What is a Contract Bond?
Contract bonds are a type of surety bond that must be filed with the owner of a project (the “Obligee”) as a condition for the contractor to bid on or to enter into a contract. Contract bonds consist of two primary categories - (1) bid bonds required of contractors as a condition for a contractor to submit a valid bid on a construction contract; and (2) final bonds required of contractors to enter into a contract.
Contract bonds must be issued by insurance carriers admitted in the state where the obligee requiring the bond resides. The insurance carrier issuing any surety bond, such as a contract bond, will also be referred to as the “surety company” or “bond company”.
Why is a contract bond required?
Contract bonds protect the project owner by transferring to a surety company the cost of damages resulting from a contractor failing to perform the duties of the contract (“Performance Bond”) and failing to pay laborers and material suppliers (“Payment Bond”).
Contract bonds are most often required by government agencies for construction projects on public property as required by The Miller Act for Federal contracts over $150,000 and so-called “Little Miller Acts” enacted by state governments that mirror the federal requirement.
How much does a Contract Bond Cost?
Contract bonds cost between 1% and 3% of the contract amount. Contract bond rates are determined by the size of the bond and the financial stability, experience and reputation of the contractor. For contractors that qualify for bond amounts up to $500,000, contract bonds cost 3% of the bond amount. For contractors needing larger bonds, the rates will be tiered based on the size of the bond. The tiered rate is essentially a volume discount for larger bond amounts. The most typical tiered rate is known as a 25/15/10 rate; translated to mean 2.5% of the first $100,000 of the bond amount, 1.5% for the next $400,000, and 1.0% for the rest.
Example: $2,000,000 Contract Bond Cost Calculation
|Bond Amount||Premium Rate||Bond Cost|
Total cost of $23,500
Is a credit check required for contract bonds?
Credit checks are required in order to obtain a contract bond.
What information is needed to qualify for a contract bond?
To qualify for a contract surety bond, contractors will be asked to provide information to the surety company to demonstrate their ability to complete the contract as expected. The information requested will vary depending on the type of work to be performed and the size of the contract.
Qualifying for Contracts up to $450,000
Several surety companies offer bonds up to $450,000 in size based primarily on the contractor's personal credit. To qualify for these programs, the contractor must have good or excellent credit and must not have any tax liens, judgements, bankruptcies or past due accounts. If a contractor’s credit score is bad, but does not contain tax liens, judgements, or bankruptcies, the contractor may still qualify for a surety bond with help from the Small Business Administration (“SBA”), collateral, or fund control.
Qualifying for Contracts over $450,000
Contractors must demonstrate credibility, capability and capacity to complete the contract. Surety companies will review the business owner's credit along with the following information to determine eligibility:
- Business financial statement
- Personal financial statement for each owner
- Bank References
- Work in progress schedule (“WIP”)
- Accounts receivable aging schedule
- Proof of insurance (General Liability)
- Customer and supplier references
What is the SBA surety bond program?
The U.S. Small Business Administration (“SBA”) surety bond guarantee program helps contractors whose small business would otherwise not be approved by a surety company. The program provides a guarantee to surety companies for up to 90% of the liability on a contract to encourage approval for contractors needing bonds on projects up to $6.5 million.The SBA is an independent agency of the federal government.
What is fund control?
Fund Control is a tool utilized by surety companies to ensure the proceeds of a contract will be used first to pay all employees, subcontractors, and suppliers of the contractor before the contractor has access to the funds. This protects the surety company from potential payment issues related to the contract. Payments are made directly from the project owner to a trust account controlled by a 3rd party fund control company, and all disbursements to the contractor and their vendors must be approved by the fund control company.