Contract bonds, also called contract surety bonds, are three-party agreements in which a surety company backs a contractor’s promise to a project owner to perform a construction contract and pay its subcontractors and suppliers. They are not insurance: the bond protects the project owner, and the contractor is ultimately responsible for repaying any claim.
Key Points
- A contract surety bond is a three-party agreement among the principal (the contractor), the obligee (the project owner), and the surety that stands behind the contractor’s obligation to the owner (SFAA).
- Contract bonds are not insurance: the contractor signs an indemnity agreement and must repay the surety for any claim it pays, so the risk stays with the contractor (SFAA, NASBP).
- The four common types are bid bonds, performance bonds, payment bonds, and maintenance bonds.
- Federal construction contracts over $150,000 require performance and payment bonds (FAR 28.102-1); contracts between $35,000 and $150,000 require alternative payment protections, and state “Little Miller Acts” vary (SFAA).
- Sureties prequalify contractors on character, capacity, and capital before issuing a bond (SFAA).
- The SBA Surety Bond Guarantee Program backs bonds for qualifying small businesses on contracts up to $9 million, or $14 million for certain federal contracts, with a 0.6% guarantee fee on performance and payment bonds and none on bid bonds (SBA).
What Are Contract Bonds?
Contract bonds are a type of surety bond that assures a project owner a construction contract will be carried out according to its terms. A surety bond is a three-party agreement. The principal (the contractor) undertakes the obligation, the obligee (the project owner, often a government agency or developer) receives the benefit of the bond, and the surety stands behind the principal’s promise (SFAA).
Depending on the bond, a contract surety bond may protect an owner from financial loss if a contractor fails to perform or doesn’t pay subcontractors and suppliers. Before issuing a bond, the surety evaluates, or prequalifies, the contractor, which is why bonding also acts as a screen for who can bid on bonded work.
Read: The role of surety companies
Are Contract Bonds Insurance?
No. Both are regulated by state insurance departments, and many sureties are divisions of insurance companies, but they work differently (SFAA). In traditional insurance, the risk is transferred to the insurer, which expects to pay some losses. In suretyship, the risk remains with the principal, and the protection of the bond is for the obligee. Sureties treat underwriting as a form of credit, so the emphasis is on prequalification and selection (SFAA).
| Feature | Contract bond | Insurance policy |
|---|---|---|
| Parties | Three: principal (contractor), obligee (owner), and surety | Two: the policyholder and the insurer |
| Who is protected | The obligee (project owner), and subcontractors and suppliers under a payment bond | The policyholder |
| Who bears the loss | The contractor, who must repay the surety under an indemnity agreement | The insurer, which expects to pay some claims |
| Underwriting focus | Prequalification: character, capacity, and capital | Spreading risk across many policyholders |
The contractor typically signs a general indemnity agreement, and sureties often ask for the personal indemnity of the owners of a closely held company (SFAA, NASBP). If the surety pays a claim, it can seek repayment from the contractor.
Why Are Contract Bonds Necessary?
Contract bonds are used on public and private construction projects for several reasons.
Assurance of completion
A performance bond gives a project owner a financial remedy if a contractor does not complete the work as the contract requires. The surety’s prequalification also screens contractors before the project starts, which is why owners often view a bonded contractor as a lower-risk choice.
Financial protection
Government owners use bonds to protect public money. Many states and the federal government require contract bonds on projects above set contract amounts, because a failed project could otherwise leave taxpayers with the loss.
Legal requirements
Federal and state laws require bonds on many public works projects above a threshold. The sections below cover the federal and state rules.
Risk mitigation
Payment bonds can also protect subcontractors and suppliers on a bonded project. Because sureties prequalify contractors, bonding may also limit bidding on bonded work to companies that can show the financial capacity to perform.
What Are the Primary Types of Contract Bonds?
There are four main types of contract bonds, each serving a specific purpose:
Bid bond
A bid bond assures the project owner that the winning bidder will sign the contract and provide the required performance and payment bonds if the contract is awarded. If the bidder backs out, the owner may claim against the bid bond, up to its stated amount. The SBA charges no guarantee fee on bid bonds (SBA).
Performance bond
A performance bond secures performance and fulfillment of the contractor’s obligations under the contract (FAR 28.001). If the contractor defaults, the surety may arrange for the work to be completed or pay the owner, up to the bond’s penal amount, and then seek repayment from the contractor under the indemnity agreement.
Payment bond
A payment bond is the protection for subcontractors and suppliers of labor and materials on a project. If the contractor does not pay them, an eligible claimant may seek payment under the bond, up to its amount. On federal construction projects, the payment bond is a separate bond required alongside the performance bond (SFAA).
Maintenance bond
A maintenance bond covers defects in workmanship or materials for a specified period after the project is completed. The period is commonly one year, but terms are set by the contract.
Learn: Increasing your bonding capacity
Where Are Contract Bonds Required?
Contract bonds are often required on federal, state, and local government projects, and they are sometimes required on private projects by owners or lenders.
- Federal projects: the Miller Act (40 U.S.C. chapter 31, subchapter III) as implemented by FAR 28.102-1 requires performance and payment bonds for any federal construction contract exceeding $150,000, furnished before the contractor is given notice to proceed (FAR 28.102-1).
- Smaller federal contracts: for construction contracts greater than $35,000 but not greater than $150,000, the contracting officer selects two or more payment protections, such as a payment bond, an irrevocable letter of credit, or certificates of deposit (FAR 28.102-1).
