General contractors and artisan contractors working on construction projects may require surety bonds to meet licensing rules, secure permits, or satisfy contract requirements from project owners. These bonds provide guarantees the contractor will fulfill their project obligations. If the contractor defaults, the bonding company covers losses or arranges completion.

This guide examines key aspects of surety bonds for general and artisan contractors including:

  • What are Surety Bonds and How They Work
  • Why Contractors Need Bonds
  • Bonding Exposures and Coverage
  • Types of Bonds Used By Contractors
  • Bid Bond Process
  • Bond Claim Scenarios
  • Bond Costs
  • Getting Bonded with Poor Finances
  • Working with Bond Producers
  • Maintaining the Surety Relationship
  • State Bond Requirements

What are Surety Bonds and How They Work

A surety bond involves a three-party agreement between the contractor (principal), the client (obligee), and a surety company. The surety provides a guarantee the principal will satisfy the obligations of their construction contract with the obligee.

If the contractor defaults due to non-completion, substandard work, delays, bankruptcy, or other contract breach, the client can file a claim on the bond. The surety will investigate and then either arrange for the contractor to fix the default or pay the obligee for losses covered by the bond.

This guarantee transfers project risk from the obligee to the surety. The client is assured compensation if the contractor fails to deliver. The bond also prequalifies the contractor, confirming their technical skills, finances, personnel, equipment, and capacity to perform the work properly.

Sureties carefully vet contractors during underwriting across areas like financial strength, operating history, project experience, licenses, equipment, key personnel, and more. Being able to meet a surety’s stringent approval standards demonstrates a contractor’s capabilities and creditworthiness.

Why Contractors Need Bonds

While surety bonds are not universally mandatory, they are often required in public works projects and substantial private construction jobs. Typical contexts where bonds are required include:

Licensing Bonds – Most states and municipal jurisdictions require contractor licensing bonds to maintain active operating status and eligibility to pull permits. These help enforce code compliance.

Permit Bonds – Often mandated on a per-project basis to work in a given jurisdiction or pull particular permits. Guarantees adherence to permit rules.

Bid Bonds – Required to demonstrate serious intent and bonding ability when bidding on major public or large private projects.

Performance Bonds – Protects against project non-completion or default. Equal to 100% of the contract value and the largest bond on most jobs.

Payment Bonds – Ensures subcontractors and suppliers are paid fully for services/materials. Avoids liens. Typically 50% of contract value.

Though not universally mandated, performance and payment bonding is a contractual norm on major construction projects as a form of risk sharing. Being able to furnish required bonds demonstrates a contractor is properly licensed, bonded, and able to provide guarantees suitable for substantial projects.

What Exposures Do Bonds Cover?

Surety bonds strictly cover failure to satisfy the designated contractual obligations. The risks depend on the bond type:

Licensing Bonds – Penalizes code violations, operating without proper licensing, or other behaviors prohibited by regulation.

Permit Bonds – Guarantees adherence to all permit requirements for a given project.

Bid Bonds – Failure to enter into the contract if selected as the winning bidder. Compensates the differential for the obligee to choose another bidder.

Performance Bonds – Protects against failure to complete the project properly and per contractual parameters. Accounts for majority of claims.

Payment Bonds – Guarantees all subcontractor and suppliers receive payment for services/materials per contract. Protects against liens.

Maintenance Bonds – Warranties correction of defective work within a set post-completion period, often 1 year.

Bonds do not cover general business liabilities or profit losses outside clear contract breach – those require standard business insurance policies. The surety bond focuses strictly on contractual default.

Types of Bonds Used By Contractors

Major bond types contractors need to understand include:

License Bonds – Required by states/municipalities for an active contractor license. Covers fines for regulatory violations. Usually $5,000 – $25,000 based on location.

Permit Bonds – Necessary to obtain permits on specific projects and jurisdictions. Guarantees following permit rules. Varies based on project size and municipality.

Bid Bonds – Accompanies project bids to demonstrate bonding capability and seriousness to undertake the contract. Typically set at 5-10% of total bid amount.

Performance Bonds – Protects against failure to complete the project properly/timely. Equal to 100% of contract value, the largest bond on most projects.

Payment Bonds – Guarantees all subcontractors and suppliers will be paid. Typically 50% of contract value.

Maintenance Bonds – Warrant work for defects post-completion, normally for 1 year. Usually set at 25% of contract value.

Contractors may need multiple bonds based on the licensing regime, project requirements, and contract specifications.

What is the Bid Bond Process?

