What Is a Contractor's Bond?

A contractor's bond is an agreement between the contractor, customer and a surety company. The contractor is listed as the principal on the bond, and the customer is the obligee. Most states require a contractor to be bonded before he can get a license. Large projects may require an additional bond covering only that project.

Function

A contractor's bond provides a financial guarantee that the contractor will perform a job correctly. If the contractor does not fulfill the contract, the surety company will pay a predetermined amount of money to the customer. Contractor's bonds may also include payouts for damage to the property caused by the contractor, lost or stolen materials and unpaid subcontractors or material suppliers.

Significance

The contractor's bond can help attract customers by making them more confident that the contractor will complete the job. This is especially important when working with new customers who are unsure of the quality of the contractor's work. Subcontractors and suppliers may also prefer to work with a general contractor who is bonded, because it assures them that they will be paid according to the contract.

Amount

The premium for a contractor's bond is based on the payout amount of the bond and the surety company's assessment of the risk. The surety company's underwriter will consider the contractor's past history with owners, subcontractors, suppliers, engineers and architects. The current net worth of the contractor is also important when determining the risk of failure on the bond. A contractor with significant assets is more likely to be able to complete a job than a contractor who is struggling to make his weekly payroll. The surety company sets the dollar limit of the bond by analyzing the contractor's available employees and equipment to decide how much work the contractor is capable of performing.

Considerations

Contractors should shop around when purchasing a contractor's bond. Premium rates can vary greatly between different surety companies. Some surety companies may offer higher dollar limits than others, allowing the contractor to bid on larger projects. The financial strength and reputation of the surety company is also important. Customers and suppliers may be reluctant to work with a contractor whose bond comes from an unknown company.

Filing a Claim

Contractor's bonds generally require the obligee to file a predefault notice to give the surety company a chance to avoid a default. First, a meeting will be scheduled between the surety company, contractor, customer and any subcontractors or suppliers involved in the default. If there is no way for the parties to come to an agreement and finish the job, the surety company may complete the work itself or hire another contractor to take over the job. If it is only a matter of funding, the surety company may advance or loan money to the contractor to finish the job. When there is no feasible way to avoid a default, the surety company must pay out the amount listed on the bond.