- State and local projects: many states and local governments require bonds on public construction through “Little Miller Acts,” and the thresholds and rules vary by state (SFAA).
- Private projects: owners and lenders may require bonds voluntarily, and the requirement comes from the contract (SFAA).
How Do Contractors Qualify for a Contract Bond?
To issue a contract surety bond, a surety prequalifies the contractor. Sureties commonly look at three factors, known as the three Cs (SFAA):
- Character: whether the contractor’s record shows a likelihood of performing the obligation it assumes.
- Capacity: the contractor’s experience, staffing, and ability to perform the work.
- Capital: the contractor’s financial strength and working capital.
A surety’s decision also sets a contractor’s bonding capacity, the amount of bonded work it is willing to support. The bond premium is a fee tied to the contract, and it varies with the contract, the contractor’s financial strength, and the surety, so a quote is the way to see a price.
Small contractors that cannot get bonded through regular channels may qualify for the SBA Surety Bond Guarantee Program. The SBA backs bonds issued by participating sureties, it is open to businesses that meet SBA size standards, and it supports contracts up to $9 million, or $14 million for certain federal contracts when a contracting officer certifies the guarantee is necessary. The SBA’s fee is 0.6% of the contract price for performance and payment bond guarantees and nothing for bid bonds, in addition to the surety’s premium (SBA). An Insurance Specialist can explain how an SBA surety bond works with a surety partner.
How Do Contract Bonds Benefit Contractors?
Bonding is a financial commitment, since the contractor remains responsible for repaying any claim, but it can open doors:
Access to more projects
Public projects and many larger private projects require bonds as part of the bidding process. Maintaining bonding capacity may keep a contractor eligible for that work and for larger contracts.
Credibility with owners
A bond shows that a surety has evaluated the contractor’s character, capacity, and capital, which can build trust with project owners and partners.
Clear project expectations
Bonded contracts spell out the obligations the bond secures, which helps contractor and owner align on deliverables.
Less competition on bonded work
Not every contractor can qualify for a bond, which may reduce the number of bidders on bonded projects.
Frequently Asked Questions About Contract Bonds
What are contract bonds?
Contract bonds are surety bonds that assure a project owner a construction contract will be performed and that subcontractors and suppliers will be paid, depending on the bond. They are three-party agreements among the contractor, the project owner, and a surety.
What is a contract surety bond?
A contract surety bond is a written agreement in which a surety backs a contractor’s obligation to a project owner. The contractor is the principal, the owner is the obligee, and the surety evaluates the contractor before issuing the bond and may pay a claim if the contractor defaults (SFAA).
Are contract bonds insurance?
No. A contract bond is a three-party agreement in which the contractor signs an indemnity agreement and must repay the surety for any claim paid, so the risk remains with the contractor. Traditional insurance is a two-party agreement in which the insurer expects to pay some losses (SFAA, NASBP).
What are the types of contract bonds?
The four common types of contract bonds are bid bonds, performance bonds, payment bonds, and maintenance bonds. Each secures a different stage of a construction project, from bidding through the warranty period.
What is a bid bond?
A bid bond assures the project owner that the winning bidder will sign the contract and provide the required performance and payment bonds. If the bidder backs out, the owner may claim against the bond up to its stated amount.
What is a performance bond?
A performance bond secures performance and fulfillment of the contractor’s obligations under the contract (FAR 28.001). If the contractor defaults, the surety may arrange for completion or pay the owner up to the bond amount, then seek repayment from the contractor.
What is a payment bond?
A payment bond is the protection for subcontractors and suppliers of labor and materials on a bonded project. If the contractor does not pay them, eligible claimants may seek payment under the bond, up to its amount.
When are contract bonds required on federal projects?
Federal construction contracts exceeding $150,000 require performance and payment bonds under FAR 28.102-1. For contracts greater than $35,000 but not greater than $150,000, the contracting officer selects two or more payment protections. State and local requirements vary under each state’s Little Miller Act.
How do I get a contract bond?
A surety prequalifies the contractor, commonly looking at character, capacity, and capital, and the contractor typically signs an indemnity agreement. An Insurance Specialist can work with surety partners to review a contractor’s financials, experience, and the bond a project requires.
How much does a contract bond cost?
The premium is a fee tied to the contract amount, and it varies with the contract, the contractor’s financial strength, and the surety, so there is no single price that applies to every contractor. If a bond is backed by the SBA program, the SBA also charges 0.6% of the contract price for performance and payment bond guarantees (SBA).
Does the SBA help contractors get bonded?
Yes, through the SBA Surety Bond Guarantee Program. An SBA surety bond helps small businesses that cannot obtain bonds through regular channels, for contracts up to $9 million, or $14 million for certain federal contracts with a contracting officer’s certification (SBA).
Sources
- Federal Acquisition Regulation — 28.102-1 General (Miller Act bond requirements)
- Federal Acquisition Regulation — Part 28, Bonds and Insurance (definitions)
- Surety & Fidelity Association of America — What Is a Surety Bond?
- Surety & Fidelity Association of America — About Surety
- Surety & Fidelity Association of America — Private Owners & Bankers (Little Miller Acts)
- NASBP — What Are Surety Bonds?
- U.S. Small Business Administration — Surety Bonds
Richard Ford
