Construction Bonds

Construction bonds are a type of surety bond used to protect project owners, investors, and taxpayers from financial losses in the event that a contractor fails to meet their contractual obligations. These bonds act as a financial guarantee that the contractor (known as the principal) will complete the work as agreed, or that losses will be covered by the bond’s issuing surety company.

Construction bonds are commonly required on public works projects, though many private developers and lenders also require them as part of their risk management strategy. They are essential for ensuring accountability, minimizing disputes, and keeping complex projects on track.

Construction bonds are three-party agreements that provide financial protection in the event a contractor fails to meet their contractual obligations. Here’s how they work:

• Principal – The contractor who performs the work.
• Obligee – The project owner who requires the bond for protection.
• Surety – The bond company that guarantees the contractor’s obligations.
   

What is the Purpose

Construction bonds exist to turn a contractor’s promises into enforceable guarantees. They protect the project owner, keep money flowing to subs and suppliers, and promote disciplined, on-time delivery, especially on public projects where accountability matters most.

• Protect owners against default/non-completion
• Ensure payment to subs and suppliers (avoid liens)
• Safeguard public funds and improve governance
• Prequalify contractors (capacity, capital, character)
• Encourage on-time, in-spec delivery
   

When They’re Used

Construction bonds are typically required in the following situations:

• Public works projects funded by federal, state, or local governments (often mandated by law)
• Private construction projects where developers want to mitigate risk
• Projects financed through loans, where lenders require bonding for protection
• Jobs involving multiple subcontractors or suppliers, to ensure all parties are paid and protected
• Competitive bidding scenarios, where a bid bond may be required to validate contractor intent and financial stability
   

What Happens if a Claim Is Filed?

If a contractor fails to perform or pay as agreed:

1. The project owner files a claim with the surety.
2. The surety investigates the claim.
3. If valid, the surety compensates the obligee or arranges for project completion.
4. The contractor must reimburse the surety for any losses paid out.
    

This bond structure reduces financial risk and ensures project continuity—whether the issue is non-performance, late payments, or unfinished work.

For Project Owners (Obligees)

• Financial protection against default — performance bonds cover the cost to finish the job if the contractor fails.
   
• Assured payments to subs/suppliers — payment bonds reduce lien risk and keep projects moving.
   
• Prequalified contractors — bonding screens for capacity, capital, and character (the “3 Cs”).
   
• Schedule & quality discipline — bond terms incentivize on-time, in-spec delivery.
   
• Lower total project risk — can improve bid participation, pricing, and lender confidence.
   
• Public funds safeguarded — required on most public works (Miller/Little Miller Acts).
   

For Contractors (Principals)

• Access to bigger projects — many public and large private jobs require bonding.
   
• Credibility signal — being bondable demonstrates financial strength and sound controls.
   
• Competitive edge in bids — owners favor contractors who can furnish P&P bonds without delays.
   
• Dispute support — surety involvement can help stabilize troubled projects and avoid formal default.
   
• Capacity planning — a surety relationship helps you grow single/aggregate limits over time.
   

For Subcontractors & Suppliers

• Reliable payment — payment bonds help ensure labor and materials are paid even if the prime struggles.
   
• Fewer liens and cash-flow shocks — reduces cascading risk across the trade chain.
   
• More stable collaboration — clear claim paths improve predictability.

Construction bonds come in several forms, each designed to protect against specific risks in a building project. Understanding the differences can help contractors and project owners choose the right coverage for each phase of the job.

Bid Bonds

Bid bonds guarantee that a contractor will enter into a contract and provide the required performance and payment bonds if selected. They prevent contractors from submitting unqualified or unserious bids.

Performance Bonds

Performance bonds ensure that the contractor will complete the project according to the terms and specifications of the contract. If the contractor defaults, the surety may step in to complete the work or compensate the project owner.

Payment Bonds

Payment bonds guarantee that subcontractors, laborers, and suppliers will be paid. These bonds reduce the risk of liens or project disruptions due to unpaid parties.

Maintenance Bonds (Warranty Bonds)

These bonds cover defects in workmanship or materials for a defined period after project completion. They protect owners from having to pay for repairs that should have been covered under the contractor’s original responsibility.