Bid bonds are a standard part of bidding on major construction projects. Key aspects include:

  • Bid specifications state if a bid bond is required and the dollar amount, typically 5-10% of total bid value.
  • Contractors obtain bid bonds to make their bid responsive and demonstrate they can get bonding for the full project.
  • The bid bond accompanies the project bid. It often gives a competitive advantage over bidders unable to secure a bond.
  • If the contractor wins the bid, they move forward with formal contract signing and obtaining required performance/payment bonds.
  • A bid winner who refuses to enter the contract forfeits their bid bond, which compensates the differential cost of choosing another bidder.
  • Contractors who bid in good faith but lose do not forfeit their bid bond.

Bid bonds screen out unqualified contractors and prevent inflated bids since bidders must stand behind their proposals. Performance on bid bonds builds bonding capacity.

Bond Claim Scenarios

If a bonded contractor fails to satisfy their contractual obligations, the obligee can make a claim to recover losses against the surety bond. Common claim situations include:

License Bonds – Operating without proper licensing, violating codes/regulations, unresolved fines, or complaints triggering disciplinary action.

Permit Bonds – Failure to adhere to permit requirements or doing unauthorized work beyond the permit scope.

Bid Bonds – Failure to enter into the contract when selected as the winning bidder.

Performance Bonds – Non-completion, failure to meet quality or code standards, timeline delays, warranty breaches, bankruptcy/closure leaving work unfinished.

Payment Bonds – Failure to pay subcontractors or suppliers per contractual terms. Subcontractor liens for nonpayment.

Maintenance Bonds – Defective workmanship requiring repair emerging within the warranty correction period, normally 1 year post-completion.

The surety will investigate claims and compensate the obligee for legitimate losses falling under the scope of the bond’s guarantees. Contractors aim to avoid claims by meeting their obligations.

What is the Cost of Bonds for Contractors?

Sureties charge an annual premium based on the bond type and amount. Typical premium rates range from 1-3% of the bond penal sum. For instance, a $10,000 license bond may cost $100 – $300 per year while a $500,000 performance bond on a large project could run $5,000 – $15,000 annually.

Factors impacting bond premium pricing include:

  • Penal sum amount. Higher bond amounts mean larger premiums.
  • Contractor financial strength and stability. Weak contractors pay more.
  • Operating experience, reputation, capabilities. Newer firms pay more.
  • Contract/project complexity and risks. More complex projects mean higher premiums.
  • Surety underwriting practices and base rates.
  • Local bond regulations and requirements. More stringent regimes cost more.

Established contractors with solid technical skills and finances can often secure reasonable premium rates for bonding at levels that support their business growth. Less stable contractors may need to provide collateral or pay high premium factors to obtain bonding, or may be declined coverage. In general, premium costs are standard and expected within construction for accessing major projects requiring bonds. Understanding the cost of surety bonds for contractors is key to effectively manage your construction business budget.

Getting Bonded with Poor Finances

Sureties evaluate three criteria when deciding contractor bondability:

  • Capacity – Technical skills, experience, personnel, and equipment to perform the work competently.
  • Capital – Financial strength and stability to operate smoothly.
  • Character – Business reputation, credit score, reliability, and transparency.

Contractors having poor personal credit, slight business operating history, or weak company finances can obtain bonding but may face greater underwriting scrutiny. Steps to improve approvability include:

  • Provide explanation and documentation that past financial issues were temporary setbacks or isolated events rather than permanent weaknesses.
  • Seek smaller bond amounts initially to demonstrate reasonableness as an underwriting risk, and build up gradually to higher bonding levels.
  • Present qualifications, licenses, equipment, personnel, safety procedures, and track record competently executing similar projects to showcase technical capacity offsetting financial factors.
  • Offer strong client references vouching for delivery quality, reliability, standing in the construction community.
  • Put up collateral such as letters of credit or liens on property to offset financial weaknesses.
  • Applying through a construction group program aggregating risks across contractors may facilitate bonding approval.
  • Work with an experienced bond producer who can advocate the contractor’s case to negotiate better terms and rates.

Reputable contractors with sound technical capabilities can often achieve bonding despite some financial constraints. The keys are transparency, demonstrating technical competence, and having a bond advocate on your side to negotiate favorable outcomes.

Working with Bond Producers

Obtaining surety bonds is easiest when partnering with an established bond producer specializing in the construction trade and representing multiple surety carriers. There are several advantages to using a specialist:

  • They understand the unique risks and business practices of contractors. This expertise helps structure optimal bond solutions and coverage amounts.
  • Representing multiple surety carriers allows the bond producer to shop for the most competitive rates and maximum eligibility to find bonding options despite financial weaknesses.
  • They advise on local and state bond regulations, documentation requirements, and compliance practices. This avoids errors.
  • Bond producers advocate for the contractor during underwriting, facilitating approvals and negotiating advantageous terms, rates, and bond amounts.
  • They handle all the paperwork, compliance, renewals, and servicing needed to keep bonds active and prevent lapses in coverage.
  • Bond producers assist with claims and procurement of bond replacements as needed.

