Let's imagine you have a $500,000 over $1,000,000 bond line. The $500,000 single limit would allow you to work on jobs no larger than $500,000. Your $1,000,000 aggregate limit would allow you to work on two jobs of $500,000, four jobs of $250,000, eight jobs of $125,000, etc. at the same time.
When providing your financial statements to a surety company, it's highly recommended that you work with a construction CPA, as they know the industry inside and out and will be able to present your company appropriately when attempting to increase your bond limits.
A contractor, or principal, uses a performance bond to guarantee that it will complete the contract in accordance with its terms. If the principal defaults, the owner may call upon the surety to complete the contract. In such a case, the surety will have to hand the contract to a new contractor or pay the costs for the owner to complete the contract.
With projects overseas and Indian reservation construction jobs, most U.S. surety companies will not consider writing surety bonds to guarantee their completion because the laws differ from state and Federal laws. Since the surety bond is legally binding and the surety company is first on the hook to pay bond claims, they don't want to take the chance of providing surety bonds in a region where they're unfamiliar with the law and risk non-payment of claims.
The majority of U.S. surety companies consider most of these project types too risky to bond. Surety bonds for public construction jobs such as performance bonds are legally binding guarantees provided by the surety company that you'll complete a job according to the contract. If you don't complete the project properly, a claim can be filed which the surety will pay initially. However, you're ultimately responsible to pay the surety company back for claims. In short, bonds for construction projects protect taxpayer's dollars.
Many things can go wrong in a large construction project. Because of this, construction bonds are almost a mandatory prerequisite of any project beyond a certain size, and for most (if not all) government and public works projects. On larger projects, construction bonds may come in portions; one to protect against overall job completion and to specifications and another to protect against the cost of materials from suppliers and subcontractors. Surety companies will evaluate the financial merits of the principal builder and charge a premium according to their calculated likelihood that an adverse event will occur.
If you are a contractor with a new business, the surety company will likely limit you to bonds for only smaller contracts (about $350K and under). The bond limit is for your own protection since your company doesn't have a proven track record of an ability to complete larger projects. Also, you don't have to obtain CPA prepared financials for smaller jobs, which often cost thousands to have prepared and can be tough for a new business. Start with smaller jobs to gain the proper experience and allow yourself to get familiar with the entire process, from bidding on jobs to completing projects, while developing a strong relationship with the surety company.
Once you have the proper experience, a track record of completed projects under your belt and have built up your relationship with the surety company, you can start bidding on larger projects (about $350K+). Your relationship with the surety company is important because when they provide you bonds for public construction jobs, they are extending a form of credit to you. As mentioned above, the bonds guarantee you'll complete the project according to the contract. If you default or perform faulty work and cause claims, the surety company will pay them at first. However, they will come back for you for reimbursement. Building a strong relationship with the surety company is vital to both your company's and the surety's success.
Each surety has its own criteria for deciding the eligibility of applicants for construction bonds. Standard criteria include having the right skill level, resources and ability to perform the requirements of the contract. The surety will analyze the applicant's financial statements and investigate work history, financial standing and credit rating.
Getting construction bonds for private home remodeling projects will be impossible, not because they're too risky for surety companies, but as a result of being private jobs. As mentioned above, surety bonds for construction jobs protect the public and are used for public projects. It's possible to get surety bonds for private home remodeling jobs that are being paid for by the government, e.g. the government stepping in and paying for projects in a particular state where a hurricane caused significant damage to homes.
Working on bigger jobs usually increases your company's overall profit, which makes getting the CPA prepared business financials that are required for larger bonds less of an issue as it often is for smaller or new contractors.
Contractor license bonds are required by most states for contractors to get their license. These bonds guarantee you'll pay any claims in full that you may cause by not operating your contracting business professionally.
A maintenance bond is occasionally required after you close out the job by whoever required the bid and performance bonds; if needed, get a maintenance bond and make any needed repairs while your bond is active.
The bid bond protects the project's owner if the bid is not honored by the principal, such as a contractor. The owner is the obligee under the bond and has the right to sue the principal and the surety (the issuer of the bond) to enforce the bond. If the principal refuses to honor the bid, the principal and the surety (the insurance company or bank issuer of the bond) are liable for any additional costs incurred in contracting a second time with a replacement contractor.
When a surety company is considering writing a performance bond, your financial statements will be reviewed to help them determine how you handle your obligations and whether you are able to handle projects that come along with a larger bond limit. Your financial statements must show sufficient working capital, cash flow, equity and profit for a surety company to increase your bond limits.
When you get construction bonds such as bid and performance bonds for a public job, you are responsible for the project's completion. If you don't complete the job according to the contract, a claim can be filed on your bond which you're ultimately responsible to pay. After all, the bonds are guarantees from a surety company that you will complete the job properly, which is why you should avoid getting in over your head by bidding on larger projects that you're not yet qualified to work on.
Bonding capacity (also referred to as your bond line) is the pre-approved dollar amount of contract bonds that you qualify for. Your single limit is the largest bond you can get for a single job. Your aggregate limit is the total amount of bonded work on hand you can have at once for several projects. Learn how choosing the wrong construction bonding company can limit your bond lines.
Performance bonds for public construction projects guarantee your performance on the project, but they are different from financial guarantees. Financial guarantee bonds ensure that payments will be made for things such as building leases or sales tax revenue. If bonds for construction projects simply guaranteed that payments would be made, more surety companies may consider writing bonds for the types of work mentioned above; however, the risk is far greater.
A payment bond guarantees all payments that are due to subcontractors and others from the principal. Beneficiaries of a payment bond are the subcontractors and suppliers. The owner benefits from such a bond because it provides a substitute to mechanic's liens as remedies for non-payment.
Also, multiyear construction contracts that last for three or more years are too risky for surety companies as they are unable to determine whether a contractor will still qualify to perform the work that far down the road. For instance, if a contractor defaults on another project while also working on a three year job, it could cause them to go bankrupt, which means the contractor wouldn't be able to finish any other jobs they were working on.
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