Subdivision Bonds

Subdivision bonds are often required by municipalities for land developers. They guarantee that public improvements (like roads or utilities) will be completed as agreed.

Supply Bonds

Supply bonds guarantee that a supplier will deliver materials or equipment as contracted. They are often used when a contractor depends on timely, large-scale deliveries.

Completion Bonds

Completion bonds are commonly used in large or complex projects. They guarantee that the entire project will be finished, even if the contractor is unable to do so.

Retention Bonds

Retention bonds allow the project owner to release retained funds (normally held back until project completion) while still maintaining protection in case issues arise later.

Construction bond costs, often referred to as surety bond premiums, typically range from 1% to 3% of the total contract value. The exact cost varies depending on several key factors, such as the contractor’s financial profile, the size and complexity of the project, and the type and duration of the bond.

Key Factors Influencing Construction Bond Costs

• Contractor’s Financial Strength: A strong credit score and healthy financial history can significantly lower bond premiums, as they indicate a lower risk of default.
   
• Creditworthiness: Surety companies review business and personal financial statements, including cash flow and balance sheets, to assess the contractor’s ability to meet obligations.
   
• Project Size and Value: Larger contracts generally lead to higher bond amounts since they represent greater financial exposure and risk.
   
• Contractor’s Experience and Reputation: A history of successful project completions helps build trust with sureties and can qualify a contractor for better rates.
   
• Type of Bond: Costs vary by bond type. For instance, performance and payment bonds usually carry higher premiums than bid bonds, which pose less risk.
   
• Bond Duration: Bonds covering longer project timelines often have higher premiums because the risk extends over a longer period.
   
• Obligee Requirements: Specific conditions set by the obligee (the project owner or regulatory body) may affect the bond’s cost and structure.
   

Fixed Premiums for Small Bonds

For smaller construction bonds (typically under $50,000), many surety companies offer fixed premium tiers, often $100 or $250, instead of using a percentage-based rate. This simplifies the cost structure for lower-value projects and provides predictable pricing.

Multiple Bonds, One Application

If both a performance bond and a payment bond are required for a project (a common scenario), you usually won’t pay two separate premiums. These bonds are generally bundled together under one combined rate, making the process more efficient and cost-effective.

How to Potentially Lower Your Bond Cost

• Improve Financial Health: Keep your credit score high and maintain organized, accurate financial statements.
   
• Show Proven Experience: Compile a record of past projects and references to demonstrate reliability and project management capability.
   
• Add a Cosigner: Partnering with a financially strong cosigner can help secure more favorable terms.
   

Calculating the Cost

Bond premiums are calculated by multiplying the total contract value by the premium rate offered by the surety company.

Example: For a $1 million contract with a 2% premium rate, the bond cost would be $20,000.

Construction bonds are commonly required to ensure accountability, especially on large or publicly funded projects. Whether mandated by law or requested by private developers, these bonds help protect all parties involved.

Public Projects

Most federal, state, and municipal construction projects require contractors to obtain bonds before work begins. This requirement is based on laws like:

• The Miller Act (federal): Requires performance and payment bonds for federal contracts over $100,000.
• Little Miller Acts (state-level): State-specific laws that mirror the federal requirement for state-funded projects.
   

In these cases, both performance and payment bonds are typically mandatory.

Private Projects

While not always legally required, many private project owners still demand construction bonds, especially on high-value jobs or when working with unfamiliar contractors. These bonds offer peace of mind by guaranteeing the project will be completed as agreed.

Industry Standards

Construction bonds are frequently required in the following scenarios:

• Bidding on public jobs (bid bonds)
• Executing government contracts (performance and payment bonds)
• Ensuring long-term quality (maintenance or warranty bonds)
• Complying with municipal or subdivision agreements (subdivision bonds)
   

If you’re bidding on or awarded a public job, or working with a cautious private developer, expect to be asked for a construction bond. Securing the right bond early can prevent delays and demonstrate your reliability as a contractor.

