Qualfiying for a contract bond is a lot like qualifying for a loan. Most surety underwriters were trained the same as bank loan officers. They evaluate you in three broad categories known as the Three Cs:

  • Character: does your record show you are faithful to your obligations?
  • Capacity: do you have the experience, skill, knowledge, personnel, and equipment to perform the project?
  • Capital: do you have the financial capacity to finance or support the project, along with other projects you have in process, until final completion and payment?

These days there is also a fourth C, Conditions -- are the terms and conditions of the contract reasonable and fair?

You will be required to sign an indemnity agreement. This agreement spells out your obligation to reimburse the surety company for any bond claims they pay or expenses they incur while completing your contract obligations.

Your business entity will have to sign this agreement and all of your business owners and their spouses will have to personally sign. We are sometimes asked why owners and spouses have to personally sign, after all you form corporations or LLCs to limit personal liability. However, you are asking a surety company that has no control over your day to day business operations to guarantee that you will perform. It is only resonable to expect those who own and control your business be willing to guaranttee that performance too.

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Common Contract Bond Terminology

Bid Bonds

Guarantees that a contractor will enter into a contract for the amount they bid and provide the required performance and payment bonds. So to obtain a bid bond you must prequalify for the performance bond.

Performance Bonds

Guarantees that a contractor will complete the work as specified in the contract.

Payment (or Lien) Bonds

Guarantees that the contractor will pay all labor, suppliers, and subcontractors and prevent liens on the project.

Maintenance (or Warranty) Bonds

Guarantees that the contractor will repair defects and fulfill all warranties during the warranty period after completion of the project.

Bond Penalty

Is the dollar amount of the bond and is the most the surety will pay in the event of a claim. The penalty on performance and payment bonds is usually 100% of the contract they guarantee. Some contracts allow for bonds less than 100% but the cost of a 100% bond is the same as a lesser bond penalty so they are not often used. Bid bond penalty is usually a percentage of the bid such as 5, 10, or 20%. However, prequalification for a bid bond is based on the full bid amount since the surety is really prequalifying you for the performance bond if you are awarded the contract.

Obligee

Is the project owner or prime contractor that you are contracting with to perfrom your work.

Bond Cost

Is a percentage of the full contact amount. Often it is a graded percentage that varies as the contract gets larger. When the project is completed the charge for the bond is adjusted up or down to match the final contract amount after change orders. Bid bonds are usually a small annual service fee or free.