What is a Construction Bond?

A construction bond guarantees that a construction job gets completed on time. Other names for a construction bond include performance bond, surety bond, or a contract bond. Laws require construction companies, builders, or general contractors to obtain a construction bond for public projects. If the contractor is unable to complete a particular project, the surety company takes action to ensure that another contractor finishes the work.

In most jurisdictions, laws require contractors to provide a construction bond for public projects such as a new government office building or a highway. This protects public funds if the builder is unable to complete the project. These laws, however, do not necessarily apply to private projects. For private projects, depending on the jurisdiction, obtaining a bond may be matter negotiation. In other words, a private owner may ask a contractor to obtain a bond as a condition for getting a particular job.

A construction bond protects against a contractor becoming insolvent. This means that the contractor is not able to pay its debts as they become due. If this occurs, most likely the contractor loses the ability to complete a particular project. A construction bond also protects against other types of risks such as the contractor failing to meet contract specifications.

A contractor obtains a construction bond from a surety company. The surety evaluates the contractor based on several factors including financial strength, credit history, references, and experience. The surety essentially reviews  the contractor’s business operations and history. If the surety is satisfied that the contractor is capable of getting a particular job done, it sells the contractor a bond. The surety usually bases the price of the bond upon a percentage of the total contract price. 

If a contractor is unable to complete a project, a default occurs. The owner of the project notifies the surety company. The bond obligates the surety to remedy the problem. The surety determines whether the default is legitimate. If it is, the surety must hire another contractor to complete the job and possibly pay a penalty depending on the terms of the bond. 

The drawback of a construction bond is its cost. Since the price of a bond often depends on the costs of a particular project, the expense for the bond may prohibit competition for projects. Less competition generally means higher prices. Ultimately, a contractor passes the cost of the bond to the party paying for the job, which in the case of a public project is generally the taxpayer. In a private project, the property owner must decide whether he should require a contractor to obtain a bond, unless local law and/or a bank financing the project requires the bond.