Getting a construction bond involves more than filling out a form. It’s a process that evaluates your business’s financial health, track record, and overall risk profile. Here’s what to expect when applying:

1. Work with a Bond Broker or Surety Agent

Choose a reputable bond agency like Lance Surety Bonds, which specializes in construction bonds. A knowledgeable agent can walk you through the process, help gather necessary documentation, and connect you with the right surety provider.

2. Complete the Application

You’ll need to provide details about your company, the specific project, and the bond amount required. Most applications include:

• Business and owner information
• Project description and contract terms
• Required bond type(s)
   

3. Submit Financial Documentation

Sureties will request:

• CPA-prepared business financial statements
• Personal financial statements
• Work-in-progress reports
• Bank references
• Resumes or bios of key company principals
   

This documentation helps assess your bonding capacity and risk profile.

4. Undergo Risk Assessment

The surety underwriter reviews your credit, finances, experience, and capacity to complete the project. For larger bonds, they’ll look even deeper into your financials, work history, and business operations.

5. Receive Your Bond Quote

Once approved, you’ll get a premium quote (usually 1–3% of the bond amount for well-qualified applicants). You may also receive multiple options depending on the surety’s assessment.

6. Pay the Premium and Sign the Bond Agreement

After payment, you’ll sign an indemnity agreement, which holds you and your business responsible for any valid claims paid by the surety.

7. Submit the Bond to the Obligee

Once issued, you’ll file the bond with the project owner or government agency requiring it.

Construction bonds are more than just formalities, they serve as legally enforceable guarantees that protect project owners and stakeholders. When a contractor fails to meet contractual obligations, these bonds provide a structured way for affected parties to seek compensation.

When Can a Claim Be Filed?

A claim can be made against a construction bond when the contractor:

• Fails to complete the project (covered by a performance bond)
• Does not pay subcontractors, suppliers, or laborers (covered by a payment bond)
• Withdraws from a bid after being awarded the contract (covered by a bid bond)
• Delivers work that is defective or outside contract specs (covered by a maintenance bond)
   

In short, claims typically arise when the contractor breaches the terms of the bonded agreement.

What’s Covered?

Coverage depends on the bond type, but generally includes:

• Cost to complete the project (performance bond)
• Unpaid invoices to suppliers and subcontractors (payment bond)
• Damages from defective workmanship during a warranty period (maintenance bond)
   

What’s Not Covered?

Construction bonds do not typically cover:

• Design flaws or architectural errors
• Force majeure events (e.g., natural disasters, war)
• Project delays not caused by the contractor
• Disputes unrelated to contract breach
   

How Are Claims Handled?

When a claim is filed:

1. The surety investigates the claim.
2. If valid, the surety may:
   • Pay the obligee directly,
   • Hire a replacement contractor,
   • Or compensate affected subcontractors or suppliers.
3. The contractor must repay the surety for the full claim amount and related legal or administrative costs.
    

Construction bond claims can be costly, both financially and reputationally. That’s why choosing a strong surety partner and maintaining compliance is so important.

To qualify for a construction bond, contractors must meet specific financial and experience-based requirements that demonstrate to the surety their capability to complete projects reliably and responsibly.

Common Requirements

• CPA-prepared business financial statements
• Personal and business credit checks
• Proof of relevant industry experience
• Completed bond application form
• Banking and supplier references
   

Surety providers use this information to evaluate the contractor’s financial strength, reliability, and overall risk level, which helps determine both the bond limit and premium rate.

Key Eligibility Factors

• Strong Credit History: A solid credit profile is one of the most important factors. While some sureties accept applicants with lower credit, they often charge higher premiums.
   
• Adequate Working Capital and Net Worth: Sufficient financial resources reassure the surety of the contractor’s ability to fulfill obligations.
   
• Clean Record: A history free of bond claims, defaults, or major contract disputes improves eligibility.
   
• Proven Project Experience: Demonstrated success managing projects of similar size and scope increases approval chances.
   

Meeting these requirements not only improves the likelihood of approval but can also help contractors secure more favorable bond rates.

Construction bonds are a critical risk-management tool, but they are not universally required or straightforward in every scenario. Below are key special cases, statutory rules, and limitations that contractors, project owners, and lawyers should know.

