Construction Bonding Requirements: What You Need to Know
If you are looking to do construction work, it is important that you follow the proper regulations. Check out this guide to learn more about construction bonding requirements.
As a project contractor, you understand there are risks involved in just about any project. Plus, there can be delays and failures that will make you fail to deliver the project as per established provisions and agreements.
Project owners and investors know that such scenarios are possible once the project starts. As such, they’ll expect you to put up a surety bond, such as a construction bond, to protect them against disruptions and financial loss. Keep in mind that this bond also offers legal protection.
So, before you get the bond, you need to understand the essential construction bonding requirements, and this post is here to guide you through.
Keep on reading to learn more.
How the Bond Works
As noted, the investors and project owners require bonds to protect their investments. In this case, the investor or project owner can be the government or an entity in the private sector.
Surety bonds are commonly required for cost-intensive projects, such as building bridges and roads. Generally, most projects are usually $100k or more. It provides assurance to the project owner (obligee) that the contractor will execute and complete the project according to the agreement.
If you are taking on a larger project, your construction bond may come in two parts. One part will cover the overall project incompletion, and the other will cover nonpayment of services and materials from suppliers and subcontractors.
Three parties are usually involved in this deal – the project owner/investor, the contractors, and the surety company. As a contractor, putting up a bond allows you to provide a financial and quality guarantee to the obligee that you have the capacity and means to deliver the project. Plus, you’ll meet all the quality requirements.
You will need to purchase the construction bond from the surety company. It’s the responsibility of the company to conduct financial and background checks before approving the bond.
The Kind of Surety Bonds Your Will Need
When approaching surety companies, they’ll review your financial merits and charge a premium based on the likelihood of potential adverse events. A surety can also replace the contractor when they abandon the project.
Here are four main types of construction bonds, and you can also click here for more:
1. Bid Bond
When bidding on potential projects, you must submit a bid bond together with your bid. This bond protects the project owner if you back out of the project after winning the bid. It also protects them if you fail to provide a performance bid, which is necessary before you start working on the project.
2. Performance Bond
After you accept the bid and you’re ready to start the project, you’re going to need performance bond. This bond protects the project owner from financial loss is the project is defective or fails to meet the contract terms.
3. Payment Bond
You may win a bid, but do you have the means and capacity to meet all the projects needs? Well, getting a payment bond helps to give that assurance. It shows that you have the financial capacity to pay workers, subcontractors, and suppliers.
4. Maintenance Bond
In some cases, you may also need maintenance bond. This helps to guarantee that you’ll fix any defects and repairs that will be discovered after the project completion. This usually lasts for a 12-month period.
As you can see, these are the bonds you will need once you start bidding on project construction projects.
Understand Construction Bonding Requirements
Now that you understand how the bond works, let’s explore what requirements you need to meet when applying for a bond. Keep in mind that requirements differ depending on the project size and the surety company you approach.
Understand The Miller Act
If you’re bidding on federal construction projects, you need to understand the construction bonding requirements as they are constituted in The Miller Act.
According to the act, the prime contractors of federal projects must provide a performance bond for any project that’s more than $100,000. Also, contract values ranging from $30,000 and $100,000, may require some form of payment protection.
You need the payment bond to pay suppliers and contractors. Failure to have the bond gives suppliers and contractors the right to sue you in the U.S. District Court.
The Essential Documents
Usually, you need several documents when you apply for construction bonds. This includes:
- Your surety application
- CPA-prepared financial statements for the past two years
- A copy of the project contract
Even though it’s not a requirement, be sure to provide proof of real estate ownership. This will help to expedite your bond processing and approval.
As a general rule, you can expect the cost of a performance bond to be about 1 percent of the project or contract value. For cases where the contract value is $1 million or more, the premium can be anywhere from 1.5% and 2%.
However, your creditworthiness as a contractor will also determine your premiums. In most cases, surety companies usually combine the performance bond and payment bond as single coverage.
Before underwriting any amount, surety agencies will consider several factors.
They will review your past contracts to ensure they were successful. If they were any issues, they would want to know how they were solved. So, be sure to have some proof of past contracts as they need them for risk analysis.
You also need to have enough working capital to get approval from surety agencies. You will also need to prove that you have the skills and ability to complete the project.
Keep in mind that some agencies will readily reject contractors with bad credit and bankruptcy.
Construction Bonding Requirements – Final Thoughts
In the United States, the law requires surety bonds for most large construction projects. As a contractor, you need to learn all the essential requirements of bonds when bidding on projects.
This post covers some of the basic stuff you need to know when approaching surety agencies. The good thing is that you can easily apply online for bonds and get quotes from different agencies.
Do you have any thoughts or ideas on meeting the construction bonding requirements? Feel free to share them in the comments section below!
You can also read more on how to raise finance to support your construction business.