Entering the public construction field may entail a bit of “culture shock” for those who have previously done only private contracting work or who are new to construction contracting altogether. Work of any nature done in the public sector is subject to tight regulation—due to safety concerns and the fact that such work is funded by taxpayers. As a taxpayer yourself, you can certainly appreciate the need to ensure that our hard-earned money is being used wisely for the benefit of the public.
Public construction also presents another challenge many private sector contractors may have little experience with—construction bonding. Here’s everything you need to know about public sector construction project bonds.
What Are Public Construction Bonds?
Construction bonds are something every contractor seeking construction work in the public sector needs to learn about. There are bonding requirements at practically every stage of the construction process, from bidding through building—and even for some time after a project has been completed.
All public construction bonds serve the same general purpose: to protect the project owner (whatever government entity that might be) from financial loss due to the unlawful or unethical actions of the contractor. Construction surety bonds ensure that contractors abide by all applicable laws, regulations, and rules specified by the project owner or pay a penalty large enough to cover the cost of remediating any problems caused by their failure to do so.
Who Needs Them?
If you plan to bid on federal, state, or municipal public works projects, or if you intend to serve as a subcontractor on such projects, you’ll likely need to purchase one or more public construction bonds for your projects. That applies to both general contractors and specialty contractors, such as electricians, plumbers, HVAC specialists, and so on.
You will definitely need to obtain certain surety bonds if you are bidding on or awarded a federal public works project valued over $100,000. This bond requirement is mandated by federal legislation known as the Millar Act, which has been around since the 1930s. Most states have their own version of the Miller Act, referred to collectively as “Little Miller Acts,” which apply to state-funded public works projects valued over a certain dollar mount, usually over $50,000.
The Main Types of Public Construction Bonds
There are three main types of bonds that are usually required for public construction projects: bid bonds, performance bonds, and payment bonds. Each bond serves a different purpose at a different point in the construction process. Here’s what you need to know:
Competitive bidding is the name of the game when it comes to public construction contract awards. Project owners put a lot of time and money into advertising new construction projects, evaluating proposals and bids, vetting potential contractors, selecting a contractor, and establishing a legally binding contract. If the chosen contractor backs out and does not accept the job, the project owner is left “holding the bag,” so to speak, and has to go through that whole time-consuming and costly process again.
Requiring a bid bond from every bidder provides a financial guarantee that the bidder is acting in good faith and intends to enter into the contract at the bid price, obtain other required bonds, and complete the work as spelled out in the contract.
Project owners also must consider the possibility that a contractor won’t complete the job according to the contract requirements or that they may default on the contract entirely. A performance bond protects against the loss of taxpayer dollars that would occur if it became necessary to bring in another contractor to finish the project.
Payment bonds are required as a way to ensure that contractors pay suppliers, workers, and subcontractors in accordance with contract terms. These bonds protect the project owner and taxpayers from any construction delays that could result from the contractor’s failure to make scheduled payments.
Insurance vs Surety Bonds
The most important thing to understand about public construction bonds (or private construction bonds, for that matter) is that they are not insurance.
Insurance protects and pays benefits to the person who purchases a policy and pays the insurance premiums. Surety bonds for public construction protect the government entity funding a project (known as the obligee), not the contractor (known as the principal) who pays the premium to purchase the bond. The third party in the construction bond agreement is the company (known as the surety) that underwrites and issues the bond.
The main difference between insurance and construction surety bonds is that insurance transfers the risk of financial loss from the policyholder to the insurance company. Construction surety bonds transfer the risk of financial loss from the project owner to the contractor (from the obligee to the principal).
How Does It Work?
When a contractor fails to live up to the terms of a public construction bond, the obligee has the right to file a claim against the bond to compensate for any financial loss incurred as a result of the contractor’s actions. The surety will investigate the claim, and if it is found to be valid, they will attempt to negotiate a settlement that gets the project completed with as little additional cost as possible. If no agreement can be reached, the surety will go ahead and pay the claim up to the full penal amount of the bond.
That’s not the end of the story, however. Surety bond agreements include an indemnification clause stating that the principal is ultimately responsible for paying out claims. That means that the principal must reimburse the surety for any amount paid out on a claim. Most sureties are willing to give the principal time to come up with the money to reimburse them for claims paid on a contractor’s behalf, and may even work out a payment schedule.
What Do They Cost?
Given that the surety must rely on the contractor to ultimately pay out any valid claims, the most important factor the surety will consider in deciding whether or not to approve a bond application is the applicant’s personal credit score, business history, and financial assets.
As with all other surety bonds, the premium rates for bid bonds, performance bonds, payment bonds and all other bonds that may be required for a public construction project are calculated as a small fraction of the total bond amount required by the obligee. The likelihood of incurring claims and the contractor’s ability to reimburse the surety for any claims paid on the contractor’s behalf are a surety’s primary concern. Applicants with good credit and strong financials may pay as little as 1% to 3% of the bond amount, while those with poor credit will likely pay a higher rate.
Request A Quote
Whether you’re new to public construction contracting or a seasoned veteran, the construction bonding experts at Contractor Surety Group will help you understand your bonding requirements and get the best possible rate.
Contact us today to request a quote.