Understanding Common Types of Construction Bonds

Construction bonds are a familiar part of life for most contractors, especially on public work. Federal contracts are subject to bonding requirements under the Miller Act, the Federal Acquisition Regulations (FAR), and most state and local governments have followed suit with additional rules. Private owners may also require bonds, particularly when a project is large enough or complex enough that the risk warrants it.

For contractors, getting bonded opens doors. For owners, it provides a level of protection they would not otherwise have. Understanding what the different bonds actually do can help construction companies prepare and get ahead of any requirements. To help clients, prospects, and others, Wilson Lewis has summarized the key details below.

What Is a Construction Bond?

A construction bond is a financial guarantee. If a contractor does not meet its contractual obligations, the bond gives the project owner or other affected parties a way to recover. What makes bonds different from insurance is who they are designed to protect. Insurance protects the person or company that buys the policy. Bonds protect everyone else. 

Three parties are always involved. The contractor purchases the bond, the project owner receives the protection, and the surety evaluates the contractor before agreeing to back them. 

What Are the Types of Construction Bonds?

One thing that surprises some contractors is how many bonds a single project can require. That is because different bonds serve different purposes at different stages, from the initial bid all the way through the warranty period after construction wraps up.

Bid Bonds — Bid bonds are typically the first bond a contractor encounters on a project. They give the project owner confidence that a contractor submitting a bid is serious about the opportunity and intends to sign the contract. Without a bid bond, an owner has little recourse if a contractor wins the award and then walks away. The bid bond addresses that risk directly and signals that a surety has already taken a look at the contractor and is willing to stand behind them at this stage.

The cost of a bid bond varies by contractor, surety, and project. Some sureties charge a small fee or a percentage of the bid amount. Others may provide bid bonds at little or no additional cost as part of an established bonding relationship.

Performance Bonds — Once a contract is signed, the performance bond guarantees that the contractor will complete the project according to the terms of the contract. Public projects almost always require one, and larger private projects frequently do as well.

If a contractor defaults, the owner files a claim with the surety. Depending on the circumstances, the surety investigates the claim and takes steps to resolve the situation. That may include financial compensation for the project owner. 

There is a secondary benefit that sometimes goes unmentioned. Getting a performance bond means a surety has already looked at a contractor’s finances, experience, and track record. As a result, a performance bond can provide additional assurance because it’s clear that the contractor has been vetted by an independent third party.

Premiums are usually calculated as a percentage of the contract value, with industry rates ranging from 1-3% for well-qualified contractors.

Payment Bonds — Performance bonds cover whether the work gets done. Payment bonds cover whether the people doing the work get paid. They protect subcontractors, suppliers, and laborers if a contractor fails to make good on what it owes them.

On public projects, payment bonds are usually required right alongside performance bonds. The two often go hand in hand. Owners benefit because unpaid subcontractors may create disputes and liens that can go on long after project completion. Subcontractors and suppliers benefit because they have a way to be paid, even if the general contractor doesn’t follow through.

Like performance bonds, payment bonds are underwritten based on the contractor’s overall risk profile, including financial strength, experience, credit history, and project performance.

Maintenance Bonds — Most of the bonding conversation centers on what happens before and during construction. Maintenance bonds are about what happens after. Sometimes called warranty bonds, they guarantee that the contractor will come back and fix defects in workmanship or materials that surface during the warranty period. A 12-month term is typical, though contracts vary.

Not every project requires a maintenance bond. They are driven by contract language rather than statute, so whether one is needed depends on what the owner puts in the agreement. When they are required, the owner is asking that the contractor stand behind the finished work. 

Preparing for Bonding Requirements

Before any bond gets issued, a surety is going to take a close look at the contractor requesting it. Most evaluate what the industry calls the Three Cs: Character, Capacity, and Capital.

Character covers reputation, credit history, and track record. Has the company met obligations in the past? Are bills paid on time? Capacity is about whether the company has the people, equipment, and experience to complete the project. Capital is finances, including cash flow, profitability, and debt.

The size of the project also becomes a factor. Smaller projects may rely mostly on credit history and basic financial information. Larger projects typically require CPA-prepared statements, work-in-progress (WIP) schedules, and detailed construction-specific reporting. Because of this, construction companies are encouraged to work with advisors to prepare for the bonding process. 

Contact Us

Each bond serves a different purpose at a different stage of a project. Contractors who understand the types of bonds are better positioned to answer customer questions, meet obligations, and maintain a competitive edge. If you have questions about the information outlined above or need assistance with another tax or accounting issue, Wilson Lewis can help. For additional information call 770-476-1004 or click here to contact us. We look forward to speaking with you soon.