Contract surety bonds are a crucial part of many construction projects. They provide important protection for project owners, general contractors who procure bonds from subcontractors and suppliers, and even lenders in some cases. At their core, contract-related bonds secure both project performance and payment of project-related costs. They are also generally mandatory for publicly-funded projects.

Having a surety relationship in place is a key component for many contractors’ business plans. The process for securing a surety relationship can seem complex and daunting. While there are questions to answer and information to provide, it does not have to be a confusing, time-consuming process.

Here is what those in the construction industry need to know about surety and how to secure the right partner.

What is contract surety?

Contract surety is a form of suretyship used frequently in the construction and product/service supply sector. Surety bonds are generally provided by insurance companies specializing in this area with the product representing a three-party obligation. The insurance company is the first party and acts as the surety, who guarantees the performance of the second party, the contractor, to a third party, the obligee. An important distinction here is that surety is not insurance for the contractor, it’s a credit guarantee like what a lending institution provides.

In layman’s terms, here’s what happens: A developer wants to build a project, so it hires a construction company. In order to provide security that the project will actually get built and bills paid, the developer requests that the contractor provides performance and payment bonds. At this point, the construction company goes to its insurance agent or broker who approaches the insurance carrier. After satisfactory review of the project and the construction company the insurance company establishes a relationship with the construction company and provides the necessary bonds.

Are there different types of contract surety bonds?

Depending on the project and the parties involved, there are different types of contract surety bonds that can be secured. They are:

• Bid bonds. A bid bond provides financial protection to the obligee when a contractor is awarded a contract but then doesn’t go on to sign the contract or provide payment and performance bonds. Requiring a bid bond for a project also helps to prevent unqualified contractors from bidding, as a surety will not issue a bid bond to an entity that is not capable of handling the project.
• Performance bonds. A performance bond protects an obligee if a contractor defaults or fails to complete construction. The bond gives the obligee recourse through the surety to get the project completed per the contract. There are usually specific terms and conditions in the contract bond specifying what this will entail.
• Payment bonds. These contract surety bonds make sure subcontractors and suppliers are paid for the labor and materials they provide for a project if the construction company doesn’t pay them. The exact type of subcontractor or supplier that can make a claim is determined by relevant statutes, the contract and the bond itself. Payment bonds indirectly benefit project owners and they should insist that contractors performing work for them have a one in place as it can reduce the chance subcontractors and suppliers will stop work and delay or derail a project.
• Warranty bonds. Sometimes called maintenance bonds, these guarantee that any defects in workmanship or materials will be repaired during the warranty period.

What’s involved in the contract surety underwriting process?

Because a surety essentially prequalifies a contractor or subcontractor and guarantees they will complete the project and pay their bills, the process for securing bonds is much like applying for a mortgage or business loan. Essentially, the credit evaluation provides insight into the entirety of a contractor’s financial strength, operations and work.

Some key factors and areas that are assessed include:

• balance sheet with net worth and working capital;
• profit and loss statement;
• statement of cash flows;
• schedules of work in progress and completed jobs;
• character and reputation of the contractor;
• credit score and credit history;
• work history;
• specific areas of expertise and experience;
• banking history and relationships; and
• projects to be bonded.

The process is thorough; however, being able to secure a contract surety bond for a project can go a long way to landing a bid. In other words, it’s not only necessary, but very much worthwhile.

What can contractors do to help the surety underwriting process?

There is a lot a contractor or subcontractor can do to make the process for securing surety support as efficient as possible. Mostly, it comes down to being organized. It’s important to have all the documentation and information the surety company will need in order to conduct their assessment. Here is what a surety company will review/need access to:

• fiscal year-end company financial statements for the past three years;
• current financial statement;
• current schedules of work in progress and completed jobs;
• current personal financial statements for company owners;
• detailed personal and company information—usually gathered through a contractor questionnaire;
• copies of bank loan agreements, including lines of credit;
• resumes or detailed bios for owners and key employees;
• supplier/creditor/project owner references;
• proof of relevant insurance;
• copies of contracts and bond forms for projects requiring bonding; and
• signed indemnity agreement whereby contractor and company owners pledge their guarantees to the surety should the surety be required to pay a claim.

If this is all available to the surety issuer in a timely manner, things will proceed far more smoothly.

Embrace the surety process—It’s good business

Partnering with an experienced surety agent and surety provider is a best practice for successful contractors. Both the agent and surety company can and should be important business partners and advisers for the contractors they support. It’s not uncommon for the agent, surety company, contractor partnership to last decades as each plays an important role in the process.