There are two main categories of bonds. Each surety company classifies them differently, but traditionally, surety companies will have contract surety bonds and commercial surety bonds. Commercial bonds are essentially miscellaneous bonds, while contract bonds are for construction contracts. Under contract surety, your construction contractors will have bid, performance, and payment bonds. These are the three main types of contract bonds
When a principal bids for a job, he may be required to post a 5%, 10%, or as much as 20% of the estimate as a deposit. The deposit is the bid bond. The bid bond guarantees that if that principal is the low and successful bidder, they will enter a contract and provide performance and payment bonds. Oftentimes, surety companies don’t charge for bid bonds. The surety company is pre-qualifying the contractor. With that bid bond, the surety company says that the contractor is pre-qualified to enter the contract.
If the contractor is the successful bidder, and they enter a contract, a performance and payment bond will be the next step.
Performance and Payment Bonds
Performance and payment bonds are what they sound like. A performance bond guarantees that the contractor will perform a contract. A payment bond guarantees that the contractor will pay their subcontractors, suppliers, and the material people on that contract. The performance and payment bonds are part of the contract. A performance bond does not contain much language, yet guarantees anything written in that contract. After approving the account as a whole, the contract is the most important part of underwriting the obligation. The surety company will read the contract, and this is another example where the principal and surety are a team.
A surety company has experience; they have read contracts before and can tell the principal about the onerous clauses in the contract. They can determine whether the principal should go through with it or see if modifications can make the contract fairer.
Another important term in contract surety is the “line of authority.” A line of authority could be something that the surety company gives to the insurance agent and/or principal to say that they are pre-qualified for contracts up to a certain amount. Some will call it a “bonding line.”
Let’s use the analogy of a bank. You might go to the bank and get a line of credit. You may not know exactly what’s needed yet, but you know that you will need money, so you go to the bank and get pre-qualified for a line of credit. It’s possible to do something similar with contract surety if you qualify. You can ask the surety for a line of credit, or a line of authority. Small contractors or those new in business might not qualify, but it is something that surety agents should know is available.
Developer bonds are another kind of bond that some sureties put into the category of contract surety, while others put them into the category of miscellaneous or commercial. These types of bonds are often confused with performance and payment bonds because they commonly say “performance” on the bond form. Most bonds have a performance element to them. A developer bond is especially risky because the developer must have the capital to do the project. A developer is not paid by the obligee, federal government, the state, the city, or the county. Developers must have the funds to complete all aspects of the project, whereas a typical contractor, who bids a public works job, is paid to do the job by the obligee. The contractor doesn’t need as much capital to be a contractor as a developer needs for development.
For example: let’s say Warren Buffet wanted to build a building. The city may require that he provide a developer bond to guarantee that he will do the offsite improvements, such as adding sidewalks, stop signs, fire hydrants, trees, etc. The city or county will want a guarantee that these improvements will happen before they issue a permit.
These categories are not the only types of contract bonds, but these are the most common types. For more information and answers to any questions, always feel free to reach out to us, or refer to our prior blogs. To follow our company, visit our socials.
Ready to Get Started?
Apply online for a free quote today!