1. Public vs. Private Project Applicability

• Federal projects exceeding certain thresholds are legally required to carry payment and performance bonds under the Miller Act.
   
• The Federal Acquisition Regulation (FAR) codifies this: for federal contracts over $150,000, both performance and payment bonds are generally required.
   
• For contracts between $35,000 and $150,000, agencies may require payment protection (which might include a bond).
   
• At the state and local level, many jurisdictions adopt “Little Miller Acts,” which mirror the federal requirement and set their own thresholds and rules.
   
• Private projects usually lack statutory bond obligations; whether a bond is required is often dictated by the owner, lender, or contract documents.

2. Developer / Subdivision Bonds

• Also called improvement bonds or plat bonds, these are required by many municipalities before work begins on new subdivisions.
   
• They ensure the developer completes infrastructure (curbs, sidewalks, roads, utilities) according to approved plans.
   
• Local ordinances often limit the penal sum (e.g. no more than 125% of estimated cost) and define the scope (must complete, not maintain) of improvements.
   
• Once all improvements are accepted, municipalities typically release or return the bond.
   

3. Exemptions, Waivers & Exceptions

• Some federal contracts performed abroad may be waived from the Miller Act’s bonding requirement if obtaining a bond is impracticable.
   
• Contracting officers have discretion to waive or alter bonding requirements when conditions justify it.
   
• Small public contracts below statutory thresholds often do not require bonds under Little Miller Acts.
   
• In private work or small residential remodeling, bonds are rarely mandated unless required by the contract or lender.
   

4. Jurisdictional & Geographic Constraints

• Tribal or sovereign land projects may fall outside standard federal or state bond statutes; tribal governance and jurisdiction can dictate alternative bonding regimes.
   
• International contracts bring added complexity: local surety licensing, exchange rates, regulatory compliance, or reinsurance may be required.
   
• In multi-year contracts, sureties may impose term limits, periodic renewal reviews, or supplemental requirements as the project progresses to mitigate long-term exposure.
   

5. Credit, Financial Issues & Bonding Capacity

• Contractors with weak credit, prior defaults, or marginal financials may face reduced bonding capacity, higher premiums, or collateral demands.
   
• Some specialized programs (e.g. SBA surety programs in the U.S.) may permit bonding under more restrictive terms, often with additional guarantors or collateral.

6. Statutory Notice & Claim Limitations (Example: Miller Act)

• Under the Miller Act, subcontractors and suppliers who have not been paid may file claims on the payment bond, but they must satisfy notice requirements and deadlines (e.g. within 90 days of last furnishing labor/materials).
   
• Lawsuits to enforce a Miller Act payment bond typically must be filed within one year of the last work date.
   
• These procedural rules are strict, and failing to comply may forfeit bond claim rights.

What is the difference between a construction bond and a performance bond?

A construction bond is a broad term that includes several types of surety bonds used in construction, including performance bonds. A performance bond specifically guarantees that the contractor will complete the project according to the contract terms.

Are construction bonds required for every project?

Not always. They’re typically required for public works contracts and large private projects. Smaller private jobs may not require them unless requested by the project owner or lender.

Do construction bonds cover changes in project scope?

Generally, no. Construction bonds guarantee performance and payment under the terms of the original contract. If the project scope changes significantly, the obligee or surety may require a new or adjusted bond.

Can subcontractors require the prime contractor to get a payment bond?

Yes, subcontractors can request proof of a payment bond before starting work, particularly if they want assurance of payment. Payment bonds protect subcontractors and suppliers from nonpayment by the prime contractor.

Can I get bonded with bad credit?

Yes. Contractors with credit issues can often still qualify through specialized programs, although they may pay a higher premium and need to provide more documentation.

What happens if a claim is filed against my bond?

The surety will investigate the claim. If it’s valid, they’ll pay the claimant, then seek reimbursement from you as the contractor. That’s why it’s important to resolve issues early and work with a trusted bonding agency.

What are the legal and regulatory aspects of construction bonds?

Construction bonds have specific legal obligations and statutory requirements that vary by jurisdiction. They differ from insurance in that bonds protect project owners and oblige contractors to fulfill contract terms, rather than covering damages or losses directly.