What Are the Different Types of Construction Bonds?

If your construction company aims to work on government or public works projects, you’ll likely be required to obtain a construction bond. These bonds are an important part of large projects, protecting project owners against financial damages if your company is unable to hold up its contractual obligations.

Sometimes referred to as contract bonds or surety bonds, the function of these bonds is to provide project owners with a guarantee that the project will be completed. You might think of them as a form of insurance on a large-scale construction project. As the company contracted to do the work, you must obtain a construction bond from a surety company.

If you’re new to the world of bonding, navigating the construction bonding process and the different types of construction bonds can be challenging. There are a variety of bonds, each with different use cases and requirements for construction companies to be aware of.

In this guide, we explore the main types of construction bonds your company may be required to obtain before starting work on government or public works projects.

If you have questions about bonding requirements or how to strengthen your company’s financial position for bonded work, contact the construction CPAs and advisors at James Moore.

 

 

What Construction Bonds Actually Do

Let’s start with the basics. Construction bonds involve three parties working together:

• You purchase the bond as the contractor.
• A surety company issues the bond after evaluating your financial strength and track record.
• The project owner receives protection if problems arise during the project.

These bonds are required for virtually all public works projects and many private construction contracts. Federal law mandates certain bonds for any contractor bidding on federal contracts valued at $150,000 or more. Many states have similar requirements for large state-sponsored public works projects.

When you begin the bonding process, the surety company will investigate your company’s finances, review your experience with similar projects and examine your current workload. This underwriting process determines whether a surety will issue the bond and at what cost.

What Are the Main Types of Construction Bonds?

Construction bonds are provided by surety companies, specialized organizations that underwrite construction projects. They offer several types of construction bonds, each with different use cases.

The main categories of construction bonds are:

• Bid bonds
• Performance bonds
• Payment bonds
• Maintenance bonds
• Supply bonds
• Subdivision bonds
• Site improvement bonds

Bid, performance and payment bonds are by far the most common of these, but any one or any combination of these bonds could be required on a government construction project.

What Do Construction Bonds Cover?

Contractors are often confused about when they need a bid bond versus a performance bond versus a payment bond in a construction contract. Let’s take a closer look at each of these bond types and explore how they’re typically used and what they cover in large construction projects.

Types of Construction Bonds and What They Cover

Bond Type	When It Is Used	What It Covers	Who It Protects
Bid bond	During the bidding or proposal phase	The contractor’s commitment to honor the bid and obtain required performance and payment bonds	Project owner
Performance bond	After the contract is awarded	Completion of the project according to the contract terms	Project owner
Payment bond	During construction	Payment of subcontractors, laborers and material suppliers	Subcontractors, laborers, suppliers and indirectly the project owner
Maintenance bond	After project completion	Covered defects in workmanship or materials during the warranty period	Project owner
Supply bond	During procurement and construction	Delivery of required materials and equipment	Customer or project owner
Subdivision bond	During public infrastructure work tied to development	Completion of required improvements such as roads and sidewalks	Municipality or public authority
Site improvement bond	During renovation or site-improvement work	Completion of required improvements according to applicable specifications	Municipality or other requiring authority

Bid Bonds

Bid bonds are used during the project proposal phase. They essentially serve as an indication that a construction company has the bonding capacity to carry out the proposed work. They protect the project owner from contractors who renege on their proposal once they’re awarded the project or who are unable to obtain a performance bond.

Without a bid bond, owners have no protection against contractors who submit unrealistically low bids, win the project and then walk away when they realize they made a mistake.

Obtaining a bid bond shows that your construction company is serious about its proposal. Some projects require all bidders to submit a bid bond with their project proposal. Bid bond amounts are often equal to 5% to 10% of the total bid.

If you’re awarded the project but refuse to sign the contract or cannot obtain the required performance bond, the project owner may make a claim against the bid bond. Depending on the circumstances, the claim may cover the difference between your bid and the next lowest bid or the cost of rebidding the project.

Performance Bonds

After they’ve been awarded a government or public works project, construction companies usually must post a performance bond. At that point, the bid bond typically ends and the performance bond takes over. This bond serves as a guarantee that the work will be completed in accordance with the terms of the contract. Performance bonds typically equal 100% of the contract value.

