemnity agreement. It’s the contract between the surety and the contractor the bond is underwritten for, and it shouldn’t be taken lightly. The GIA obligates the contractor to repay the surety for any loss caused by a failure to complete the project or meet the requirements laid out in the contract and bond. It ensures the surety won’t absorb a loss on behalf of the principal’s inability to perform, and it encourages contractors to honor the obligations they agree to when obtaining a bond.

A co-obligee, also called a dual obligee, is when an additional obligee is added to the contract surety bond for a construction project, naming a party who wasn’t in the original contract. A common example is when a project owner finances the work through a lender: the owner adds the lender as a second obligee because the lender now has money at risk. If the project defaults and the lender takes a loss, they can file a claim against the bond.

If the principal fails to provide the work agreed upon in the contract, the surety becomes responsible for the obligation stated in the contract bond. The surety conducts its own investigation of the alleged default without jeopardizing either party’s rights, to confirm whether the claims made against the bond are accurate, following the construction laws and industry precedents that apply.

The surety has a few options once a claim is filed against a contract bond. It can work with the obligee to agree on a new contractor to finish the project, known as the tender option. It can take over and assume full responsibility, hiring a contractor to complete the work itself. It can step back and let the obligee arrange completion. Or, after its investigation, it can deny the claim if it confirms there was no actual default.