General agents lacking surety expertise often don’t represent multiple surety carriers and may not grasp the nuances contractors face. Going direct to a surety carrier without a producer can also pose challenges:

  • Carriers may be reluctant to underwrite bonds for smaller contractors without the scale of a bond producer aggregating multiple contractor risks.
  • Navigating paperwork, financial disclosures, and processing requirements on your own is difficult without expert support.
  • Lack of advocacy during underwriting often leads to poorer results or denials where a savvy producer could negotiate improvements.
  • Ill-informed decisions can be made on proper bond types/amounts without advisor guidance.

Specialized surety bond producers streamline education, market access, compliance, renewals, claims handling, and all aspects of the bonding process. Their expertise provides key guidance while their advocacy secures optimal terms and uninterrupted coverage. The modest bond producer fee is well worth these services and enhanced results.

Maintaining the Surety Relationship

Once a contractor secures initial bonding, preserving ongoing bondability requires maintaining fiscal and operational strength and closely communicating with the surety throughout the relationship. Smart practices for keeping your surety relationship solid include:

  • Pay premiums and renew bonds on time to prevent coverage lapses which raise underwriting concerns.
  • Meet all requirements to keep licenses current and avoid disciplinary actions. Stay up to date on code changes.
  • Perform work competently and fulfill contract obligations to limit bond claims. Build a reputation for reliability.
  • Manage company finances prudently including AR/AP, cash flow, profitability, overhead controls and debt levels. Update financial statements.
  • Discuss any disputes, delays, or changes on bonded projects transparently with the surety to avoid misunderstandings.
  • Build up technical capacity and bonding levels gradually as you successfully perform larger projects.
  • Maintain open communication channels with your bond producer and surety underwriter.

Consistently demonstrating technical skills and financial stability enables contractors to strengthen bonding relationships and access larger bonds supporting business growth and bidding on major public and private projects.

State Bond Requirements

Licensing bond requirements for contractors vary considerably at the state level:

  • Alabama does not currently mandate license bonds for general contractors, though local jurisdictions may require them.
  • Alaska requires license bonds of $25,000, $20,000 or $5,000 depending on contractor license type. Bonds must remain active for 3 years.
  • Arizona requires a surety bond based on projected annual volume – $2,500 minimum for under $150,000 volume or $5,000 minimum for $150,000+ volume.
  • Arkansas requires license bonds ranging from $5,000-$10,000 based on license type.
  • California requires all contractors maintain an active $25,000 license bond from an approved surety company.
  • Florida requires all licensees have a $100,000 surety bond or irrevocable letter of credit.
  • Georgia mandates a $10,000 surety bond that contractors must maintain.
  • Hawaii may require a surety bond of $1,000-$100,000 based on financial history.
  • Louisiana requires commercial license applicants obtain a $10,000 license bond.
  • Maryland does not have a statewide bond requirement but may mandate bonds for certain commercial projects.
  • Massachusetts requires a $5,000 license bond for Home Improvement Contractor registration.
  • Michigan mandates either a $15,000 bond for residential builders or $10,000 bond for maintenance/alteration contractors.
  • Mississippi does not require license bonds.
  • Nevada requires a surety bond ranging from $1,000-$500,000 to protect consumers.
  • New Mexico requires a $200,000 license bond.
  • North Carolina allows minimum bond amounts from $175,000 to $1 million to serve as financial qualification alternatives.
  • North Dakota does not require license bonds but may mandate separate performance and payment bonds per project.
  • Oregon requires all licensees carry a $12,000 surety bond, or $15,000-$20,000 for contractors with disciplinary issues.
  • South Carolina mandates a $15,000 surety bond from all contractors.
  • Tennessee requires a $10,000 license bond from all contractors.
  • Utah requires a $15,000+ license bond from general building and residential/small commercial contractors.
  • Virginia requires Class A and B contractors obtain a surety bond.
  • West Virginia requires licensed contractors working on $100,000+ commercial projects get a wage bond equal to 6 months payroll.
  • Wisconsin does not require license bonds.

Municipal jurisdictions may mandate additional bonds beyond state licensing rules. Verify requirements in your operating region. While bonding is not universal, it is vital for major public and commercial construction projects. Specialized surety bond producers efficiently guide contractors through the nuances of bonding in your jurisdiction to maintain readiness to bid and perform substantial bonded work.

Conclusion

Bonding provides important risk transfer and financial security on construction projects. Through bid, performance, payment, license, permit and maintenance bonds, general contractors and artisan contractors demonstrate their qualifications for significant public and private jobs. Partnering with experienced surety bond advisors allows navigation of approval, compliance, optimal pricing and terms, and meeting local requirements. Bonding facilitates access to opportunities and scaling business growth for construction contractors seeking to graduate towards more advanced projects in the public and commercial space.