During the construction project, the surety will frequently check in on the progress of work to ensure the project is progressing as planned. The construction company’s work in progress (WIP) schedule provides this information and should be updated and shared with the surety regularly. If serious problems develop, the surety may step in before the situation results in a full default.

In the event a construction company is not able to fulfill the contract, the surety may assist by providing financing to help complete the project, hiring another contractor to finish the work, or compensating the owner for financial losses. The contractor remains responsible for reimbursing the surety for any money it spends resolving the claim.

Payment Bonds

In some instances, companies may be required to obtain a payment bond in addition to the performance bond. Payment bonds (also called labor and material payment bonds) guarantee that all subcontractors and materials suppliers will be paid. They also protect laborers and typically accompany performance bonds. Payment bonds may equal the full contract value.

This ensures the owner of the project will not have a lien placed on their property if the general contractor goes bankrupt and can’t fulfill its financial commitments. Payment bonds can also help keep projects moving by giving subcontractors and suppliers greater confidence that they will be paid.

If a subcontractor or supplier is not paid, they may file a claim against the payment bond. The surety will investigate the claim and pay valid amounts owed. The contractor must then reimburse the surety according to the terms of the indemnity agreement.

Maintenance Bonds

Also known as warranty bonds, these bonds guarantee that the work completed on a project is free from defects in workmanship or materials. Maintenance bonds remain in place for a limited period of time after the completion of a project. If defects are found during this period, project owners may make a claim to cover the costs of repairs.

These bonds are particularly useful for defects that only become apparent after the project has been completed.

Supply Bonds

These bonds hold suppliers accountable for providing the construction materials and equipment required to complete the project. If supplies specified in a purchase order aren’t provided, the bond covers the difference, protecting the customer from financial damages.

Subdivision Bonds

Public works projects often require construction companies to build civic structures such as sidewalks and roadways. A subdivision bond ensures that the construction of these structures is completed in line with all relevant specifications and construction codes mandated by the local municipality.

Site Improvement Bonds

These types of bonds are only used in renovation projects, not new construction. They ensure that the renovations are completed to the specifications put in place by local municipalities.

 

 

Understanding Bonding Capacity

Your bonding capacity determines the total value of projects you can bond at any given time. Surety companies set this limit based on your financial strength, experience and current workload. Understanding your capacity helps you bid appropriately and avoid overextending your company.

If you tie up most of your bonding capacity on one large project, you might not have enough capacity left to bid on other opportunities.

Smart contractors manage their bonding relationships carefully and work to gradually increase their capacity as their business grows and their financial position strengthens.

Working with surety professionals early in your growth plans helps you understand what steps you need to take to qualify for larger bonds. This might include strengthening your balance sheet, improving your financial reporting or gaining experience with progressively larger projects.

James Moore: Renowned Construction CPA in Florida and the Southeast

Understanding the various construction bonds is important for construction companies with aspirations of bidding on government and public works contracts. Virtually all construction work of this type is required to be bonded. Knowing which type of bond you need, and what it’s used for, is key to your success.

Developing a working knowledge of these construction bonds is one thing; getting approved for a construction bond is quite another. Remember, a construction bond is essentially a guarantee that a surety makes on your behalf that your construction work will be completed on time, on budget, and on spec. Ensuring that the surety feels comfortable making that guarantee can be a significant undertaking.

A major component of developing the capacity to do bonded work is strengthening the internal financial infrastructure of your company. To obtain bonding, your company needs reliable internal financial statements and well-established construction accounting and project management systems. In this, the support of an experienced construction accounting firm can prove indispensable.

At James Moore, our construction accounting group brings decades of experience advising construction companies throughout Florida and the Southeast. Our professionals provide assurance, accounting and tax planning services tailored to construction companies — ensuring that your company can secure bonding, correctly account for projects, and benefit from the many tax benefits available to construction companies.

To learn more about how James Moore can help your construction company prepare to obtain a construction bond, get in touch today.

 

 

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.